The Economic Gains from Trade

What are the economic effects of opening up the two regions to international trade? America as a whole benefits from the fact that imported clothing costs less than clothing produced at home. Likewise, Europe benefits by specializing in clothing and consuming food that is less expensive than domestically produced food.

We can most easily reckon the gains from trade by calculating the effect of trade upon the real wages of workers. Real wages are measured by the quantity of goods that a worker can buy with a~ hour’s pay. Using Table 15-2,we can see that the real wages after trade will be greater than the real wages before trade for workers in both Europe and America. For simplicity, assume that each worker guys 1 unit of clothing and 1 unit of food. Before trade this of goods costs an American worker hours of work and a European worker 7 hours of work.

After trade has opened up, as we found, the price of clothing is $3 per unit while the price of food is $2 per unit. An American worker must still work 1 hour to buy a unit of food, because food is domestically produced; but at the price ratio of 2 to the American worker need work only 1 V 2 hours to produce enough to buy 1 unit of European clothing. Therefore the bundle of goods costs the American worker 21/2 hours of work when trade is allowed this represents an increase of 20 percent in the real wage of the American worker. For European workers, a unit of clothing will still cost 4 hours of labor in a free-trade situation. To a unit of food, however, the European worker peed produce only %of a unit of clothing (which requires 2/3 X 4 hours of labor) and then trade that 2/5 clothing unit for 1 unit of American food. The”. total European labor needed to obtain the bundle of consumption is then 4 + 2% = 6%, which represents an increase in real wages of about 5 percent over the no-trade situation . When countries concentrate on their areas of comparative advantage under free trade, each country is better off. Compared to a no-trade situation, workers in each region can obtain a larger quantity of consumer goods for the same amount of work when they specialize in their areas of comparative advantage and trade their own production for goods in which they have a relative disadvantage

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