Get the answer of: What are the Advantages of Free Trade between Two Countries?
Trade between nations is based on Ricardian principle of comparative advantage. Ricardo cited the example of England and Portugal in this context. Both the countries can produce cloth and wine. But England is relatively more efficient in cloth production and Portugal in wine.
Thus if each country specialises in the production of only one commodity (in which it is relatively efficient) it can gain. Each can have more of both the commodities than in the absence of trade. This is possible if there is no government restriction on trade.
For simplicity, we use a two-country, two-commodity example, but it will work for more countries or more commodities as well. Free trade refers to absence of government restriction on foreign trade. And Ricardo pointed out that free trade among nations leads to an efficient allocation of the world’s limited resources.
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Each country will be able to have more of all commodities than in the absence of trade. Samuelson has argued that free trade increases society’s consumption possibilities (by enabling it to go beyond its production possibilities curve).
Sources of Gains from free Trade:
Now the question is— what are the sources of advantages of free trade between countries? The important point is that it is possible for two (or more) countries to increase output and economic well-being by specialising on the basis of comparative advantage, regardless of how that comparative advantage may have originated. So, the most important source of gains from trade is increased labour productivity due to specialisation.
There are two more benefits from trade besides the increased output from comparative advantage. One is growing competition and the other is economies of scale.
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Thus, there are three sources of gains from trade, viz.:
(1) Increased output due to specialisation,
(2) Growing competition, and
(3) Advantages of large-scale of production.
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Growing Competition:
International trade increases the number of competing firms from whom consumers can buy. It thus widens their range of choice of goods and suppliers. This benefit of trade is of considerable significance in those c6untries where a few firms constitute a particular industry If there are a few firms, each one will be a high-cost producer.
The benefit of trade can be very important in such a situation. For example, Indian car buyers can have a wide range of choice in cars if there is free trade with other leading car-manufacturing nations like the U.S.A. and Japan, even though there are only six to seven leading car producers in India. Due to pressure of foreign competition, domestic producers respond quickly to demands of some car buyers for smaller and more fuel-efficient cars.
Economies of Scale:
Access to a large world market instead of a narrow domestic one may enable firms to produce at low cost by operating on a more efficient scale. If a commodity is mass produced due to a country s access to a wide market, costs will fall.
Thus, consumers will enjoy a two-fold advantage – lower price and larger volume. Producers of computers, automobiles, heavy machinery and steel require a very large market in order to produce at a scale that results in the lowest possible cost per unit.
You can add one more point. An improvement in the terms of trade is also a source of gains from trade. A rise in the price of exports or a fall in the price of imports implies an improvement in the terms of trade.