Winners and losers from trade
Who gains and who loses when a country opens to trade, and why the gains outweigh the losses.
FinanceA company's marketAbout 5 min: 2 reading, 3 practiceUpdated
General education, not financial advice.
- Use the world price to tell whether a country will export or import a good
- Identify who gains and who loses in an exporting and an importing country
- Explain why total surplus rises with trade, and the other benefits Mankiw lists
Builds toward: Judge a company. Read a company's accounts, apply Graham's tests, and make a rough valuation.
A company's market: pricing power, taxes and trade: lesson 11 of 15
- A company's market
- Price elasticity of demand 6 min
- Elasticity and total revenue 5 min
- Consumer and producer surplus 4 min
- Market efficiency 5 min
- Price ceilings and floors 6 min
- Who really pays a tax 5 min
- Deadweight loss 5 min
- How tax size changes the loss 5 min
- Absolute and comparative advantage 5 min
- Why trade helps both sides 5 min
- Winners and losers from trade 5 min
- Tariffs and quotas 5 min
- What makes productivity grow 5 min
- Growth policy 5 min
- Why unemployment exists 6 min
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Pairs with any introductory economics textbook; for example N. Gregory Mankiw, Principles of Macroeconomics (6th ed.), chapter 9
What it is
Mankiw imagines a small country, Isoland, deciding whether to allow free trade in textiles. Before trade, the domestic price balances domestic supply and demand. Once trade is allowed, the domestic price moves to the world price, the price in world markets. Isoland is assumed to be small, so it takes the world price as given.
Exporter or importer? Compare the two prices:
- World price above the domestic price: Isoland has a comparative advantage in textiles and will export them.
- World price below the domestic price: other countries have the comparative advantage, and Isoland will import.
Quick check
Tap an answer to check it.
Before trade, a country's steel sells for 600 a tonne. The world price is 450. Will it export or import steel once trade opens?
- It would export only if the world price were above the domestic price
Show answer
Import: foreign steel is cheaper. A world price below the domestic price means others have the comparative advantage.
Why it matters
In an exporting country the price rises to the world price:
- Domestic producers gain (they sell more, at a higher price).
- Domestic consumers lose (they pay more).
- Producers' gains are larger than consumers' losses, so total surplus rises.
In an importing country the price falls to the world price:
- Domestic consumers gain.
- Domestic producers lose.
- Consumers' gains are larger than producers' losses, so total surplus rises.
In both cases, trade raises a nation's economic well-being in the sense that the winners' gains exceed the losers' losses. The winners could, in principle, compensate the losers and still be better off. Mankiw notes that this compensation rarely happens, and that losers from trade are often better organised than winners, so they may lobby for tariffs or quotas.
Other benefits, beyond the standard analysis, in Mankiw's list:
- More variety of goods.
- Lower costs through economies of scale: firms can sell to world markets, not just a small home market.
- More competition, which limits firms' market power.
- A better flow of ideas, since new technology often travels with traded goods.
Worked example
An importing country. At the world price of 4, home producers supply 20 units and home buyers want 80, so 60 are imported. Before trade, the price was 7, with 50 units bought and sold. (Supply: Q = 10P − 20; demand: Q = 120 − 10P.)
Moving from 7 to the world price of 4:
- Consumer gain: 3 × 50 (the old buyers pay 3 less) + ½ × 3 × 30 (new purchases) = 150 + 45 = 195.
- Producer loss: 3 × 20 (on what they still sell) + ½ × 3 × 30 (on what they no longer make) = 60 + 45 = 105.
- Net gain to the country: 195 − 105 = 90.
Text description
Home supply and demand cross at a price of 7 and 50 units before trade. Trade brings the price down to the world price of 4. At 4, home producers supply 20 and home buyers take 80; the gap of 60 is imported. The shaded area shows the gain to buyers from the lower price (195); home producers lose part of it (105), leaving a net gain to the country of 90.
Common mistake
Saying "trade benefits everyone". It doesn't: in an importing industry, domestic producers and their workers lose. The claim is that total gains exceed total losses, so the country as a whole is better off.
Key terms
- world price
- the price of a good in world markets
- exports
- goods produced at home and sold abroad
- imports
- goods produced abroad and sold at home
- economies of scale
- lower costs per unit from producing in large quantities
- small economy
- one that takes the world price as given
Practise the key terms
Tap a card to turn it over. 5 cards.
| Front | Back |
|---|---|
| world price | the price of a good in world markets |
| exports | goods produced at home and sold abroad |
| imports | goods produced abroad and sold at home |
| economies of scale | lower costs per unit from producing in large quantities |
| small economy | one that takes the world price as given |
Practice
Work it through
An exporting country: before trade, the price of wheat was 3; the world price is 5. At 3, farmers sold 100; at 5, they produce 140 and home buyers take 60.
- 140 − 60
- 5 − 3
Quick quiz
Tap an answer to check it.
When a country starts importing a good, who loses?
- They gain from the lower price
Show answer
Domestic producers of that good. The domestic price falls to the world price.
In what sense does trade raise a nation's well-being, according to Mankiw?
- Some groups lose
Show answer
The winners' gains exceed the losers' losses. Total surplus rises, though not every person gains.
Which is one of the extra benefits of trade that Mankiw lists?
- In an importing country, producers face lower prices
Show answer
Firms can produce at larger scale and lower cost. Economies of scale are one of four extra benefits he names.
Sort it
Which group does this belong to?
Home consumers when the country imports
The price fallsShow answer
Gains. The price falls
Home producers when the country imports
They face cheaper foreign competitionShow answer
Loses. They face cheaper foreign competition
Home producers when the country exports
The price risesShow answer
Gains. The price rises
Home consumers when the country exports
The price risesShow answer
Loses. The price rises
In short
- Compare the world price with the domestic price to see whether a country exports or imports.
- Exporting: producers gain, consumers lose. Importing: consumers gain, producers lose.
- Either way, total surplus rises: gains exceed losses.
- Extra benefits: variety, economies of scale, competition, ideas.
Mastery check
Answer without looking back. Score 80% or more and the lesson is marked done. Your result is kept only in this browser.
Check yourself
Answer in your head first, then open the answer. Nothing is saved.
The world price is above a country's domestic price. Will it export or import?
Show answer
Export.
In the worked example, what is the country's net gain from opening to trade?
Show answer
90 (consumers gain 195, producers lose 105).
Why might a country restrict trade even though it raises total surplus?
Show answer
Because the losers are often better organised politically than the winners and lobby for protection.
Further reading
- N. Gregory Mankiw, Principles of Macroeconomics, 6th ed. (South-Western Cengage, 2012), chapter 9.
- On this site: Why trade helps both sides and Tariffs and quotas.
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