Free Trade and Protection
Demonstrating Gains From Trade
Domestic Supply and Demand Model
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In the domestic supply and demand model, prior to trade, consumers pay Pd for Qd quantity of goods or services. Consumer surplus is outlined in red while producer surplus is outlined in green.
Showing Exporting Gains on a Model
A country will export if the world price is higher than the domestic price. Australia exports goods and services such as iron ore, education related travel and coal because the price the world is willing to pay for these goods and services is higher than the amount the domestic market is willing to pay for.
The model above shows exporting gains as the World Price (Pw) is higher than the domestic price (Pd). As a result, producer surplus increases as they receive a higher price at Pw and export a higher quantity at Q2.
Domestic consumers experience a fall in consumer surplus as they have to pay a higher price at Pw for a lower quantity of goods and services at Q1.
Exporting is beneficial to the economy as the level of total surplus increases, as shown by the gain in producer surplus of the triangle between Q1 and Q2. This triangle was created from exporting and did not appear as consumer or producer surplus in the domestic demand and supply model.
Showing Import Gains on a Model
A country will import if the world price is lower than the domestic price. Australia imports goods and services such as cars, personal travel and refined petroleum because the price the world is willing to pay for these goods and services is lower than the amount the domestic market is willing to pay for.
The model above shows importing gains as the World Price (Pw) is lower than the domestic price (Pd). As a result, consumer surplus increases as they receive a lower price at Pw and consumer a greater quantity at Q2.
Domestic producers experience a fall in producer surplus as they have to sell goods and services at a lower price at Pw, hence selling a lower quantity at Q1.
Importing is beneficial to the economy as the level of total surplus increases, as shown by the gain in consumer surplus of the triangle between Q1 and Q2 (just flipped horizontally from the area from the export model). This triangle was created from importing and did not appear as consumer or producer surplus in the domestic demand and supply model.
Countries export and import because it is beneficial to producers and consumers. Exporting and importing increases the total level of surplus, and hence why free trade should not be disrupted. Protectionism always decreases the gains from trade.