6.2 Trade

Question 1

Define Absolute advantage

Answer 1

• where one country is able to produce a greater quantity of a good or services with the same quantity of inputs per unit time, than its competitors

Question 2

Define Comparative advantage

Answer 2

• An economy’s ability to produce a particular good or service at a lower opportunity cost than its trading partners
• This means they have to give up producing less of another good than another country, using the same resources.
• Countries can specialise where they have comparative advantage.
  -This increases economic welfare.

Question 3

Define Free Trade

Answer 3

• the act of trading between nations without protectionist barriers, such as tariffs, quotas or regulations.

Question 4

What are the benefits of free trade?

Answer 4

• Countries can exploit their comparative advantage, which leads to a higher output using fewer resources
  -This increases world GDP and improves living standards.
• Free trade increases economic efficiency by establishing a competitive market.
  -This lowers the cost of production and increases output, may lead to lower prices for consumers
• By freely trading goods, there is trade creation because there are fewer barriers.
  -This means there is more consumption and large increases in economic welfare.
• More exports could lead to higher rates of economic growth.
• Specialising means countries can exploit economies of scale, which will lower their average costs.

Question 5

What are the costs of free trade?

Answer 5

• Resulted in some job losses, since countries with lower labour costs have entered the market-rise in structural unemployment
• No protection against anticompetitive behaviour like ‘dumping’ - when companies sell goods abroad at below production costs in order to put competitors out of business
• Free trade might have contributed to some environmental damage.
  -This is especially from the increase in manufaturing
• Harm infant industries
• Can create imbalances in the Balance of Payments - free trade can mean some countries benefit more than others.
  -This means certain countries can build up very large trade deficits, meaning an excessive amount of leakages from a country’s circular flow of income

Question 6

What are the reasons for changes in the pattern of trade between the UK and the rest of the world?

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Answer 6

• Comparative advantage
• Impact of emerging economies
• Growth of trading blocs and bilateral trading agreements
• Changes in relative exchange rates

Question 7

The reasons for changes in the pattern of trade between the UK and
the rest of the world….
* Comparative advantage

APPLICATION-China and UK

Answer 7

• Recent growth in the exports of manufactured goods from developing countries to developed countries.
  -This is because developing countries have gained an advantage in the production of manufactured goods, due to their lower labour costs, so production shifted abroad.
• The deindustrialisation of countries such as the UK has meant the manufacturing sector has declined.
  -This means that production of manufactured goods has shifted to other countries, such as China, whilst the UK now focuses more on services, such as finance.
• This has led to the industrialisation of China and India.
  -Their share of world trade and the volume of manufactured goods means that their exports has increased.
• (EVAL:However, since China’s population is now ageing, their wage competitiveness has fallen. This is also due to the rise of the middle class in China, who demand higher
  wages and consume more)

Question 8

The reasons for changes in the pattern of trade between the UK and
the rest of the world…
* Impact of emerging economies

APPLICATION-China and India

Answer 8

• Collapse of communism has meant that more countries, especially developing countries, are participating in world trade.
• International trade is arguably more important for developing countries than developed countries.
  -It contributes towards 20% of LEDC economies compared to 8% of the US economy.
• Between 1995 and 2005, India’s share of textiles and clothing fell from 35% in 1995 to 16% in 2005.
• Instead, India’s manufacturing sector seems to produce more engineered goods than clothing and textiles.
  -This has resulted in UK manufacturers selling fewer manufactured goods abroad.
• China and India are important for African infrastructure-they have invested in their infrastructure in exchange for natural resources.
• Both China’s and India’s share in agriculture, mining and fuel has declined.
• Both countries are important in the Euro area, with trade and financial relations.
• China is a main import source, whilst both are important for capital.

Question 9

The reasons for changes in the pattern of trade between the UK and
the rest of the world…
- Growth of trading blocs and bilateral trading agreements

APPLICATION-EU CAP

Answer 9

• Trading blocs are usually groups of countries in specific regions that manage and promote trade activities.
• Trading blocs lead to trade liberalisation (the freeing of trade from protectionist measures) and trade creation between members
• With more trading blocs, trade has been created between members, but diverted from elsewhere.
• Trade creation refers to the increase in economic welfare from joining a free trade area, such as a customs union- it will occur when there is a reduction in tariff barriers, leading to lower prices, this switch to lower cost producers will lead to an increase in consumer surplus and economic welfare.
• Trade diversion occurs when tariff agreements cause imports to shift from low-cost countries to higher-cost countries-may occur when a country joins a free trade area with a common external tariff, it is considered undesirable because it concentrates production in countries with a higher opportunity cost and lower comparative advantage.
• Protectionist barriers are often imposed on countries who are not members, so trade is diverted from producers outside the bloc to producers within the trading bloc.
• The policies of developed countries have limited the ability of developing countries to export primary commodities.
• For example, the EU Common Agricultural Policy (CAP) means domestic farmers receive subsidies to encourage production and lower costs.
  -This increases the incomes of domestic farmers and protects the industry, but farmers in other countries find it hard to compete with them.
  -Therefore, they are not able to access the market in developed countries, which limits their participation in trade

Question 10

The reasons for changes in the pattern of trade between the UK and
the rest of the world…
- Changes in relative exchange rates

APPLICATION-China and USA, UK

Answer 10

• For a long time, China has been running a trade surplus with the US.
• Since 2006, the US trade deficit has narrowed with China, and China has reduced their trade surplus, too.
• China has planned this change from export-led growth to growth fuelled by
  domestic consumption.
• When running the trade surplus, China had kept their currency’s value low, in order to make their exports relatively cheap.
• It could be argued that one of the reasons for the UK’s current account deficit is the strength of the pound compared to the Euro.
• In 2015, it reached a seven year high against the Euro.

Question 11

Define protectionism

Answer 11

• restricting imports from other countries through tariffs, quotas and/or government regulation

Question 12

What are the methods of protectionism?

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Answer 12

• Tariffs
• Quotas
• Embargoes
• Export subsidies
• Excessive administrative burdens (‘red tape’)

Question 13

List 3 arguments in favour of protectionism

Answer 13

• infant industry argument
• protect against “dumping”
• raise revenue for the government (tarrifs)

Question 14

Explain how the infant industry argument favours protectionism over free trade

Answer 14

• if developing countries have industries which are relatively new, then at the moment they would struggle against international competition
• however, if they invested in the industry then in the future they may be able to gain a comparative advantage
• protection would allow developing industries to progress and gain experience to enable them to compete in the future

Question 15

Explain how the dumping argument favours protectionism over free trade

Answer 15

• the government impose protectionist measures to prevent countries against exploitation from dumping
• allows countries to remain competitive in the market
• but dumping is hard to prove

Question 16

State how protectionism can lead to greater government revenue, and then evaluate this point

Answer 16

• import taxes can be used to raise money for the government
• especially in developing countries which can be used to develop infrastructure, education etc
• however, this will only be a relatively small amount of money

Question 17

Define and Explain the impact of a tariff?

Draw a diagram to show this

Answer 17

• Tariffs are taxes on imports to a country.
• It could lead to retaliation, so exports might decrease.
• The impact of tariffs is that the quantity demanded of domestic goods increases, whilst the quantity demanded of imports decreases.

Question 18

Define and Explain the impact of quotas?

Answer 18

• A quota limits the quantity of a foreign produced good that is sold on the domestic market.
• It sets a physical limit on a specific good imported in a set amount of time.
• It leads to a rise in the price of the good for domestic consumers, so they become worse off.

Question 19

Define and Explain the impact of embargoes?

Answer 19

• This is the complete ban on trade with a particular country.
• It is usually politically motivated.

Question 20

Define and Explain the impact of export subsidies?

Answer 20

• a form of government intervention to encourage goods to be exported rather than sold on the domestic market.
• The government might use direct payments, tax relief, or provide cheap access to credit.

Question 21

Define and Explain the impact of excessive administrative burdens (‘red tape’)?

Answer 21

• It increases the cost of trading, and hence discourages imports
• It makes it difficult to trade with countries imposing red tape, and is particularly harmful for developing countries which are unable to access these markets.
• It is harder to notice this type of protectionism, which is why it is favoured among some countries.

Question 22

What are the causes and impact of countries adopting protectionist policies?

Answer 22

• If a country employed several protectionist measures, then a trade deficit would reduce-this is because they will be importing less due to tariffs and quotas on imports.
• Infant industries might need protecting-these are industries which are relatively new and receive support.
• Protectionism is usually short term until the industry develops, at which point the industry can trade freely.
• Protectionism could be used to correct market failure-it can deal with demerit goods and protect society from them.
• Governments might employ protectionist measures to improve the current account deficit.
• Governments might want to protect domestic jobs.

Question 23

What are the consequences of countries adopting protectionist policies?

Answer 23

• Protectionism could distort the market and lead to a loss of allocative efficiency as it prevents industries from competing in a competitive market and there is a loss of consumer welfare.
• Consumers face higher prices and less variety as by not competing in a competitive market, firms have little or no incentive to lower their costs of production.
• It imposes an extra cost on exporters, which could lower output and damage the economy.
• Tariffs are regressive and are most damaging to those on low and fixed incomes-increased income inequality
• There is a risk of retaliation from other countries, so countries might become hostile.
• Protectionism could lead to government failure.

Question 24

Define economic integration

Answer 24

• an arrangement among nations to reduce or eliminate trade barriers and coordinate monetary and fiscal policies

Question 25

What are the 5 levels of economic integration (from least integrated to most integrated)

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Answer 25

• free trade area
• customs union
• common or single market
• economic union
• monetary union

Question 26

What are the 2 key characteristics of a free trade area?

Answer 26

• removal of tariffs and quotas on trade between member states
• member states reserve the right to determine their own trade policy towards non-members

Question 27

What is a customs union and its 2 key characteristics?

Answer 27

• Countries in a customs union have established a common trade policy with the rest of the world.
• removal of tariffs and quotas on trade between member states
• For example, they might use a common external tariff.
• It also has free trade between members. The European Union is an example of a Customs Union.

Question 28

What are some features of a customs union?

Answer 28

• Safety measures for imported goods, such as for food, are common across all members.
• There is a common trade policy-this helps to create and guide trading relationships with countries and blocs outside the Customs Union.

Question 29

What are the 3 characteristics of a common or single market?

Answer 29

• removes restriction on free movement of labour and capital between member states
• removes non-tariff barriers by harmonising product standard, employment laws, taxation policy, competition policy, etc
• adoption of common policy in one or more areas

Question 30

What are two characteristics of an economic union?

Answer 30

• greater degree of harmonisation and coordination of economic policies
• some degree of centralisation of economic policies, in particular macroeconomic policies

Question 31

What are the 2 characteristics of a monetary union?

Answer 31

• extends macroeconomic policy coordination to the monetary field
• the degree of monetary union can vary between a fixed system to semi fixed or the adoption of a common currency

Question 32

What are main characteristics of the Single European Market (SEM)?

Answer 32

• Free movement of goods, services, capital and labour between nations.
• Administrative provisions, laws and regulators are approximated between member nations.
  -This could mean some laws are better suited to some countries, and not so much for others.
• Competition policy is common across the whole of the EU.
• There are common external tariffs.

Question 33

List 4 benefits/advantages of economic integration

Answer 33

• consumer benefits
• labour benefits
• capital benefits
• long-run benefits

Question 34

Explain how consumer benefits can arise from economic integration

Answer 34

• Lower costs and increased competition leads to lower prices
• Greater variety and innovation leads to increased consumer welfare

Question 35

Explain how labour benefits can arise from economic integration (for a single market)

Answer 35

• increased labour mobility enables wage costs to converge
• more likely to find a job/position that you want, thus greater welfare and more productive
• unemployment to be spread more evenly between member states

Question 36

Explain how capital benefits can arise from economic integration (for a single market)

Answer 36

• increased capital mobility increases relative supply in each country
• enables businesses to grow and innovate

Question 37

Explain how long-run benefits can arise from economic integration

Answer 37

• more innovation can take place in efficient markets
• leads to R&D and economies of scale
• good for consumers in LR

Question 38

List 3 disadvantages of economic integration

Answer 38

• trade diversion
• rising externalities
• labour disadvantages

Question 39

Explain what is meant by trade diversion, and why is can be a disadvantage of economic integration

Answer 39

• when tariff agreements cause imports to shift from low-cost countries to higher-cost countries
• increased prices for consumers
• more efficient non-members are crowded out by member states

Question 40

Explain how rising externalities can result from economic integration

Answer 40

• associated with the free movement of people
• places pressure on infrastructure and the insufficient supply of merit goods, such as healthcare and education

Question 41

Explain how labour may be disadvantaged as a result from economic integration

Answer 41

• lower wages as migrant labour drives down local wages
• quality of life may fall

Question 42

What are the consequences for the UK of its membership of the European Union (EU)?

Answer 42

• Trade creation and trade diversion
• Reduced transaction costs
• Economies of scale
• Enhanced competition
• Migration

Question 43

The consequences for the UK of its membership of the EU…
- Trade creation and trade diversion

Answer 43

• With more trading blocs, trade has been created between members, but diverted from elsewhere.
• Trade creation occurs when a country consumes more imports from a low cost producer, and fewer from a high cost producer.
• Trade diversion occurs when trade shifts to a less efficient producer.
  -Usually, a country might stop importing from a cheaper producer outside a trading bloc to a more expensive one inside the trading bloc.
• Protectionist barriers are often imposed on countries who are not members, so trade is diverted from producers outside the bloc to producers within the trading bloc.
• The UK trades mainly with the EU, at the expense of former trade links in the Commonwealth.

Question 44

The consequences for the UK of its membership of the EU…
- Reduced transaction costs

Answer 44

• Since there are no barriers to trade or no border controls, it is cheaper and simpler to trade.

Question 45

The consequences for the UK of its membership of the EU…
- Economies of scale

Answer 45

• Firms can take advantage of a larger potential market in which to trade.
• For example, the EU has 500 million people to sell to.
• By specialising, firms and countries can exploit their comparative advantages, and the gains of efficiency and advanced technology can be reaped.

Question 46

The consequences for the UK of its membership of the EU…
- Enhanced competition

Answer 46

• Since firms operate in a more competitive market, they become more efficient and there is a better allocation of resources.
• There could be the long run benefits of dynamic efficiency too, although these benefits are not always spread evenly across each member.

Question 47

The consequences for the UK of its membership of the EU…
- Migration

Answer 47

• By being a member of a Customs Union, the supply of labour is increased, which could help fill labour shortages.
• However, this might mean some countries lose their best workers.

Question 48

What is the role of the WTO in trade liberalisation?

Answer 48

-The WTO promotes world trade through reducing trade barriers and policing existing agreements.

-It also settles trade disputes, by acting as the judge, and organises trade negotiations.

-Every member of the WTO must follow the rules. Those who break the rules face trade sanctions.

-In addition to trade in goods, the WTO covers the trade in services and intellectual property rights.

-As of 2015, there are 161 member states in the WTO.

Question 49

What are some possible conflicts between regional trade agreements and the WTO?

Answer 49

-Trading blocs might distort world trade or adversely affect those who do not belong to them.
-There could be an inefficient allocation of resources as a result of policies such as the EU CAP.

-Conflicts between blocs could lead to a rise in protectionism. A common external tariff contradicts the WTO’s principles, since although there is free trade between members, protectionist barriers are imposed on those who are not members.

-Some countries might argue that the WTO is too powerful, or that it ignores the problems of developing countries.
- This could be since developed countries do not trade completely freely with developing countries, which limits their ability to grow.

-Setting up a customs union or a free trade area could be seen to violate the WTO’s principle of having all trading partners treated equally.
-This is especially if a common external tariff is
applied.

-However, they can complement the trading system and the WTO strives to ensure that non-members can trade freely and easily with the members of a trade bloc.