Theme 4 Flashcards
Assumptions of comparative advantage
- no transport costs
- no trade barriers
- constant return to scale (eg average cost of production is constant
- perfect mobility of resource between different uses
- buyers/ consumers have perfect knowledge
Formula for terms of trade
Index of export prices/index of import price x100
Limitations of comparative advantage principle
- transport costs might outweigh the benefit of comparative advantage
- similarly trade barriers might distort comparative advantage
- increased specialisation and production might result in rising average costs caused by diseconomies of scale
Advantages of specialisation
- efficient resource allocation
- higher world output and therefore higher living standards
- lower price and more choice for consumer
- incentive fro domestic producer to become more efficient
- larger markets for firm enabling them to benefit from economies of scale
Disadvantages of specialisation and trade
- the law of comparative advantage is based on unrealistic assumptions
- for developing economies, specialisation in the production of primary products might prevent diversification into more productive manufacturing industries
- there is a danger of overdepedence on imports especially those of strategic importance
- a country’s goods and services may be uncompetitive resulting in a persistent trade deficit.
Factors influencing a country’s term of trade
- relative inflation rates-if inflation is rising at a higher rate than trading parter mean export prices rising faster than import prices so causes a rise in terms of trade
- changes in raw material price -for a country that import most raw materials increase in price could cause a fall in terms of trade
- changes in exchange rate - if value of currency increase then exports will increase and imports will decrease so would result in a fall in the terms of trade
- tariffs- would lead to an increase in import prices resulting in a fall in terms of trade
- dependency on primary products-if a country is dependent on primary product may find its terms of trade decrease over time(Prebisch singer hypothesis)
Impacts of changes in a country’s terms of trade
- living standards- an upward movement in terms of trade is an improvement as it implies a country has to export less to buy a given quantity of import.
- balance of payments on current account if export prices are increasing more than imports makes exports less competitive meaning value of balance of payments is going to get worse(this in turn could depreciate the exchange rate)
- Inflation- A fall in terms of trade may be associated with high inflation.
- developed countries -sometimes suffer from (the resource curse) because ownership of minerals and fuels causes an appreciation in exchange rate leading to an increase in terms of trade . Meaning a loss of competitiveness in their manufactured goods and services leading to slower economic growth
Types of trading bloc
- free trade area
- customs union
- common markets
- monetary unions
Free trade area
-trade barriers are removed between member countries but individual members can still impose tariffs and quotas on countries outside the area
Customs union
-free trade between member states and a common external tariff on goods imported from outside the union
Common markets
-these are customs unions but with the added dimension that it is not only goods and services that can be moved freely within the area but also factors of production (labour)
Monetary unions
-thee are custom unions that adopt a common currency. Eg the eurozone
Cost of regional trade agreements
- trade diversion- trade me diverted from low cost producers outside the union to high cost inside because of high tariffs on goods outside the bloc
- distortion of comparative advantage -the existence of trade restriction on goods from countries outside the agreement will distort comparative advantage and lead to a less efficient allocation of resources, lowering global economic growth.
- loss of independent monetary policy- in monetary unions you cant control your interest rate or exchange rate
Benefits of regional trade agreements
- trade creation
- increased FDI
In addition monetary unions may get
- elimination of transaction costs -no costs when changing currencies when goods are imported or exported
- price transparency-consumers have the ability to compare prices more easily across national borders
- elimination of currency fluctuations-this eliminates uncertainty and might help attract FDI
Role of WTO
- to promote free trade between the 188 member countries
- to settle trade disputes between members
