Chapter 4: Free Trade and Welfare

How does international trade affect the welfare of people? By participating in international trade, can everyone improve their standard of living? If some (though not all) people were to suffer from trade liberalization, what can we do for them? These are long-standing questions in international trade to which a great deal of theoretical efforts have been devoted and a vast number of results has been accumulated under the title of gains-from-trade propositions. This chapter addresses the gains-from-trade propositions and related issues in the competitive circumstance. We first introduce some welfare criteria and investigate their implications for the existence of so-called social utility functions. Based on a social utility function, we prove the basic gains-from-trade proposition. Roughly, we can say that “free trade is better than no trade”. Then, we turn to the cases where trade liberalization would bring about conflicts of interests among people in a country. We show that the conflict among people can be dissolved or mitigated if trade liberalization is accompanied by some appropriate redistribution policies. We also introduce some useful analytical tools such as the trade utility function, trade indifference curve, and the offer curve.