International Trade

Question 1

Advantage

Answer 1

• Absolute advantage: This occurs when one country can produce a good with fewer resources than another.
• Comparative advantage (David Ricardo): A country has a comparative advantage if it can produce a good at a lower opportunity cost: i.e. it has to forego less of other goods in order to produce it.
• The law of comparative advantage: This states that trade can benefit all countries if they specialise in the goods in which they have a comparative advantage.

Question 2

Benefits of Free Trade 1

Answer 2

1. Reducing tariff barriers leads to trade creation - Trade creation occurs when consumption switches from high cost producers to low cost producers.
   • The removal of tariffs leads to lower prices for consumers (P1 – P2) and an increase in consumer surplus (1+2+3+4)
   • The government will lose tax revenue of area 3
   • Domestic firms will sell less and lose producer surplus of area 1
   • However overall there will be an increase in economic welfare of (2+4)

Question 3

Benefits of Free Trade 2

Answer 3

2. Economies of Scale - If countries can specialise in certain goods they can benefit from economies of scale and lower average costs. This is especially true in industries with high fixed costs or that require high levels of investment.
3. Increased competition - With more trade, domestic firms will face more competition from abroad, therefore there will be more incentives to cut costs and increase efficiency. It may prevent domestic monopolies from charging too high prices.

Question 4

Benefits of Free Trade 3

Answer 4

4. Increased exports - If UK firms have a comparative advantage then, with lower tariffs, they will be able to export more and create more jobs.
5. Trade is an engine of growth - World trade has increased by an average of 7% since 1945, causing this to be one of the big contributors to global economic growth.
6. Make use of surplus raw materials - Middle Eastern counties such as Qatar are very rich in reserves of oil, but without trade there would be not much benefit in having so much oil.

Question 5

Arguments for Restricting Trade 1

Answer 5

1. Infant industry argument - If developing countries have industries that are relatively new, then at the moment these industries would struggle against international competition. Therefore they need tariff protection while they develop their industries to be more competitive.
2. The senile industry argument - If industries are declining and inefficient they may require large investment to make them efficient again. Protection for these industries could act as an incentive to for firms to invest and reinvent themselves.
3. Protection against dumping - The EU sold a lot of its food surplus from the CAP at very low prices on the world market. This caused problems for world farmers because they saw a big fall in their market prices. Tariffs can protect against dumping.

Question 6

Arguments for Restricting Trade 2

Answer 6

4. Need to diversify the economy - Many developing countries rely on producing primary products in which they currently have a comparative advantage. However, relying on agricultural products has several disadvantages:
   i) Prices can fluctuate due to environmental factors.
   ii) Goods have a low income elasticity of demand. Therefore even with economic growth, demand will only increase a little.
5. Environmental - It is argued that free trade can harm the environment because countries with strict pollution controls may find consumers import the goods from other countries where legislation is lax and pollution allowed.