Depicting a Free Trade Equilibrium in the Immobile Factor Model

Differences in price ratios is all that's needed to stimulate trade once the barriers to trade are removed. Since the price of cheese is higher in France upon the opening of free trade, US cheese producers will begin to export cheese to the French market where they will make a greater profit. Similarly French wine producers will export wine to the US market where it commands a higher price. The effect of the shift in supply is to force the price of cheese relative to wine down in France and up in the US until they equalize at a price ratio which equalizes world supply of wine and cheese with world demand for wine and cheese.

When a free trade equilibrium is reached the following conditions will prevail,

1) Both countries face the same terms of trade

2) Both countries will demand the same ratio of wine to cheese .

3) Exports of cheese by the US equals imports of cheese by France.

4) Exports of wine by France equals imports of wine by the US.

The free trade equilibrium is depicted in the Figure. The countries produce at the points P and P and consume after trade at the points C and C respectively. Thus the US exports ZP units of cheese while France imports the equivalent CZ. Similarly France exports ZP units of wine while the US imports the equivalent CZ. Each country trades with the other in the ratio CZ/ZP gallons of wine per pound of cheese. This corresponds to the free trade price ratio,, represented as the slope of the lines CP.

International Trade Theory and Policy - Chapter 70-14: Last Updated on 9/16/99