How Countries Benefit from Free Trade. Gains from Exports

In this article, we're gonna talk about how a country can gain from exporting goods or services through international trade. 

Understanding the Market (Without Trade)

So let's take for example the market for copper in Chile. Let's say that there's a market with no international trade at all we're just looking at Chile by itself. So the equilibrium price of copper is $4,000 a ton in Chile without any kind of international trade. So we just say we've got our downward-sloping demand curve and our upward-sloping supply curve in the market of Chile. So we've got our equilibrium price of $4,000 and then we've got 2 million tons of copper is the equilibrium quantity.


Consumer & Producer Surplus

Now we've got our consumer surplus is that blue triangle and then we've got our producer surplus is this yellow triangle. Now if we were to add those two together that would be our total surplus so our total surplus is that entire blue and the yellow triangle. 

Now let's introduce the world price, so the world price of copper is $5440 a ton. Now you'll see that the world price is higher than the equilibrium price in Chile of copper per ton which is $4,000. So because the world price is higher than the price in Chile, Chile will export copper. So producers of copper in Chile have an incentive to say "Hey, we have a comparative advantage in producing copper, if we go out and look at countries other than Chile we can get $5440 a ton for copper. So Chile is going to be a net exporter, they're gonna export copper.

Now I want to show you how consumer surplus producer surplus and total surplus are going to change when we introduced the idea of trade in allowing Chile's copper manufacturer producers to trade on the global market. So we said that the world price was $5440 ton, so what we're gonna do we're gonna put that line above our price equilibrium price line of $4,000. 

The Effect of  Trade

So what is gonna happen is we're gonna have some shifts of consumer surplus and producer surplus. So consumer surplus is now just a tiny triangle before it was that big triangle and now it is shrunk because now some of the consumers in Chile are having to pay a higher price for copper. So they're not demanding as much copper but here's the thing though there is a huge benefit to producers, producers that their surplus used to be that yellow triangle we had seen before but now they not only have this but they also get a part which used to be part of the consumer surplus and then this extra part under the world price line.


So basically there is a shift, when we introduced the idea of trade and we allow the copper producers to export copper in the world market there's gonna be a shift of some of the consumer surplus is going to go to the producer surplus, and when we think about shifting from consumers to producers that doesn't change the total surplus because the total surplus is just going to be the (consumer surplus + producer surplus). So we're thinking if the country is better off or worse off we care about the new portions so that green area is new surplus and so Chile as a whole when we consider the gains to producers and the losses to consumers because consumer surplus shrunk then when we think about the net effect the triangle of total surplus here was there before but now we've got this new green area it goes to producers so total surplus has increased.


Why is that the case? So now at this world price of $5440, there are the copper producers in Chile are willing to supply 2.5 million tons of copper but at that price of $5440 Chilean consumers say we'll only demand 1.5 million tons of copper, so we got this gap because of we have international trade that we're allowing in this example, that gap is going to be exports that are going to be the number of exports.


So we can take that we can just take the (2.5 - 1.5) and that is going to give us 1 million so there's 1 million tons of copper that are being exported because at this higher price. What does higher price signify is Chile has a comparative advantage relative to the rest of the world in producing copper. So they can go out on the world market and say "We get sellers for $5440" now Chilean consumers are saying "At that price, we're only good to me at 1.5 million" tonnes but the producers are saying they will supply 2.5 million tonnes but it doesn't matter because it's not like there's gonna be a surplus or copper leftover because of the world market. 

So the Chilean producers can say "We'll go out and get this price by selling that copper on the world market." and so they end up exporting 1 million tons of copper to other countries and so we end up with this net benefit where we get this whole new green triangle which is producer surplus but it's increasing the total surplus and as a whole Chile is better off because it's exporting this copper.