Free trade

• What is free trade?

  Trade between countries without barriers or obstacles
• What type of diagram will be used to illustrate free trade?

  Supply and demand diagram
• In the initial free trade diagram, does the country have a comparative advantage?

  No
• What two curves are drawn on the initial free trade diagram?

  Domestic supply and domestic demand
• How are domestic supply and domestic demand labelled?

  SD and DD
• What does SD represent in the free trade diagram?

  UK supply
• What does DD represent in the free trade diagram?

  UK demand
• What determines the price and quantity of clothing in the UK in a closed economy?

  Equilibrium
• What are the price and quantity at equilibrium labelled as in a closed economy?

  q1 and P1
• What happens when the UK opens up its economy to free trade, assuming it doesn't have a comparative advantage?

  It can trade with any country
• If the UK doesn't have a comparative advantage, who does?

  Global producers
• If global producers have the comparative advantage, how does their price compare to the UK price?

  It is lower
• How is the world price labelled?

  PW
• What is drawn at PW on the diagram?

  A horizontal world supply curve
• Why is the world supply curve drawn horizontally?

  Global suppliers can easily supply the UK
• How is the world supply curve labelled?

  ITW
• What dominates in the UK market for clothing after the introduction of the world price?

  Lower price
• What happens to domestic supply at the lower world price?

  It reduces
• What is the reduction in domestic supply called?

  Contraction
• Why does domestic supply contract when the price is driven down?

  Costs are higher than world suppliers
• What happens to firms that cannot cover their costs of production at the lower world price?

  They leave the market
• What is the term for businesses leaving the market and shutting down?

  De-industrializing
• How do domestic consumers benefit from the lower world price?

  They can buy clothing cheaply
• What happens to domestic demand at the lower world price?

  It increases
• What is the increase in domestic demand called?

  Extension or expansion
• What is the result of domestic demand being higher than domestic supply?

  Excess demand
• How is the excess demand satisfied with free trade?

  Via imports
• After free trade lowers prices from P1 to PW, what happens to domestic supply?

  It reduces
• If domestic firms do not have comparative advantage, what happens to domestic supply from q1 to q2?

  Contraction of domestic supply
• After free trade domestic demand extended from q1 to q3, what happens to imports?

  They become the excess demand
• With free trade, what do imports increase to?

  From Q2 to Q3 units
• What is the equation for revenue?

  Price times quantity
• Before free trade, what area represents domestic producer revenue?

  A+B+D+E+F
• After free trade, what area represents domestic producer revenue?


  A
• What happens to domestic producer revenue when they don't have comparative advantage?

  It falls
• What was foreign producer revenue without any free trade?

  Zero
• After free trade, what area represents foreign producer revenue?

  B+C
• What happens to consumer surplus because prices are driven down?

  There is a gain
• How is consumer surplus defined?

  Area above price, beneath demand curve
• With free trade at PW what is the gain of consumer surplus?

  DFNG