International Trade

Question 1

What is absolute advantage?

Answer 1

An economy can produce a greater total of goods for the same quantity of inputs

Question 2

What is comparative advantage?

Answer 2

A country has a comparative advantage if it can produce a good at a lower opportunity cost than another country. A lower opportunity cost means it has to forego less of other goods in order to produce it.

Question 3

What a gains from trade?

Answer 3

When due to the existence of comparative advantages countries can actually consumer more at cheaper prices if they open to trade.

Question 4

What are the criticisms of comparative advantage?

Answer 4

1. Costs of trade e.g. transport costs
2. Externalities of trade
3. Diminishing returns/diseconomies of scale
4. Static comparative advantage - holding back development of countries
5. Dutch disease - specializing in primary products which hurt long-term performance
6. Can have an not pareto improvement
7. Gravity theory - size and distance of countries can impact trade

Question 5

What are the assumptions of comparative advantage? (5)

Answer 5

1. There are only 2 good produced
2. There are no transport costs
3. Both markets operate under perfect competition
4. Labour is the only factor of production
5. Labour i mobile in the domestic market but immobile between markets

Question 6

What is the Heckscher-Ohlin therom on trade?

Answer 6

Each country will have a comparative advantage in the good whose production is intensive in the abundant factor

Question 7

What is intra-industry trade? Who engages in more of it, who doesn’t?

Answer 7

Trade between industries. Developed economies and rapidly developing countries e.g. China/Malaysia/Thailand engage in more intra-industry trade.
Resource rich developing economies and less developed countries tend to have less intra-industry trade

Question 8

What happens to GDP when there is a) a trade surplus, b) a trade deficit?

Answer 8

All else equal:
a) increase GDP
b) decrease GDP

Question 9

What impact does a trade deficit have on the exchange rate?

Answer 9

Negative - it can cause a depreciation in the exchange rate

Question 10

What is the current account?

Answer 10

Measures the inflow and outflow of goods, services, investment incomes and transfer payments

Question 11

What is the capital account?

Answer 11

Measures the inflow and outflow of assets and liabilities e.g. FDI, bonds etc

Question 12

If there is a deficit on the current account there must be a ______ on the capital account.

Answer 12

Surplus

Question 13

What are the problems of a current account deficit? (5)

Answer 13

1. Exchange rate could depreciate causing inflation
2. Deficit financed by financial flows can be vulnerable to capital flight if foreign investors sell assets
3. Can be a sign of an uncompetitive economy
4. Foreigners have an increased claim on domestic assets
5. Leakage from circular flow of AD as expenditure leaves economy to buy imports

Question 14

What are the benefits of a current account deficit? (2)

Answer 14

1. Higher levels of domestic consumption than would otherwise be possible
2. A potential devaluation in the exchange rate can increase the competitiveness of exports

Question 15

How can a current account deficit be reduced? (3)

Answer 15

1. Devalue the currency to make exports cheaper and imports more expensive (assume elastic demand)
2. Reduce consumption spending through tight fiscal/monetary policy
3. Supply-side policies e.g. productivity improvements