Trade is beautiful.  People cooperating.  Voluntary.  Peaceful.  Everyone exchanging something they value less highly for something they value more highly.  These are some of the ideological reasons people love trade, but what about the tangible reasons?

Here is one way to explain the gains from trade without relying on ideology.

Situation 1 is an America that doesn’t trade.  We’re going to look at two goods America can produce.  I’ve called them Good A & B but they could be snowboards & skis… or guns & butter.

The curve in Situation 1 is called a “Production Possibility Frontier.”  America can produce any combination of Goods A & B along that frontier, but cannot produce beyond it.  The American consumer, without access to foreign markets, prefers to consume at Point A1 & B1.  So, we draw a trade line tangent to that point:

Situation 1 No Trade


Next, let’s add 3 possible indifference curves:

Sit 1 with indifference curves


Situation 2: Now America begins trading with foreign countries.  When this happens the trade line rotates on its axis.  It is still touching the Production Possibility Frontier, but now we can reach a higher indifference curve:

Sit 2So what does this show us?  Once trade begins Americans discover that Good A is cheaper overseas.  Americans start consuming more of the cheap Good A and start consuming less of Good B.  (Americans are consuming at the blue point, but still producing at the original green point).

Situation 3: After opening up trade, domestic production will adjust in response to the changes in demand described above.  Americans start producing less of Good A (which was cheaper internationally) and start producing more of Good B.  On our graph that is expressed as a movement along the Production Possibility Frontier to the final purple point.  America ultimately produces Good A at point A4 & Good B at point B4.  Knowing this we draw a new trade line tangent to that purple point, which depicts America’s new level of domestic production.  This new trade line allows Americans to reach the third & highest indifference curve.  The difference between what Americans consume & what they produce are, of course, our imports & exports respectively:

Situation 3 production adjusts

Now …. did you see what happened?  Here’s the important part…. this is the gain from trade.  Look back at where Americans were consuming in Situation 1 before trade, and where they’re consuming now in Situation 3 after trade:


Sit 4 Gains from Trade
After trade Americans can now consume more of BOTH Goods A & B.   That is the magic of trade, and it is a practical benefit not just ideological preference.



Free Trade image2