Principles of International Trade

Question 1

What is trade?

Answer 1

Trade involves the exchange of good and service. International trade is the exchange of goods and services between countries.

Question 2

What are advantages of international trade?

Answer 2

• A country is able to export a good with low production cost through specialisation.
• Citizens of a country get the opportunity to import goods that aren’t domestically produced.
• Countries get to consume products made using the latest technology.
• Employment for supporting services such as insurance, transportation and banking may increase with the development of international trade.
• World output increases

Question 3

What are some disadvantages of free trade?

Answer 3

• Due to high quality and low cost imported goods to the domestic market may discourage domestic producers.
• If imports outweigh exports, BOP problems will arise.
• Illegal products may come into the country
• Specialisation could lead to a depletion in the factor endowments of a country.

Question 4

What are the two principles of trade?

Answer 4

1. Absolute advantage
2. Comparative advantage

Question 5

What assumptions are made in the principles of international trade?

Answer 5

• only two countries are involved in trade
• each country can produce two products only
• each country has the same amount of resources
• Productivity differs between countries, therefore quantities will differ.
• No transport costs are incurred
• No restrictions on free trade
• the exchange rate operating for international trade, must be between respective domestic opportunity cost ratios.

Question 6

Define the absolute advantage theory.

Answer 6

A country is said to have absolute advantage if it can produce a product more efficiently than another country, this means producing the highest number of output with a given level of resources. The cost is lower than another country to produce a given level of output.

Question 7

Define the comparative advantage theory.

Answer 7

This is where international trade is determined through the specialisation in the product with the lower opportunity cost. It will only take place when opportunity costs are different as otherwise no advantage would be gained.

Question 8

What is the process of finding the comparative advantage?

Answer 8

We calculate the opportunity cots for both the countries producing two products and determine the specialisation of a product based on the lowest opportunity cost from the two countries.

Question 9

What are the limitations of absolute & comparative advantage?

Answer 9

• In today’s economy, transport costs are incurred.
• The assumption that there are only two countries operating and two products are produced is unrealistic
  -Production costs are unlikely to be constant
  -The assumption that there are no trade restrictions
• a government may decide not to overspecialise but to diversify production.
• It doesn’t consider political influences, obligations of trade agreements and trade in non homogenous goods.

Question 10

What’s a trading possibility curve? (TPC)

Answer 10

It shows the consumption combinations possible through specialisation. It shows how a economy benefits from international trade.

Question 11

What is the process of constructing a TPC?

Answer 11

-Firstly we calculate the opportunity costs of producing both the products to both countries.
- We determine the country to specialise in a product based on the lowest opportunity cost.
-Thirdly, we multiply decimal answers to get 1 complete unit.
- we then determine the exchange rate by calculating the midpoint, for mutual benefit.
- we finally construct the TPC illustrating the curves post trade and pre trade.

Question 12

What is the World trade oragnisation?

Answer 12

It is the only global international organisation dealing with the rules of trade between nations. Their goal is to help producers of goods & services, exporters and importers conduct their business.

Question 13

What is a trade bloc?

Answer 13

It is a group of countries situated in the same region that join together to enjoy the benefits of free trade and to eliminate trade barriers among member countries.

Question 14

What are the types of trade blocs?

Answer 14

Free Trade Area (FTA)
Customs union
Common market / single market
Economic union

Question 15

What is a free trade area?

Answer 15

A FTA is a trade bloc whose member countries have signed a free trade agreement, which eliminates tariffs and quotas among them, where members have the freedom to decide their own trade barriers for non member countries.

Question 16

What is a customs union?

Answer 16

A group of countries come to an agreement to trade without barriers among themselves and set a common external tariff with nonmember countries.

Question 17

What is a common market?

Answer 17

This represents a deeper form of integration than the customs union. In addition to free trade of goods and services, it allows the movement of factors of production.

Question 18

What is an economic union?

Answer 18

This is the highest form of integration which allows the free trade of goods and services with common economic policies. It includes a common external tariff, harmonisation of economic policies, free movement of factors of production and a common currency. This increases dependance. It also works towards creating a single currency with centralised economic policies.

Question 19

What are the advantages of an economic union ? i.e Economic monetary union is an example of one.

Answer 19

-No transaction costs. No costs are incurred for the conversion of currencies.
- Price transparency. It is easy to compare prices of goods across the countries.
- Encouragement of Foreign direct investment - This involves investment in the form of a controlling ownership in a business in one country by an entity based in another country.

Question 20

What are the drawbacks of an economic union?

Answer 20

• The loss of an independent monetary policy, indicates the inability for a country to set its own interest rates.
• loss of exchange rate flexibility
• Transition cost, the costs involved in changing from one currency to another.

Question 21

What is trade creation?

Answer 21

It occurs when a country moves from buying goods from a high cost country to a low cost country. This occurs due to the removal of tariffs and allows countries to specialise in products with a lower opportunity cost = comparative advantage.

Question 22

What is trade diversion?

Answer 22

It takes place when a country moves from buying goods from a low cost country to a high cost country. This occurs when membership of a trading bloc results in a country buying imports from a less efficient country within the bloc rather than from a more efficient non member country.

Question 23

What are the advantages to member countries of economic integration?

Answer 23

Increased trade volume
Increased GDP
Higher income
Trade creation
wider choice
higher living standards

Question 24

What are the disadvantages to member countries of economic integration?

Answer 24

High unemployment- After joining a trade bloc, elimination of protectionism may lead to a problem of survival of infant and sunset industries.
-Small businesses may collapse-
-Trade diversion
- It encourages regional trade and not global trade
- Firms within a trading region can merge and become too powerful, this may result in monopolies which might exploit consumers within the block.