1.3 The Relationship Between International Trade and the Standard of Living

Countries participating in international trade gain national economic well-being. From the standpoint of exports, a country benefits from international trade because a new source of demand in foreign markets raises sales and the prices of the exported products. While domestic consumers lose economic well-being because they must now pay higher prices and buy a smaller quantity of the exported product, their losses are usually less than the gains of domestic producers. If the economic losses to domestic consumers and the gains to producers are valued the same, then the nation as a whole experiences an increase in economic well-being.

From the standpoint of imports, countries benefit from having additional source of supply in their domestic markets. Increased availability of the product reduces the domestic price and improves well-being of consumers who can now buy a larger quantity. Meanwhile, domestic producers are hurt as the lower domestic price causes them to supply a smaller quantity. Because consumers gain more than domestic producers lose in economic well-being, the entire country benefits from international trade.

In summary, free trade improves a nation’s economic well-being by raising its export prices rise relative its import prices. The increase in export prices relative to import prices represents an improvement in the nation’s terms of trade. The improvement in the terms of trade causes domestic production to expand as productive resources are used more efficiently. Meanwhile, domestic consumption increases because of the lower import prices and the increase in production and real income. Table 1.1 summarizes the effects of international trade on living standards.