The reasons for international trade Flashcards
factor endowment
The availability of capital, enterprise, labor, and land in an economy.
absolute advantage
a situation, where, for a given set of resources, one country can produce more of a particular product than another country.
Opportunity Cost Ratio
The quantity of one product compared to the quantity of another product that has to be sacrificed to produce it. For example, an opportunity cost ratio of one car: eight tables; this means that for every one car to be produced, eight tables are given up.
Comparative advantage
A situation where a country can produce a product at a lower opportunity cost than another country.
Free trade
International trade that is not restricted by taxes on imports and other policy tools designed to give domestic producers protection from competition from imports.
Free trade allows an efficient allocation of resources with countries being able to specialize on producing those products that they have a comparative advantage in.
The benefits of Free trade
Factor Endowments may differ. Through free trade, a country that has fertile land and appropriate climate to specialize in growing oranges while allowing countries that have financial institutions and appropriately educated workers in banking.
Allowing countries to specialize in the products they have a comparative advantage in should increase world output and employment and so should raise living standards.
The competition that may arise from free trade can put pressure on firms to keep their prices and costs down and raise the quality of their products. As a result, consumers may enjoy lower prices and better products than would have been the case in the absence of free trade. Firms may also be able to buy raw materials and capital goods at lower prices.
Firms might produce a higher output if they are selling to an international market. The higher output could enable firms to take greater advantage of economics of scale. Consumers may be able to buy a greater variety of products as they may have a wider choice of products.
Trading possibility curve
a diagram showing the effects of a country specializing and trading
Terms of Trade
A numerical measure of the relationship between export and import prices
Causes of Changes in the Terms of Trade
A favorable movement in the terms of trade occurs when there is a rise in export prices relative to import prices. For instance, export prices may rise by more than import prices or import prices may fall while export prices remain unchanged.
The causes of changes in the terms of trade are are changes in the demand for and supply of exports and imports, the price level and the exchange rate. An increase in the demand for exports would increase their price and so cause a favorable movement in the terms of trade.
A rise in a country’s relative inflatoin rate would also make its export prices higher relative to its import prices. A government reducing the exchange rate is sometimes referred to as a deliberate deterioration of its terms of trade. This is because it is a deliberate attempt to reduce export prices and raise import prices in order to make the country’s products more internationally competitive.
Prebisch Singer Hypothesis
It suggests that the terms of trade tend to move against countries that produce primary products. This is based on the view that demand for manufactured goods and for services than the demand for primary products when income increases.
Limitations of the theory of absolute and comparative advantage
Some countries don’t want to overspecialize
High Transport costs may offset the comparative advantage
The exchange rate may not lie between the opportunity cost ratios
Other governments may impose trade restrictions
The theory of comparative advantage assumes that resources are mobile and that there are constant returns.
It might be difficult to understand where a country’s comparative advantage lies.
