Chapter 4 - Internatioal Trade and Protectionism

Question 1

What is free trade?

Answer 1

When trade occurs between coutries without restrictions or barriers

Question 2

What is an ‘Absolute Advantage’?

Answer 2

When a country can produce more of a good or service compared to another country using the same quantity of factors of production.
-Can produce it more cheaply than another country in absolute terms

Question 3

What is the law of comparative advantage?

Answer 3

That countries should specialise in good and services they can produce at a lower opportunity cost compared to another country.
Only then should they trade with another nation.

For example:
2 countries, same factors of production, making computers and cotton
Country A specialises in Computers, country B in cotton
‘It only makes sense for country A to sell a computer to country B if they get more cotton in return than they could have produced themselves using the resources they used to make the computer’

Question 4

What are the benefits of counties producing the good that gives them a comparative advantage?

Answer 4

Together, more can be produced from the same resourecs. Both countries benefit by consuming beyond their PPC with quantity maximised and prices low given the gains from specialisation.

Countries specialising see an improvement in allocative efficiency as resources go to countreis who are the most efficient producers to maximise output and satisfy as much consumer demand as possible.

Question 5

What must the rate of exchange be for 2 countries with a comparative advantage to trade with eachother?

Answer 5

The rate of exchange for goods and services must lie between the opportunity cost ratios of production for the two.

Question 6

What are the sources of comparative advantage?

Answer 6

1) Greater quantity or quality of factors of production compared to another country.
I.E Greater abundance of natural resources, better quality natural resources, higher quantity/quality of necessary labour etc..

2) Research and development can cause comparative advanatges to change overtime
More sophisticated production at cheaper rates, workers leaning new skills ETC

Question 7

What must countries be mindful of when following comparative advantage theory?

Answer 7

Over-specialisation

This is when a country becomes dependant on imports leading to unbalanced growth and income inequality.

EXAMPLE = VENEZUELA AND OIL

Question 8

So, does every country in the world only trade with coutries that have the comparative advantage for that good/service? COOL SENTENCE

Answer 8

No, trade patterns in the world are not concentrated only to the coutries with a comparative advantage as theory would suggest. This is because of some assumptions made in comparative advantage theory that do not apply in reality.

Question 9

What are the evaluation points for comparative advantage theory? 8

Answer 9

1) Assumes perfect information
For both consumers and producers however consumers lack info of where cheapest good is being produced and may buy from an inefficient producer allowing these countries to survive and be profitable

2) Transport costs are assumed to be 0
In real world, large transport costs may erode a country’s comparative advantage and make it cheaper to import goods from a closer, less efficient producer

3) Patentable power
Countries w/o comparative advantage may be able to afford expensive research and development spending allowing for patentable products giving countries advnatage despite not being most efficient producer

4) Assumes no EOS advantages
Countries w/o coparative advantage can set up large scale production of a good/service to benefit from eos and compete with countries that have the comparative advantage

5) Ignores impact of exchange rate changes
A country with comparative advantage will lose out to a less efficient producer if their exchange rate strengthens

6) High inflation rates
Overtime can erode price competitiveness of a countries good/service despite being specialised

7) Protectionist measures
Tariffs and quotas imposed by governments, inflate prices of imports from countries with comparative advantage, providing domestic producers an artificial advantage. Same with domestic subsidies and non-tariff barriers

8) Non-price competition
Countries w/o comparative advantage can compete on non-price factors such as: service quality, branding, advertising, product longevity ETC.
Creating strong customer base to sell to despite being pricier than specialised countries and less efficient.

Question 10

What is the diagram for free trade? Explain and analyse it.

Answer 10

1st) Without foreign trade, equilibrium price and quantity in the market will be at Q1, P1 with oly domestic producers satisfying domestic demand
2nd) If government opens up economy to free trade, price will decrease to Pw, reflecting cost advantage of countries with comparative advantage in this sector
3rd) World supply curve is perfectly price elastic as at this price world suppliers can supply small domestic market without having to increase price to incentivise greater production
4th) At this lower price, domestic supply contracts from Q1 to Q2 and domestic demand expands to Q3 due to laws of supply and demand
5th) This creates excess demand in domestic market (shortage) of Q2Q3, as there are no restrictions on imports, excess demand is satsfied by imports from world supply
6th) Consumers now purchasing Q1Q3 more units at a lower price, increasing CS.

Price = Decrease from P1 to Pw
Domestic Supply = Decrease from Q1 to Q2
Domestic Demand = Increase from Q1 to Q3
Imports = Q2Q3
Domestic Producer Revenue = Decrease from A+B+E+F+D -> A
Foreign Producer Revenue = B+C
Consumer Surplus = Gain in CS of D+E+F+G
Producer Surplus = Loss in PS of D+E

Question 11

What are the benefits of Free Trade? 6

Answer 11

1) Exploittion of comparative advantage
With greater free trade and specialisation, resources are allocated where countries have their comparative advantage -> allocative efficiency is attained as resources go to countries who are most efficient producers -> maximise output and satisfying as much consumer demand as possible -> solving basic economic problem -> maximising net benefit to consumers and producers

2) Large economies of scale
With access to a larger international market, business are able to exploit EOS -> lowering their AC -> increase PE -> higher profits and potentially lower prices for consumers

3) Increased competition and lower prices
With larger market to access -> competition becoms global -> producer forced to be more efficient -> AE, benefiting consumers -> non-price compeitiong of quality and customer service -> businesses forced to be DE to compete

4) Increased choice for consumers and businesses
Businesses can source raw materials from all around the world at cheapest prices -> consumers can access greater market to purchase goods, allowing them to find best price.
Businesses can pass lower prices onto consumers -> gains in market share and consumer surplus -> improving material and non-material standards of living

5) Higher rates of economic growth
Greater market size and specialisation means higher export potential and revenue generated from exports -> (x-m) increases, increasing AD, decreasing unemployment -> boost living standards

6) Faster rates of technology transfers
Access to new technologies/products is better -> spread of technology is improves -> technological advnacements occur faster -> improving business efficiency and profitability -> lower prices for consumers + more products -> gains in CS

Question 12

What is protectionism?

Answer 12

Any barrier that restricts free trade to protect domestic producers from foreign competition

Question 13

What are the different types of protectionism?

Answer 13

Tariffs, Quotas and Domestic Subsidies

Question 14

What is the diagram for Tariff protectionism? Analyse and explain it

Answer 14

1st) A tariff, a tax on imports, will raise market price from Pw to Pw+T, shifting world supply curve upwards from Sw to Sw+T
2nd) Due to higher price, domestic demand will contract from Q2 to Q4 and domestic supply will extend from Q1 to Q3
3rd) Domestic producer revenue increases from A to A+B+E+F+G
4th) Consumers lose out paying a higher price and a DWL of consumer surplus of area I
5th) Excess demand of Q3Q4 that remains will be satisfied by imports from foreign producers BUT because they must pay the tariff, their revenue falls from B+C+D to C
6th) Governments recieve tax revenue of H
7th) Number of imports decreases from Q1Q2 to Q3Q4, this comes with AIE of domestic producers producing units at a higher cost than foreign producers, indicated by area G

Price = Increases from Pw to Pw+T
Domestic Supply = Increases from Q1 to Q3
Domestic Demand = Decreases from Q2 to Q4
Imports = Decrease from Q1Q2 to Q3Q4
Domestic Producer Revenue = Increases from A to A+B+E+F+G
Foreign Producer Revenue = Falls from B+C+D to C
Government Revenue = H
Consumer Surplus = DWL of I
Producer Surplus = Increases by E+F
Resource Allocation = Allocative Inefficiency of Area G

Question 15

What is the diagram for Quota protectionism? Analyse and explain

Answer 15

1st) An import quota is a restrction on the physical quantity of a good that can be imported into a country
2nd) Domestic producers will produce Q1 units at Pw, leaving excess demand of Q1Q2.
3rd) With import quota of Q1Q3, foreign producers can only supply part of this excess demand, up until quota of Q1Q3 units.
4th) Excess demand has not been fully satisfied at Pw, with Q3Q2 excess demand remaining -> this puts upwards pressure on price to ration the excess demand
5th) Higher prices incentivise more domestic producers to enter the industry with no more imports being allowed, increasing domestic supply and shifting supply curve right from Sd to Sd+Quota.
6th) Price settles where Sd+quota meets Dd with no excess demand remaining, as the higher prices have rationed demand and caused a contracion in domestic demand from Q2 to Q4
7th) Domestic suppliers now supply Q1 and Q3Q4 units at a higher price, increasing their revenue from A to A+E+C+H+I
8th) Foreign producers only supply their quota at Pquota, changing their revenue from B+C+D to B+F+G
9th) Consumers suffer from higher prices at Pquota, with a loss in consumer surplus of area J
10th) Number of imports decreases from Q1Q2 to Q1Q3
11th) Allocative inefficiency of domestic producers producing units at a higher cost than foreign producers indicated by area i

Price = Increases from Pw to Pquota
Domestic Supply = Increases from Q1 to Q1 + Q3Q4
Domestic Demand = Decreases from Q2 to Q4
Imports = Decrease from Q1Q2 to Q1Q3
Domestic Producer Revenue = Increases from A to A+E+C+H+I
Foreign Producer Revenue = Changes from B+C+D to B+F+G
Consumer Surplus = DWL of consumer surplus of area J
decreases by E+F+G+H+I+J
Resource Allocation = Allocative inefficiency indicated by area i

Question 16

What is the diagram from Domestic Subsidy protectionism? Analyse and explain it

Answer 16

1st) A subsidy is a money grant offer to producers to lower their costs of production
2nd) Subsidies reduce costs of production for domestic firms, shifting domestic supply curve right from Sd to Sd+sub
3rd) Market price remains at Pw as the value of subsidy is not enough for domestic producers to outcompete world suppliers and charge a lower price, therefore domestic demand remains at Q2
4th) Domestic supply increases to Q3 as they receive subsidy, receiving a price equivalent to Pw+sub -> increasing their revenue from A to A+B+D+E+F
5th) Cost to the government of D+E+F
6th) Foreign producers supply excess demand of Q3Q2 units, with their revenue falling from B+C to C
7th) Imports decrease from Q1Q2 to Q3Q2
8th) There is allocative inefficiency with domestic producer producing units at a higher cost than foreign producers indicated by area F
9th) No loss in consumer surplus as prices in market remain at Pw, consumers are likely to suffer through burden of the cost to the government

Price = Remains at Pw
Domestic Supply = Increases from Q1 to Q3
Domestic demand = Remains at Q2
Imports = Fall from Q1Q2 to Q3Q2
Domestic Producer Revenue = Increase from A to A+B+D+E+F
Foreign Producer Revenue = Decreases from B+C to C
Government cost = D+E+F
Consumer Surplus = No change
Resource Allocation = Allocative Inefficiency with domestic producers producing units at a higher cost, indicated by area F

Question 17

What are the reasons for protectionism / costs of free trade? + evaluation of each point (7)

Answer 17

1) Infant Industry Argument
Under free trade, small industries may not have EOS to compete with larger companies from abroad, meaning free trade would not allow them to grow. STRONG argument for developing countries looking to diversify and over come over-specialisation.
EVAL =
-Protectionism for this reason may fail in long term due to complacency and protecionism dependancy
-Developing countries may lack power to enact such protectionism without risking heavy retaliation, they shold seek support from WTO

2) It protects against dumping
Dumping is sale of a product in overseas market below costs of production due to heavy subsidies or min.pric schemes generating an excess supply. -> dumped products will be artificially much more competitive than domestic products leading to industry decline, structural unemployment and anger
EVAL=
-Dumping is very difficult to prove; finding info regarding costs of production and proving products have purposfully been sold below cost -> if protectionist measures are imposed to prevent dumping, country may feel wrongly targeted and retaliate.
-Trade talks through WTO may be a better option

3) Protects against unemployment
If under free trade countries lose comparative advnatge or a domestic industry goes into decline -> structural unemployment -> cost on government who lose key macro objective -> protectionism can prevent this
EVAL =
-If industry is already in decline then protectionism is just delaying the inevitable. Can be argued that despite costs it will be etter to allow workers to become more occupationaly mobile and transfer into other sectors

4) Protect quality standards
Product, health/safety and enviromental standards can be imposed on imported goods to protect domesic consumers. These standards could be lacking with free trade
EVAL +
- Must be scientific evidence backing it up, often there isnt, meaning countries that suffer from protectionism may feel hard done by and retaliate
-Can be tougher for developing countries to meet these standards, would increase costs of production and maybe they lose their comparative advantage

5) To compete with lower labour costs abroad
-Imports can be coming from a country with low cost labour advantages, Gov may find advantage unfair and impose protectionist measures. Important to protect domestic workers min wages and strong worker rights and is unfair reason for exports to be uncompetitive
EVAL =
-This will signifcantly worsen allocation of resources as it promotes more inefficient domestic production -> less resources going to efficient producers where comparative advnatge lies -> distorting comparative advantage -> cosumers pay for protecionism through higher prices

6) TO reduce a CA deficit and promote economic growth
Under free trade it is possible for import expenditure to signifcantly outweigh export revenue -> protectionsim reduce import expenditure assuming ceteris paribus -> improve CA balance -> AD equation increases and boosts in economic growth
EVAL =
Biggest problem is retaliation from trade partners -> countreis wont like that their producers are forced to suffer -> impose protectionism against our country -> worsening export revenue -> possible counteracting any gains in CA -> long term worsening CA position -> a trade war is a negative sum game for all involved

7) To raise Gov revenue
In developing countries raising tax revenue can be difficult therefore tariffs can be easy solution -> imorving fiscal intake -> improve Gov expenditure on infra
EVAL =
-Consumers will have to pay higher price on imports -> burdening poor dependant on which goods are tariffed -> if demand and supply for good is price inelastic then quantity of imports could fall drastically -> negating any gains in fiscal intake

Question 18

What are the cons of protectionism? (8)

Answer 18

1) Biggest problem is retaliation
Trade partners will not like that their domestic producers have to suffer, disagreeing for reasons of protectionism -> impose protectionist measures against our country -> trade war is a negative sum game for everyone involved -> both coutntries suffer with lower export revenue -> costs to each domestic producer

2) Tariffs and quotas will burden consumers, DWL of CS
Increased prices -> loss of CS -> key imports are also often clothing, food, vehicles -> all of which goods that poor rely on making taxes regressive

3) Protectionsim can harm domestic firms
For example tariffs / quotas imposed on RAW MATERIALS -> increasing costs of production -> reducing profitability -> higher prices, cost push inflation, shifting SRAS -> even finished goods will come in at higher pride, increasing inflation

4) Infaltionary nature can lead to loss of macroeconomic objective
aforementioned reasons

5) Subsidies are very costly to GOv
Opportunity cost

6) Worsening of resource allocation
Protectionsim promotes domestic production despite domestic producers being less efficient and producing at higher costs than foreign firms with comparative advantage -> misallocation of resources -> allocative inefficiency with more resources being allocated to less efficient producer

7) Goes against aims and principles of WTO
One core rule of WTO is for member countries to only impose protecionist measures that WTO has approved, which are fair, conssitent and non-discrimnatory. -> breaking rules will lead to heavy fines and allwing trading partnes to impose stricter retaliatory protectionist measures

8) Price inelastic demand and supply for imported good
If inelastic -> Q of goods imported will change proportionatlly less than change in price -> reducing impact of tariffs/quotas -> worsening expenditure -> worsening CA

Question 19

What are the arguments FOR UK membership of the EU? (arguments against BREXIT) + EVALs (5)

Answer 19

1) Increased trade given size of EU market, 500 million consumers
-No tariffs exist within EU, allwoing traed creation to occur where UK has comparative advantage
-Consumers can purchase low cost goods instead of higher cost domestically produced
-More efficient allocation of resources
-Net exports can grow as UK has access to market w/o restrictions, allowing boost in AD
BREXIT would take away all of this -> lower economic growth -> increased unemployment -> consumers paying tariffs

EVAL =
-Trade negotiations post brexit can circumvent this

2) Increased FDI in UK
With EUs large market size, and being a member allows the UK to access this, the UK economy becomes attractive for foreign businesses to invest in. UK used to be seen as a gateway to Europe, especially with UKs advanced infrastructure and relaible financial institutions and strong currency

EVAL =
-Argument has even more weight post brexit as there has been a strong depreciation of pound as UK is large importer, increasing supply of GBP

3) Brexit has triggered large and permanent drop in value of GBP
came as shock to investors -> panic selling of GBP due to lack of confidence -> CAN BE beneficial in improving CA through WIDEC -? BUT because UK is net importer then a weak exchange rate is dangerous -> for firms importing raw materials for production -> increased costs -> consumers importing goods -> reduced consumer surplus -> increased cost push inflation + lower economic growth could equal staglation

EVAL =
-Long term could be beneficial as UK is large exporter of financial sevices therefore could use lower exchange rates to gain competitive advantage and allow for more balacned economic growth, however this is a long way off happening

4) Staying inside UK maintains strong relationship with EU
-If trade agreements cannot be made then there is risk of trade war, EU has negotiation advantage and can squeeze UK

EVAL =
UK and US are strong allies and UK can negotiate trade deals with them if EU imposes strong protectionsit policies

5) Loss of immigration is hurting UK economy
EU migrants entering UK would fill job vacancies that otherise wouldnt be filled I.E Agriculture, cleaning, construction
-> reduced productive potential of UK economy -> lower economic growth -> loss in tax revenues from workers

EVAL -
Immgrants do however put pressure on key public services like healthcare, education and infrastructure as they are eligble for same rights as UK citizens

Question 20

What are the arguments for the UK to leave the EU? (Arguments FOR brexit) 3 + eval

Answer 20

1) UK businesses free from burdensome regulations that increase costs of production
I.E product standards, health and safety standards, agricultural policy
-> more profit for firms -> more free trade outside EU -> more economic growth -> more jobs

EVAL =
Certain EU laws are beneficial for stakeholders such as workers, consumers ETC

2) UK sovereignty is restored
UK is now able to set it its own laws, control its own borders without having to pay EU membership fees -> UK citizens will be free to vote for laws and policies within own elected government -> also money si freed to spend on UK public services

EVAL =
-Some argue that the mebership fee is a small price to pay for beenfits from EU, being around £8.5bn.
-With yearly spedning budgets to cover education, healthcare and infra being £100bn, it makes little difference

3) UK can negotiate its own free trade deals with countries outside EU
Some countries like Thailand have previosuly suffered from EU’s common external tariff.
UK can buy products from elsewhere that have comparative advanatge and now without CET are much cheaper -> gains in CS plusn gains in export revenue

EVAl =
-Such negotiation with other countries is much more complex and time consuming to actually fulfill.