Explain the possible costs and benefits for an economy arising from its involvement in international trade. (15)

Question 1

Intro

Answer 1

• Trade is the exchange of goods and services between economic agents.
• When the conditions are right, trade brings benefits to all countries/economies involved and can be a powerful driver for sustained growth and rising living standards.

Question 2

Para 1 Benefits

Answer 2

• The theory of comparative advantage coined by David Ricardo explains that when a country focuses on producing a limited scope of goods that they are more productively efficient than other countries at producing, there are gains to be made.
• One of these gains is economies of scale, where firms can exploit economies of scale and improve their productive efficiency.
• Multinational corporations (MNCs) can move their factories to countries with lower wage costs, reducing their costs. This can lead to lower prices for domestic consumers, a key gain from trade.

Question 3

Diagram

Answer 3

• Foreign producers can develop massive economies of scale leading to lower COPs, this leads to lower prices than if the good was produced domestically (Pw is lower than Pa).
• When there is international trade Pa shifts downwards from Pa to Pw for consumers.
• Quantity supplied by domestic producers reduces and becomes Qs1 and the foreign quantity increases and becomes Qd1. Consumer Surplus (CS) increases as well. Total welfare increases.

Question 4

Para 2 Costs

Answer 4

• Trade can lead to unfair competition & dumping. Dumping refers to the selling of the good to a foreign market at a price below the marginal cost of production with the intention to drive out competitors.
• An example of this is the US accusing China of dumping steel imports.
• Over-reliance on foreign countries can make an economy susceptible to externally induced unemployment, such as the coupling effect, which is the interdependence between countries’ economies.
• This can result in a decrease in aggregate demand (AD), net income (NI), and employment in the country.
• The Covid-19 virus is the latest example of how this can occur. Additionally, an economy heavily dependent on imported goods can be susceptible to imported inflation, leading to a fall in aggregate supply (AS).