the reasons for international trade chapter 25 Flashcards
factor endowment
the availability of capital, enterprise, labour and land in all economy
absolute advantage (used in the context of international trade)
a situation where, for a given set of resources, one country can produce more of a particular product than another country
why does international trade take place
International trade takes place because countries have different factor (resource) endowments. It is usually easier to move goods and services between countries than factors of production, and so international trade occurs.
what affects the types of products countries produce
The differences in factor endowment affect the types of products countries produce and the quality and quantity of the products, as well as their cost of production.
how can a country have absolute advantage in producing a product
A country has an absolute advantage in producing a product if it can produce more of the product with the same quantity of resources than another country.
what happens if a country specializes in the product in which it has an absolute advantage then trades based on opportunity cost ratios
total output will rise and both countries will be able to consume more products
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 means that the production of eight tables has to be given up to produce one car.
comparative advantage (used in the context of international trade)
a situation where a country can produce at a lower opportunity cost than another country. trade is more based on comparative advantage
why do some countries buy products from abroad when the country’s own producers can produce it with fewer resources
This allows the purchasing country’s producers to concentrate on producing those products they are even better at producing.
how can comparative advantage be illustrated
it can be illustrated as the no of goods produced or in terms of the factors of production needed to produce a given number of units of a product
free trade
international trade not restricted by taxes on imports and other policy tools designed to give domestic producers protection from competition from imports.
what happens when free trade exists
When free trade exists, firms are free to export and import what they want in the quantities they want. No taxes or limits are imposed on exports and imports, no subsidies are given to create cost advantages and there is no unnecessary paperwork (‘red tape’) involved.
what does free trade allow
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. free trade can also allow countries to use factor endowments of different countries.
what happens when when countries specialize in products where production is most efficient
Allowing countries to specialize in those products where their production is most efficient should increase world output and employment and so should raise living standards.
effect of free trade
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.
impact of international market on free trade
firms might produce a higher output. the higher output could enable firms to take greater advantage of economies of scale. consumers may also be able to buy a greater variety of products as they may have a wider choice of products. firms may also have a wider source of raw materials and capital goods
trading possibility curve
a diagram showing the effects of a country specializing and trading
imports
goods and services purchased from other countries
exports
goods and services sold to other countries
terms of trade
a numerical measure of the relationship between export and import prices
what influences the benefits it can gain from engaging in international trade
influenced by how many imports the country is able to purchase with the revenue it gains from the exports it sells. this, in turn, is influenced by the prices it receives for the exports it sells and the prices it pays for the imports it buys
formula of terms of trade index
index of exports prices/index of import prices * 100
what does it mean by the terms of trade increasing
this is described as a favorable movement or an improvement in the terms of trade. it means of fewer exports have to be sold to buy any given quantity of imports
what does it mean by the terms of trade decreasing
this is described as an unfavorable movement or deterioration in terms of trade means that the index number has fallen. now more exports will have to be exchanged to gain the same quantity of imports
when does a favorable movement occur
A favorable movement in the terms of trade occurs when there is a rise in export prices relative to import prices.
when does an unfavorable movement occur
An unfavorable movement occurs when there is a fall in export prices relative to import prices.
what are the causes of changes in terms of trade
changes in the demand for and supply of exports and imports, the price level and the exchange rate.
how does demand for exports affect trade
An increase in the demand for exports would increase their price and so cause a favorable movement in the terms of trade.
how does inflation rate affect prices
A rise in a country’s relative inflation rate would also make its export prices higher relative to its import prices.
what is determined deterioration of trade
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.
what does the Prebisch-Singer hypothesis suggest
The Prebisch-Singer hypothesis suggests that the terms of trade tend to move against countries that produce primary products.
what is the Prebisch-Singer based upon on
This is based on the view that demand for manufactured goods and for services rises by more than demand for primary products when income increases.
why can the impact of a favorable movement may not always be beneficial
This is based on the view that demand for manufactured goods and for services rises by more than demand for primary products when income increases.
why may an unfavorable movement in terms of trade may actually reduce a deficit on the current account of the balance of payments
If demand for exports and imports is elastic, the fall in export prices relative to import prices should increase export revenue relative to import expenditure.
why does absolute and comparative advantage not provide a full explanation of the pattern of international trade
Some governments may want to avoid overspecialization.
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.
problems with theory of comparative advantage
it assumes that resources are mobile and that there are constant returns. also countries do not always adapt to changes in comparative advantage. it may be difficult to determine where a country’s comparative advantage lies because of the vast number of product and many countries
