13: International Trade Flashcards
What is trade?
What are exports?
What are imports?
International trade involves the buying and selling of goods and services across international boundaries.
Exports are goods and services and sold produced domestically but sold abroad.
Imports are goods and services from other countries bought for domestic use.
What is specialisation?
Specialisation occurs when an individual, firm or country concentrates production on one or a few goods and services.
Benefits of trade?
- Increases in domestic production and consumption as a result of specialisation. e.g. Greece has a large coastline so it is better at producing shipping services whilst Switzerland is landlocked but has the technology to produce good watches.
- Economies of scale in production - firms can decrease cost per unit production, thereby becoming more efficient and selling its output at a lower price.
- Greater choice for consumers.
- Increased competition and greater efficiency in production - due to competition firms try and produce at the lowest possible cost which benefits consumers.
- Lower prices for consumers - due to efficiency but also because if another country produces a product at a price cheaper than the domestic price, consumers can benefit from this.
- Acquiring resources - countries may need natural resources to produce other things, such as steel to produce cars or oil to produce most things. The UK doesn’t have oil, so it must trade.
- Free trade and a more efficient allocation of resources - if trade is free (i.e. no government intervention) it can leads to a more efficient allocation of resources.
- New ideas and technology spread
- Countries become interdependent reducing the chance of hostilities and violence
- Trade is an ‘engine for growth’.
Explain the theory of absolute advantage:
Adam Smith came up with the theory of absolute advantage. Absolute advantage refers to the ability of one country to produce a good using fewer resources than another country. This country should therefore specialise in the production of this good.
Explain, using a diagram, the gains from trade arising from a country’s absolute advantage in the production of a good:
Draw a PPF graph, one good on x one good on y.
Draw two lines representing the production of two countries. One produces 8 of one good (lets say cars) at 0 of the other (lets say coffee) and 4 coffees at 0 cars. The other country producing 2 cars at 0 coffee but 6 coffees at 0 cars. Country A has comparative advantage in cars and country B has comparative advantage in coffee.
Add up the amount produced in comparative advantage and add up an amount produced anywhere on the PPF for each of them. The comparative advantage will be more.
You can illustrate how much they receive with trade by showing country A gave country B 3 cars in exchange for 3 coffees, as the hypothetical price ratio is 1:1. This leaves A with 5 cars and 3 coffees and B with 3 cars and 3 coffees. Draw these points on the graph.
Due to trade they can produce at a point outside their PPFs.
What if one country can produce more of both of the goods on the PPF? What does this look like?
This means the country has absolute advantage of the production of both goods, this looks like a PPF graph with two lines that do NOT intersect. The country with the flatter line has comparative advantage of the good on the x axis. This is because if country A can produce 21 chickens at 0 cows and 1 cow at 0 chickens, and country B can produce 25 chickens at 0 cows and 20 cows at 0 chickens, it is more advantageous for country B to produce cows, as it can easily trade for chickens since cows are clearly harder to produce and therefore more valuable to country A.
a) How do you calculate opportunity cost using data?
b) How do you calculate it using the graph?
a) Opportunity cost of cows = maximum number of chicken you can make / maximum number of cows
Opportunity cost of chickens = maximum number of cows you can make / maximum number of chicken
They should be reciprocals of each other. Produce the one with the lower opportunity cost.
b) The opportunity cost is simply the slope of the line which can be calculated using ∆x/∆y
What is the law of comparative advantage?
The law of comparative advantage states that as long as opportunity costs in two or more countries differ, it is possible for all countries to gain from specialisation and trade according to their comparative advantage. Thus, the global allocation of resources improves, resulting in greater global output and greater global consumption, allowing countries to produce outside their PPF.
What happens in the case of parallel PPCs?
These do not usually occur in real life but it means the two countries have identical opportunity costs for the production of the two goods. No country has comparative advantage and so they will not benefit from specialisation or trade.
Describe the sources of comparative advantage:
Countries have comparative advantage over another country because of factor endowments, meaning differences in quantities and qualities of factors of production, and in levels of technology. For example countries with more technological advancements, countries with more temperate climates, more educated workers etc.
limitations of comparative advantage:
- The theory of comparative advantage depends on many unrealistic assumptions:
- It is unrealistic to ignore transportation costs.
- Specialisation may not allow necessary structural changes in the economy.
- Trade on the basis of comparative advantage may lead to excessive specialisation.
The theory of comparative advantage depends on many unrealistic assumptions:
- Factors of production are immobile and fixed - IRL FOP are constantly changing.
- Technology is fixed - IRL technology is continuously improving.
- There is perfect competition - this is rarely ever the case.
- There is full employment of all resources - no countries produce on their PPFs.
- Imports and exports balance each other out - IRL there are trade deficits.
- There is free trade - in reality there is strong government intervention in markets that influences quantities of imports and exports.
How might the law of comparative advantage not allow necessary structural changes in the economy?
It may be beneficial for developing countries in the future to produce more industrial goods and services, despite having comparative advantage in agricultural products now. As they become more developed, their comparative advantages may change. If they follow the law of comparative advantage strictly, it may not lead to economic growth in the future. Also certain resources are becoming more scarce, and therefore more valuable. If a country has these resources it is best to use them for production.
Why might trade on the basis of comparative advantage not lead to excessive specialisation?
If a country only has comparative advantage in one or a few products thy may become dependent on this product. This means if the export prices fall for this product, the countries entire economy could be affected negatively. Furthermore if a country is reliant on agricultural products, as many first world countries are, they may be terribly affected by fluctuations in weather.
Brief history of the WTO:
During the great depression in the 1930s countries imposed tariffs to increase domestic production which lead to retaliatory tariffs, causing tariff wars which damaged international trade. In 1947 the general agreement on tariffs and trade (GATT) was established as a response to liberalise trade. This later became the World Trade organisation in 1994.
