Free Trade

View FREE Lessons!

Definition of Free Trade:

Free trade is trade that is unrestricted by tariffs, quotas, or any other government regulation.  

Detailed Explanation:

People have innate abilities that give them an advantage over other people to perform specific tasks. Companies have trade secrets, patents, or personnel that provide a leg up on their competition. Likewise, a country is endowed with a unique climate and resource pool that gives it a comparative advantage. Prosperity is maximized when people, companies, and countries specialize in producing the goods or services they are most efficient in providing and trade for other goods and services. Trade is needed to enable specialization. Free trade advances economic growth by enabling countries to produce more of the goods they are most efficient at manufacturing. Those goods are sold to consumers in other countries, and the revenue generated from trade is used to purchase needed goods manufactured elsewhere. 

For example, assume Sun country is able to produce oranges at an average cost of $0.02 an orange. Greenhouses and heaters are required to grow oranges in Cold country. Their farmers' average cost is $.10 per orange. However, Cold country’s cooler climate is conducive to growing cranberries, where the average cost is $.01 a cranberry. Sun country needs a climate-controlled greenhouse to grow cranberries at an average cost of $.06 a cranberry. Farmers in Sun country are able to grow, ship, and sell their oranges to Cold country's residents for less than the cost to grow oranges in Cold country. Likewise, farmers in Cold country are able to grow, ship, and sell cranberries to people in Sun country for less than the cost to produce cranberries in Sun country. Both countries would benefit from trade. Sun would specialize in growing oranges and Cold would produce cranberries. Without trade, Sun country residents would pay more for cranberries, while consumers in Cold country would pay more for oranges. The lower prices resulting from trade benefits consumers in both countries.

What happens to the orange growers in Cold country and the cranberry farmers in Sun country? Some Cold country farmers may switch to producing cranberries to meet the demand for cranberries in Sun country. Other Cold country orange farmers would go out of business. The opposite is true in Sun country. Their cranberry farmers would either switch to oranges to meet the demand of Cold country, or go out of business. Cranberry farmers in Sun country would protest, "Cold country is taking our jobs and livelihood." They would be correct. Meanwhile, the orange growers in Cold country would complain that they are losing jobs to Sun country. They too would be correct. Each group may seek trade protection from their government. Politicians may protect an industry by imposing a tariff, subsidy, or quota. Tariffs, subsidies, and quotas all disrupt the benefits of free trade. Tariffs are taxes on imports. The intent is to help the domestic producer by adding to the cost of an imported good. Some jobs may be saved, but consumers continue to pay more. Subsidies are government payments or tax breaks paid directly to businesses in industries the government wants to support. The effect is the same as lowering the manufacturer's cost. However, it is a bill paid by the taxpayers. Quotas limit the supply of imported goods. Domestic industries must supply the rest. Consumers continue to pay a higher price than with free trade. Historically economists have favored free trade because consumers benefit from lower prices, and resources are allocated the most efficiently. Jobs may be lost at one location, but in time they are gained elsewhere, and when these workers find work, everyone gains, especially when it is in a field where the country has a comparative advantage. 

Dig Deeper With These Free Lessons:

Managing Supply Using Outsourcing, Tariffs, Subsidies, Quotas & Licenses
Production Possibility Frontier
Comparative Advantage and Specialization
Economic Systems

Search the Glossary

Investment Calculator:

Market Overview:

Market quotes are powered by

Single Quote:

© Higher Rock Education and Learning, Inc. All rights reserved. No portion of this site may be copied or distributed by any means, including electronic distribution without the express written consent of Higher Rock Education and Learning, Inc.