Ricardo showed that what was important was the comparative advantage of each nation in production. If trade diversion is greater than trade creation, formation of the customs union or FTA would diminish world welfare.
Producing plant ice required large amounts of fuel, in the form of coal, and capital for machinery, so producing ice at a competitive price was challenging. GDP is the best measurement of economic well-being available, but it has significant conceptual difficulties.
Protectionism exists in many different forms, but the most common are tariffssubsidiesand quotas. It is in this sense that free trade maximizes world welfare. For example, a Jeep and a Volkswagen are both automobiles, but they are highly differentiated as seen by the consumer.
Each time these parts and materials cross a border, an international trade transaction has occurred; and then, when the final good is exported, another international trade transaction has occurred. In contrast, protectionism holds that regulation of international trade is important to ensure that markets function properly.
How International Trade Works International trade gives rise to a world economy, in which supply and demand, and therefore prices, both affect and are affected by global events.
Trade in Factors of Production and Services Traditional economic theory assumed that goods are traded between countries, but that factors of production e.