International trade Flashcards
1
Q
What is absolute advantage
A
- When a country can produce more goods or services compared to another using the same resources i.e. factors of production
- More output with same resources means their productivity is higher
- We say that the country has a lower absolute cost of production as they don’t require as many resources
2
Q
Why did David Ricardo suggest using comparative advantage instead of absolute advantage
A
- Comparative advantage factors in the opportunity cost which is an additional cost of production which needs to be taken into account
- Even countries who don’t have an absolute advantage can successfully trade if they have a comparative advantage
3
Q
What is comparative advantage
A
- A country should specialise (use all resources) in producing goods and services where they have a lower opportunity cost compared to another country and then trade
- We say the country has a lower relative cost as their opportunity cost of production is lower
4
Q
How can you show absolute and comparative advantage on a table
A
- e.g. India and Ghana producing cotton or computers
- India can produce 20 tonnes of cotton and 10 computers and Ghana can produce 16 tonnes of cotton and 2 computers so India have an absolute advantage in both
Draw a separate table for opportunity cost - The OC to India of producing 1 tonne of cotton = 1/2 a computer and OC of producing 1 computer = 2 tonnes of cotton
- The OC to Ghana of producing 1 tonne of cotton = 1/8 of a computer and OC of producing 1 computer = 8 tonnes of cotton
- Therefore, India have a lower OC for computers and Ghana have a lower OC for cotton i.e. comparative advantage respectively and trade is mutually beneficial for both
5
Q
How can you show absolute and comparative advantage on a diagram
A
- With India and Ghana example, draw PPF with computers on y axis and cotton on x axis
- Draw India’s trading PPF by connecting 10 on the y axis and 20 on the x axis
- Draw Ghana’s trading PPF by connecting 2 on y axis and 16 on the x axis
- India y and x intercept is higher for both so higher absolute advantage
- Ghana gradient is shallower so has comparative advantage on x axis (cotton) and India gradient is steeper so has comparative advantage on y axis (computers)
6
Q
What conclusions can be draw from comparative advantage theory
A
- Max output of goods and services produced in the world due to specialisation, meaning countries can consume beyond their PPF
- Lowest prices due to increased supply of the goods and services
- Increased allocative efficiency as more output means satisfying more consumer demand, this is the most efficient allocation of scarce resources
7
Q
How can you show a country consuming beyond their PPF through trade
A
- India are sacrificing 2 tonnes of cotton by producing 1 computer, so if they want to sell computers to Ghana, they want more than 2 tonnes of cotton in return, or they would just produce computers and cotton themselves
- Ghana would be willing to buy computers for anything less than 8 tonnes of cotton as otherwise, they would produce computers themselves
- Therefore, as the long as the price of 1 computer is between 2 and 8 tonnes of cotton, India are receiving more cotton than they are trading away computers and Ghana are receiving more computers than they are trading away cotton
- This means both countries are consuming outside a PPF with computers on y axis and cotton on x axis
8
Q
Where can a country’s comparative advantage come from
A
- Quantity of factors of production (known as factor endowment) e.g. China has CA in manufacturing due to massive workforce so low wages and costs, Saudi has huge supply of oil
- Quality of factors of production (productivity) e.g. UK has CA in financial services due to the highly skilled workforce, Germany with cars due to highly skilled labour and productive capital
This is why we trade certain goods with some countries more than others
9
Q
How do countries without comparative advantage have successful industries domestically and internationally
A
- Comparative advantage doesn’t take into account transport costs, which impact which countries you would want to trade with
- CA assumes perfect information about OC and quality
- Assumes every country has the same EoS which would impact costs and prices in long run
- Doesn’t take into account non-price factors like branding/innovation/reputation
10
Q
What are the reasons for trade patterns
A
- Comparative advantage
- Countries in trade blocs trade more with each other as no protectionism
- Protectionism reduces trade
- Transport costs e.g. UK doesn’t trade much with Australia compared to Europe, even if Australia has comparative advantage
- Non-price factors
- Exchange rates e.g. strong exchange rate makes exports dearer eroding comparative advantage
- High inflation rates erode comparative advantage as well
11
Q
How can you show the impact of free trade on domestic industries and consumers if the UK doesn’t have comparative advantage, using a diagram
A
- Draw upward sloping domestic supply and downward sloping domestic demand and equilibrium price P1
- If another country has CA, the world price Pw is lower than P1 and world supply is perfectly elastic at this price due to the large quantity of global suppliers
- At lower price there has been a contraction in domestic supply as firms can’t compete and forced to shutdown or downsize. Domestic producer revenue has fallen as P*Q decreased. Domestic producer surplus fallen.
- At lower price there has been an extension in domestic demand so consumers have more choice and quantity, consumer surplus gain.
- The excess demand is satisfied by imports coming in from the rest of the world. Foreign producer revenue has risen as P*Q increased
12
Q
How can you show the impact of free trade on domestic industries and consumers if the UK has comparative advantage, using a diagram
A
- Draw upward sloping domestic supply and downward sloping domestic demand and equilibrium price P1
- If UK opens up economy to trade, they have comparative advantage so P1 is the globally competitive price
- Increased foreign demand pushes price up to Pw, causing extension in domestic supply and contraction in domestic demand
- Excess supply is exported to the rest of the world. Export revenue calculated by Pw x excess quantity supply
13
Q
What are the advantages of free trade (refer to diagram of UK without comparative advantage)
A
- Comparative advantage exploitation shown on diagram as an increase in quantity of imports, means more efficient allocation of resources (allocative efficiency if country with lowest opportunity cost produces more)
- Lower prices and higher q due to CA exploitation, EoS when firms become a global supplier, global competition. Shown in diagram as price falls from P1 to Pw, consumer surplus increase, quantity supplied increases. Means higher living standards.
- Higher profit for firms as they can get EoS benefits, they can reinvest, pay off debts, dividends etc
- Higher growth as increased exports means increase in AD. Shown on diagram as foreign producer export revenue has risen by Pw*excess demand. Creates jobs, boosts living standards, less poverty
- Greater technology diffusion as domestic firms can import new tech, foreign firms reinvest in new tech with higher profits. Leads to innovative products, more choice, quantity at lower prices for consumers and firms can get ahead of rivals
14
Q
What are the disadvantages of free trade (refer to diagram of UK without comparative advantage)
A
- Overspecialisation means demand/supply side shock to that industry heavily decreases growth. Leads to inequality if people working in that industry get higher income compared to others. Over-reliant on imports which can be affected by conflicts, supply shocks like pandemics, transport issues
- Could be unfair trade practices like over-subsidisation and excess supply is ‘dumped’ abroad for a low price, bad for other countries
- Unemployment risk high as domestic supply contraction (deindustrialisation) causing structural unemployment, very bad for macro economy
- Could be less regulation about product safety, worker rights, environmental tradeoffs despite increased output
- Less comparative advantage could lead to current account deficit
15
Q
What is protectionism
A
Barriers to trade to protect domestic firms from foreign competition
16
Q
What are the different types of protectionism
A
- Tariff i.e. tax on imports
- Quota i.e. limit of the quantity of imports allowed to enter the country
- Embargo i.e. ban on imports, mainly seen in times of war and conflict
- Domestic subsidy i.e. increase in output and lower cost for domestic firms
- Devaluation i.e. weakening currency for cheaper exports from domestic firms
- Administration barriers like red tape (paperwork) and standards/regulations
17
Q
Explain the tariff diagram
A
- Draw free trade diagram where world suppliers have comparative advantage
- Tariff causes world supply and price to rise Vertical difference between the 2 supply curves = tariff per unit
- Extension in domestic supply as firms can now compete so enter the market or existing firms increase output, attracted by higher price. Domestic producer revenue risen as price and quantity both rise
- Contraction of domestic demand due to higher prices means excess demand fallen so volume of imports fallen.
- Government revenue is are of tariff per unit x new volume of imports
- Foreign firm revenue fallen as volume of imports fallen and government taken what would have been extra revenue at higher price
18
Q
How does a tariff impact producer and consumer surplus i.e. allocative efficiency
A
- Consumer surplus dropped and DWL of CS in the area of triangle to the right of gov revenue
- Producer surplus gain which recovered some of the lost CS but not all of it
- Since quantity supplied by less efficient domestic producers has risen, there has been allocative inefficiency where area left of gov revenue represents this loss of world efficiency
19
Q
Why would a country use protectionism using the infant industry argument
A
- Allow infant industries to grow without being eliminated by global competition straightaway and achieve EoS to be globally competitive themselves in the future, then take away the protectionism
- This can help diversify the economy so there are lots of industries prospering which helps avoid over-specialisation and deindustrialisation
- Shown on tariff diagram by extension in domestic supply
- However, lack of competition for domestic firms causes complacency and inefficiency so businesses nay not become more globally competitive in the future. Also foreign countries may retaliate and infant industries can’t grow if they can’t export products to RotW
20
Q
Why would a country use protectionism using the dumping argument
A
- Dumping is when a good is sold at a price below cost of production overseas, destroying overseas industries, it is illegal
- Countries can stop this through protectionism e.g. tariff which increases price of imports, taking away dumping advantage
- However, the country has to prove that the other country is dumping before WTO allows protectionism, but since it hard to prove many countries just bypass WTO and do it anyway, leading to sanctions and retaliation
21
Q
Why would a country use protectionism using an unemployment argument
A
- Industries without comparative advantage shutdown causing structural unemployment, lots of consequences for individual and economy
- Tariff means extension in domestic supply and labour is derived demand, so saves/creates jobs
- However, if the industry is very uncompetitive, protectionism might just be delaying inevitable dying of that industry so it may be better to move workers to more productive industries. However, if dumping then don’t let industry die, fight to survive. Retaliation could lead to more jobs lost than saved from the initial protectionism as less exports
22
Q
Why would a country use protectionism using the standards argument
A
- Raise health and safety, product, environmental and worker standards which foreign producers aren’t meeting to protect key stakeholders e.g. consumers, workers
- However, proof through WTO that raise in standards is necessary. If not, will be sanctioned by WTO or retaliation by other countries
23
Q
Why would a country use protectionism using the government revenue argument
A
- Government revenue can by developing countries for spending on education, health, infrastructure, welfare in
- Can be used by developed countries to further help domestic producers e.g. through subsidies
- However, if domestic demand and supply are price inelastic, imports won’t decrease as much so more gov revenue is collected. More elastic means imports decrease a lot so gov revenue isn’t as higher
24
Q
Why would a country use protectionism using the current account deficit reduction argument
A
- Imports decrease so, ceteris paribus, trade deficit falls so current account deficit falls
- Could also increase (X-M) so more econ growth
- However, ceteris paribus assumption unlikely as foreign countries will not accept this as a reason for protectionism and retaliate, reducing export revenue. In reality there is more likely to be worsening of CA deficit as export revenue falls more than import revenue falls
Also inelastic means import reduction is smaller so less affect on CA deficit
25
Q
What are general evaluation points/disadvantages of protectionist policies
A
- Higher prices, lower quantity for consumers reduces living standards, loss of consumer surplus and DWL area right of gov revenue
- Regressive tax as they are often placed on essential goods causing inequality and drives up costs of production for firms
- Retaliation risk is high and likely to be harsher than initial protectionist measures. Causes trade war where all the drawbacks are worse and the benefits don’t occur
- Domestic firms harmed if raw material costs rise or due to retaliation reducing exports
- Breaking of WTO rules leads to sanctions
- Allocative inefficiency as the most efficient firms aren’t producing more DWL to the left of gov revenue
- Expensive for government e.g. subsidies
- Revenues, quantity of imports, DWL depend on elasticity e.g. inelastic means domestic firms can’t respond with more supply quickly and there are no close substitutes yet so demand doesn’t fall. DWL is low as gov revenue is high
26
Q
What is the WTO
A
International organisation that regulates world trade, with 164 member states who all agree with what ‘ideal trade’ should be
27
Q
What does the WTO believe ideal trade should be
A
- Non-discriminatory so countries can’t just decide some countries to place high tariffs on. It has to be a formal agreement
- Free from barriers so least protectionism possible
- Predictable so investment, job creation will take place and businesses can flourish
- Fair competition e.g. no dumping and in these cases protectionism is ok in short term
- Beneficial for developing countries
28
Q
What are the roles of the WTO
A
- Set and enforce rules on international trade so if broken there are sanctions
- Resolve trade disputes so less trade wars
- Provide a forum for negotiating trade liberalisation reducing time taken for agreements e.g. trade diplomats for different countries are all based in WTO headquarters so don’t need to travel across the world
- Monitor further trade liberalisation to make sure trade is happening as in the agreement
- Increase transparency and accountability of decision making process so countries can critique decisions
- Help developing countries benefit from free trade
- Cooperation with other economic institutions like IMF when it comes to enacting economic and trade policies
29
Q
What is international competitiveness
A
The ability of a nation to compete successfully overseas and sustain improvements in living standards and output
30
Q
What are the 3 sections that make up competitiveness
A
- Price competitiveness compared to other countries
- Non price competitiveness as even with higher costs/prices, countries can still be competitive if they have branding, loyalty, high quality
- Ability to attract factors of production e.g. FDI leads to higher productivity and skills, innovation, infrastructure
31
Q
What are the measures of competitiveness
A
- Union labour costs (ULC) = total labour costs / output produced so lower they are, more price competitive, based productivity affecting output and regulations like min wage
- Global competitiveness index (GCI) which rates many factors that affect competitiveness not just ULCs
32
Q
What factors determine international competitiveness
A
- ULCs based on productivity, regulation, labour skills
- Tax regimes e.g. lower cooperation tax improves price competitiveness and attracts FDI, lower income tax means more domestic workers and brain gain from abroad
- Innovation improves price and non price competitiveness
- Improved infrastructure improves efficiency of domestic firms as moving products around the country and internationally easier, and attracts FDI
- Regulation increases costs and makes agreements take longer so decreases price, non price competitiveness and FDI
- Economic stability improves ability to attract FDI
33
Q
Evaluate the UK’s internationally competitive
A
Very high GCI due to
- High skilled labour force
- Lowest corporation tax in developed world and quite low income tax
- Good infrastructure
- Quite low regulation
- Stable macroeconomy since financial crisis
However quite bad price competitiveness:
- High min wage
- Quite low productivity
34
Q
Why would a country use policies to improve international competitiveness
A
- More balanced growth e.g. higher exports and investment instead of just consumption
- Long run growth
35
Q
How can the government use supply side policy of infrastructure spending to improve international competitiveness
A
- Improve infrastructure as easier, quicker cheaper to move goods and services around the country and world, improving efficiency which reduces costs, leading to lower prices and improved price competitiveness
- Easier to attract FDI as firms attracted to lower costs
36
Q
How can the government use supply side policy of tax incentives to improve international competitiveness
A
- E.g. lower corporation tax means higher retained profits for firms, which they can spend on investment in technology and infrastructure, increasing efficiency and lowering costs of production so improved price competitiveness
- Improved non-price competitiveness due to innovation causing high quality goods and services
- Attracts FDI
37
Q
How can the government use supply side policy of deregulation to improve international competitiveness
A
- Deregulation by removing laws which increase costs for businesses e.g. reduce environmental and health and safety standards, min wage leads to lower costs and higher price competitiveness
- Less regulation attracts FDI
38
Q
How can the government use supply side policy of education spending to improve international competitiveness
A
- E.g. reform curriculum, training for workers, apprentice schemes which improves skills in the labour force, improves productivity and drives down ULCs so higher price competitiveness
- More productive, highly skilled workers make higher quality products improving non price competitiveness
- Highly skilled labour force attracts FDI who want to take advantage
39
Q
What are evaluation points for supply side policies used to improve international competitiveness
A
- Very expensive so speak about opportunity cost, especially if benefit falls due to higher taxes required to fund
- Policies may not work e.g. firms with lower corporation tax may not invest with retained profits
- Time lag, e.g. education takes a long time to work so no short term boost
- Should be targeted e.g. UK needs it for productivity and regulation not investment and tax
- If another country is e.g. lowering corporation tax even more than you, you are not gaining international competitiveness
