2. The International Economy - Trade

Question 1

What are the advantages of international trade?

Answer 1

1. Increased choice of goods and services
2. Increased competition
3. Bigger potential market - E of S
4. Greater drive for innovation and invention
5. Increased exports - export led growth
6. Increased economic growth - decreased poverty
7. Theory of comparative advantage

Question 2

What is the theory of absolute advantage?

Answer 2

This theory states that countries are better to specialise in things there best at and trade to gain the other necessary goods & services etc - this benefits all parties.

Question 3

What is the theory of comparative advantage?

Answer 3

This theory states that countries are better to specialise in what they are RELATIVELY better at (not necessarily the best) - this still benefits all parties.

Question 4

What are the assumptions for the Model of Comparative Advantage?

Answer 4

1. Only 2 economies
2. Each economy produces only 2 goods each
3. There is completely free trade
4. You ignore transport costs
5. Resources from each economy can produce each good equally well
6. You ignore E of S

Question 5

What are the two situations in which a comparative advantage exists?

Answer 5

It may exist where economy A is better at producing good A and economy B is better at producing good B.
Or, economy A may be better at producing both goods A & B but economy B is relatively best at producing good B.

Question 6

Illustrate the first instance of comparative advantage using a numerical example.

Answer 6

UK: 20 tractors & 100 wool
France: 10 tractors & 150 wool
Total: 30 tractors & 250 wool

UK - comparative advantage in tractors
Fr - comparative advantage in wool
UK specialise in tractors & Fr specialise in wool

UK: 40 tractors & 0 wool
France: 0 tractors & 300 wool
Total: 40 tractors & 300 wool
(specialisation has increased the ‘total’ outputs for both)

To determine the terms of trade we go between the initial opportunity costs of production for each economy.
Initially;
UK: 1:5 (tractors to wool)
Fr: 1:15 (tractors to wool)
Fair terms of trade will therefore be 1:10

Using these terms of trade the two economies would now trade so they both have an adequate number of each good - say the original quantities

UK: 30 tractors & 100 wool
Fr: 10 tractors & 200 wool
Total: 40 tractors & 300 wool

As you can now see both economies have benefitted from specialisation and trade - the UK are up 10 tractors down no wool and Fr are up 50 wool down no tractors.

Note: trade is only mutually beneficial while the terms of trade are fair and balanced.

Question 7

Illustrate the second instance of comparative advantage using a numerical example.

Answer 7

UK: 30 cars & 6 trucks
Germany: 35 cars & 21 trucks
Total: 65 cars & 27 trucks

Note: Germany are better at both but the UK are relatively best themselves at cars.
UK - specialise in cars
Ger - specialise in truck

UK: 60 cars & 0 trucks
Germany: 0 cars & 42 trucks
Total: 60 cars & 42 trucks
(specialisation has increased the ‘total’ outputs for trucks only but trucks are relatively more valuable than cars so the gain of 15 trucks exceeds the loss of 5 cars)

To determine the terms of trade we go between the initial opportunity costs of production for each economy.
Initially;
UK: 5:1 (cars to trucks)
Fr: 5:3 (cars to trucks)
Fair terms of trade will therefore be 5:2

Using these terms of trade the two economies would now trade so they both have an adequate number of each good - say roughly the original quantities

UK: 45 cars & 6 trucks
Germany: 15 cars & 36 trucks
Total: 60 cars & 42 trucks

As you can now see both economies have benefitted from specialisation and trade - the UK are up 15 cars down no trucks and Germany are down 20 cars but up 15 trucks and bc trucks are relatively more valuable than cars overall they’re better off.

Note: trade is only mutually beneficial while the terms of trade are fair and balanced.

Question 8

What are the factors that create a comparative advantage?

Answer 8

1. Quantity and Quality of FoPs
2. Climate & Geography
3. Demographics - ageing population?
4. Capital Investment - infrastructure spending
5. Economies of Scale, Productivity etc
6. Research & Development - innovation and invention
7. Exchange Rates - affecting competitiveness
8. Import Controls - tariffs, quotas etc
9. Technology - enabling high productivity
10. Non-price competitiveness - quality etc

Question 9

What do the UK currently have a comparative advantage in and what did they preciously have it in?

Answer 9

Previously;
Steel, Copper, Textiles, Heavy Ships and Manufacturing - this was bc we had easily accessible ore - cheap to export - CA in manufacturing
Currently;
Financial Services, Alcohol, Sea Food, Tertiary Education, Medicine, Civil Engineering - for different reasons, e.g. have right sea conditions for good sea food

Question 10

How do you calculate the terms of trade?

Answer 10

Average Export Price Index / Average Import Price Index x 100

Question 11

What are the criticisms of the comparative advantage theory?

Answer 11

1. Overstates the benefits of specialisation by ignoring some negative externalities/costs
2. False assumption that markets are perfectly competitive and no diminishing returns
3. Total specialisation will create massive structural unemployment
4. CA isn’t a static concept - constantly changing
5. Some industries like food production can’t be completely relied upon for exports bc its too risky
6. The model is an oversimplification - 2 economies and 2 goods

Question 12

What are the costs of international trade?

Answer 12

1. Loss of jobs and inequality in income caused by competition
2. Less efficient firms exit the market. As firms close, displaced workers are made to retrain for expanding firms jobs.
3. An increase in imports causes domestic industries to compete with imports. Technology and capital expand might not be as developed in some countries.

Question 13

What have been the main changes in the patterns of trade in the global economy?

Answer 13

1. Emergence of regional trading blocs - significant impact on the pattern of global trade. Trade Creation for countries within the blocs but Trade Diversion for those outside them.
2. Like several advanced economies, the UK’s trade in manufactured goods has fallen relative to its trade in commercial and financial services.
3. The collapse of communism - opening-up of many former-communist countries. These countries have increased their share of world trade by taking advantage of low production costs and low wage levels.
4. Newly industrialised countries like India and China have dramatically increased their share of world trade and their share of manufacturing exports. China, in particular, has emerged as an economic super-power.

Question 14

What has been the overall picture of global trade over the years?

Answer 14

Although subject to short term fluctuations as a result of the economic cycle, the value of trade has continued to grow, reflecting the increased significance of trade and globalisation. As a % of world GDP, trade increased from 40% in 1990 to 60% in 2014.

Question 15

What is the fundamental reason behind the growth of trade?

Answer 15

Increased trade openness and globalisation.

Question 16

What are protectionist policies?

Answer 16

Protectionist policies are those economic policies that aim to restrict imports from other countries through methods such as tariffs on imported goods, import quotas, subsidies, embargoes and a variety of other government regulations.

Question 17

What is a tariff?

Answer 17

Tariffs are essentially taxes on imports, used to raise import prices and improve the competitiveness of domestic business.

Question 18

What is a quota?

Answer 18

Quotas are regulations limiting the quantity of a particular product which under official controls can be produced, exported, or imported.

Question 19

What is a subsidy?

Answer 19

This is a payment made to firms by the government - often encouraging them to do something. They may be provided to domestic businesses to improve competitiveness.

Question 20

What is an embargo?

Answer 20

This is when there is a complete ban on trading with another nation or economy.

Question 21

Why may a country adopt protectionist policies?

Answer 21

1. Protection of infant industries
2. Protection of employment
3. Retaliation
4. Strategic Reasons
5. Political Reasons
6. To prevent entrance of harmful goods
7. To protect against unfair competition and dumping

Question 22

What is ‘dumping’?

Answer 22

This is when a country exports a product to another country at a price which os below the cost of production for that good - this is made possible by subsidies granted to the firms by governments. This ruins the competitiveness of other domestic industries. E.g. China accused of ‘dumping’ steel in US markets.

Question 23

What are anti-dumping duties?

Answer 23

These are taxes imposed on a good that is believed to have been ‘dumped’, they aim to cancel out the gov subsidy that made the good so cheap to produce in the first place.

Question 24

What are the possible negative consequences of protectionist policies?

Answer 24

1. Subsidies to protect domestic industries cost taxpayers money and preserve more expensive industries than developing industries cld provide
2. Subsidies have a high opportunity cost - spending on healthcare etc
3. We prevent the poor world exporting there way out of growth and trap ourselves in low value industries
4. Economic growth and living standards may fall as economies can’t benefit from specialisation
5. Only shifts UE from one place to another
   Overall, everyone loses out - decreased foreign earnings for developing countries - developed countries can’t trade as much with developing ones - growth rates for both fall - China and Germany struggle so does rest of world/Eu

Question 25

What are the possible positive consequences of protectionist policies?

Answer 25

1. Protection against dumping
2. Preventing domestic unemployment
3. May act as effective sanction for political reasons
4. May protect infant industries
5. May prevent the importing of harmful/dangerous goods

Question 26

What is a customs union?

Answer 26

A group of states that have agreed to charge the same import duties as each other and usually to allow free trade between themselves.

Question 27

What are the main features of a customs union?

Answer 27

The countries in a customs union agree to;
Abolish tariffs and quotas between member nations to encourage free movement of goods and services.
Adopt a common external tariff (CET) on imports from non-members countries. Thus, in the case of the EU, the tariff imposed on, say, imports of Japanese TV sets will be the same in the UK as in any other EU country
Preferential tariff rates apply to preferential or free trade agreements that the EU has entered into with third countries or groupings of third countries
EXAMPLE = EUROPEAN UNION

Question 28

What is the European Single Market?

Answer 28

The EU single market involves integration between nations and is built upon four key freedoms:

1. Free Trade in Goods: Businesses can sell their products anywhere in the EU’s member states and consumers can buy where they want with no penalty.
2. Mobility of Labour: Citizens of EU member states can live, study and work in any other country. The aim is to improve the mobility of labour
3. Free Movement of Capital: Currencies and capital can flow freely between member states and EU citizens can use financial services in any member state
4. Free Trade in Services: Professional services such as pensions, architecture, telecoms and advertising can be offered in any member state

Question 29

What are the arguments for UK membership in the ESM?

Answer 29

1. Increased FDI in the UK
2. Increased productive capacity bc of immigration of skilled workers
3. Increased quality education opportunities abroad - increases productive capacity l-term
4. Increased economic stability & confidence
5. No divorce settlement costs
6. Increased customer base - more scope for E of S
7. Increased competition - increased innovation and invention - increased efficiency
8. If we leave our SS growth will fall making an inflationary gap more likely
9. If we leave there will be massive job losses - 52% of jobs linked to the Eu
10. Structural Unemployment will concentrate in areas - e.g. North - Manufacturing
11. Inelasticity of imports from Eu countries means tariffs will worsen our BoP
12. Increase in xenophobic views if we leave
13. Negative environmental implications - out of the tradable pollution permits schemes

Question 30

What are the arguments against UK membership in the ESM?

Answer 30

1. Increased sovereignty out
2. Control of migration rates etc
   Very limited benefits…

Question 31

Who are the WTO?

Answer 31

The World Trade Organisation - global, international, organisation - deal with the rules of trade between nations. A forum for governments to negotiate trade agreements and settle disputes.

Question 32

What are the fundamental principles that underpin the foundation of the multi-lateral trading system? (WTO agreements/conditions for trade)

Answer 32

1. Non-Discrimination
2. Transparency and predictability of trade barriers
3. More beneficial for less developed countries
4. More competitive
5. Protect the environment
6. More open

Question 33

What are the possible different functions of the WTO?

Answer 33

1. Trade Negotiations - spell out principles of trade liberalisation and permit exceptions - set procedures for settling disputes
2. Implementation and Monitoring - required to be informed of laws/rules enforced by governments to maintain transparency
3. Building Trade Capacity - allows special provisions to improve trade opportunities for developing countries

Question 34

What is a fundamental view of the WTO?

Answer 34

They believe there is a link between freer trade and economic growth - due to the theory of comparative advantages.