Can You Explain Free Trade With Reference To Demand And Supply Analysis?


1 Answers

Tariq Habib Profile
Tariq Habib answered
In the absence of transport costs, tariffs, and quotas, the price in America must be equal to the world price. Why? Because if the American price were above the European price, sharp-eyed entrepreneurs would buy where clothing was cheap and sell where clothing was expensive; Europe would therefore export clothing to America. Once trade flows fully adjust to supplies and demands, the price in America would equal the world price level.
This shows how prices, quantities and trade flows will be determined under free trade in our clothing example. The horizontal line at $4 represents the supply curve for imports; it is horizontal or perfectly price elastic because American demand is assumed to be too small to affect the world price of clothing.

Moreover, the level of prices in the no trade equilibrium determined the direction of the trade flows. America's no trade prices were higher than Europe's so goods flowed into America. Remember this rule under free trade indeed in markets generally goods flow uphill from low price regions to higher price regions. I hope this answer will satisfy your question.

Answer Question