International trade Flashcards
International trade
The exchange of goods and services across ineternational borders.
Absolute advantage
This occurs when one country can produce a good with fewer resources and lower costs than another.
Comparative advantage
A country has comparative advantage over another in the production of a good if it can produce it at a lower oppurtunity cost. This means thay have to give up less of another good than another country, using the same resources.
The law of comparative advantage
This states that trade can benefit all countries if they specialise in the goods in which they have comparative advantage.
Theory of comparative advantage - numerical examples
Country A can produce 30 units of wine and 10 units of wheat with their resources, and country B can produce 32 units of wine and 20 units of wheat.
- Country B has absolute advantage in producing both products
- Country A on the other hand should produce whine as they have a low oppurnunity cost of producing wine
Numerical example
Evaluate comaparative advantage theory
- Specilaising fully could alos lead to structural unemployment, since workers might not gain the transferable skilles they need in order to change sectors, or they are simply unable to change.
- Comaprative advantage does not consider the exchnage rate when cosidering the cost of rpoduction for both countries, therefore if the price of one good increases it is more worthwhile to produce that good even if a country has comparative advantage in another good.
- Countires can develop an advtantage in the production of a good, such a vietnam in the production of coffee
- Comparative advantage is derived from a simple model with two countries; the
global trade market is significantly more complex than this. - It can be argued that comparative advantage is no longer a relevant concept. Countries do
not only produce a handful of goods and services, like the theory suggests. Rather, a wide
variety of goods and services are produced, and there is very little specialisation. This is
helped by the advancement of technology
Advantages of free trade
- Comparative advantage
- Reduction in import tariffs leads to net welfare gain
- Economies of scale
- Increased competition and incentives
- Increased exports
- Making use of surplus raw materials
Advantages of free trade - Comparative advantage
The theory of comparative advantage and free trade suggests that a country can increase their economic welfare by cutting tariffs.
It allows them to operate beyond their PPF and therefore results in long run growth.
Increased efficiency: Companies choose to specialize their production on goods or services they can make more efficiently and then purchase what they cannot create from trading partners.
Advantages of free trade - Trade creation
- Reducing import tariff can lead to a net gain of economic welfare, TRADE CREATION DIAGRAM.
Advantages of free trade - Increased competition and incentives
- Increased competition, free trade means domestic monoploies will face more competition from other countries, this increased competition encourages firms to cut costs and be more efficitent.
- If an economy protects its domestic industry by increasing tariffs industries may not have the incentives to cut costs.
Advantages of free trade - Rising exports
- Increased exports, as well as benefits for consumers importing goods, firms exporting goods where the UK has a comparative advantahe will also see improvements in economic welfare. Lower tariffs on UK exports will enable a higher quantity of exports boosting UK jobs and economic growth
Advantages of free trade - Making use of surplus raw materials
- Make use of surplus raw materials, not a huge benefit of being rich in reservess of oil and other resouces without trade. Japan has very low raw materials and without trade with have low GDP.
Advantages of free trade - Economies of scale
Economies of scale, free trade enables countries to specialise in producing certain goods, therefore they can produce a higher output and benefit from lower average costs, this is important for industries particulary with high fixed costs.
Trade creation diagram
- The removal of tariffs leads to lower prices for consumers and an increas in consumer surplus of areas 1,2,3,4.
- Imports will increase from Q3-Q2 to Q4-Q1.
- BUT the government will lose tax revenue of area 3.
- Domestic firms proudcing this good will sell less and lose producer surplus equal to 1.
- However, overall there will be a increase in economic welfare of 2+4.
Arguments against free trade
- Infant industry argument
- Senile industry argument
- Diversify the economy
- Raise revenue for the government
- Helps balance of payments
- Protection against dumping
Arguments against free trade - Infant industry argument
- If developing countries have industries that are relatively new and they would initially struggle against international competition, however if they invested in the industry than in the furture they may be able to gain comparative.
- Infant industries have much higher average costs, do not have economies of scale.
- Protection would allow developing industries to progress and gain experience to enable them to be able to compete in the future.
Arguments against free trade - Senile industry argument
- If industries are declining and incufficient they may require signifcant investment to make them efficient again, protection for these industries would act as a incentive for firms to invest.
Arguments against free trade - Diversify the economy
- Many developing countries rely on producing primary products in which they currently have comparative advantage.
- Prices can fluctuate due to enviromental/weather factors
- Goods have a low-income elasticity of demand therefore with economic growth demand will only increase a little.
Arguments against free trade - Raise revenue for the government
- Tarrifs, tax on imports can be used to raise money for the government, however this is relatively small.
Arguments against free trade - Helps BoP
Reducing inports can help the current account as it resticts imports.
EVAL in the long term this is likely to lead to retaliation and also cause lower exports so it might be counter productive
Arguments against free trade - Protection against dumping
Dumping occurs when a country has excess stock and so it sells below cost on global markets causing other producers to become unprofitable.
EXAMPLE - The EU sold a lot of its food surplus from the CAP at very low prices on the world market, this cased probelms for world farmers because they saw a big fall in their market price.
Tarriffs
Tax on imports DIAGRAM
- The tariff raises the price from Pw to Pw + t, this leads to a decline for imports, imports were Q4-Q1, after the tariff imports fall to Q3-Q2.
- Consumer surplus falls by 1+2+3+4
- Government revenue of area 3
- Domestic suplliers gain an increase in producer surplus of area 1.
- Net welfare lost is 2 and 4.
Qouta
- Limit on the amount of imports that can be brought.
- Reduce imports
- Without the qouta the market price is Pw, and the quantity of imports is Q4 to Q1, world exporters make revenue of areas A B C.
Imosing Qoutas
- Fall in imports to just Q3-Q2
- Domestic suppliers gain more revenue, the price rises to p Qouta and domestic suppliers supply more Q1 to Q2, it can CREATE JOBS.
- Consumers pay a higher price and so total quantity falls from Q4 to Q3.
- There is a net welfare loss for society because the increase in producer surplus is outweighed by the decline in consumer surplus.
- World exporters will make less revenue, unless demand is very inelastic.
Quotas v Tariffs
Quotas tend to cause a bigger fall in economic welfare because the government don’t gain any tax revenue, that you get with tariffs.
Quotas allow the country to be certain on the number of imports coming in. Tariffs is more unknown because it depends on the elasticity of demand and how consumers and suppliers react to the tariff.
Quotas may be harder to enforce if it is difficult to count the amount of the good coming into the country.
Quotas could be more unfair. Some export firms may do well if they get the quota allowance, but others may lose out. It becomes a political issue on how to distribute the quotas. Firms may also dislike the uncertainty of not knowing how many quotes to gain
