Theme 4 - Trade and protectionism Flashcards
what is absolute advantage
occurs when a country can produce a product using fewer factors of production than another nation
what does comparative advantage state
that a country should specialise in the goods or services it could produce at the lowest opportunity cost, and then trade it with another country
for each country to be able to exploit their comparative advantage. what needs to happen
- a rate of exchange has to be suitable, and that rate of exchange must lie between the opportunity cost ratio of production for the two given countries
what determines whether or not a country has comparative advantage
the quantity and quality of factors in the nation, eg Ghana may be able to produce more cotton due to fertile soil
what is free trade
trade between countries with no barriers in the way
benefits of free trade
Increased efficiency and resource allocation:
- Countries specialize in goods where they have a comparative advantage, focusing on what they produce most efficiently.
- This leads to better global resource allocation, increasing overall productivity and reducing waste.
Access to goods not produced domestically:
- Countries can import goods that are difficult or impossible to produce locally.
- Consumers and businesses have access to a wider range of products, improving living standards and production capacity.
Lower prices and competition:
- Free trade fosters competition, encouraging firms to lower prices to remain competitive and adopt better technologies.
- Consumers benefit from lower prices, while economies of scale and technological transfers boost industry efficiency.
Greater consumer choice:
- Open markets introduce a variety of products from different countries.
- Consumers enjoy a broader selection of goods, improving quality of life and driving firms to innovate to meet diverse demands.
Economic growth:
- Increased trade boosts exports and foreign investment, which stimulates economic activity.
- This leads to higher GDP growth, job creation, and improved living standards in the long run.
impact on consumer and producer surplus when free trade occurs
lower prices, greater choice, consumer surplus increases
- Free trade introduces lower-priced imports.
- Consumers can buy goods at a lower price due to increased competition and access to cheaper foreign products.
- The reduction in prices allows consumers to save money, increasing their surplus.
producer surplus decreases - Domestic firms face lower-priced imports, forcing them to lower their prices to remain competitive.This reduces the revenue per unit for domestic producers, decreasing their producer surplus.
what is dumping
when a country sells a good below its cost of production
reasons for protectionism
Infant industries
- Small or new industries struggle to compete with established foreign firms that benefit from economies of scale.
- Protectionism allows these industries time to grow, eventually achieving economies of scale and becoming internationally competitive.
Protection against ‘dumping’
- Foreign firms may sell goods below cost to dominate the market, hurting domestic producers.
- Tariffs or quotas prevent this, allowing domestic firms to remain competitive and sustain production.
To protect domestic employment
- Cheap imports can outcompete domestic goods, leading to job losses in local industries.
- Limiting imports preserves domestic jobs, particularly in industries that are vulnerable to foreign competition.
To increase tax revenue (tariffs)
- Governments can impose tariffs on imports to generate revenue.
- This extra tax revenue can be used to fund public services or reduce deficits, benefiting the broader economy.
To protect against unfair low labour costs
- Countries, especially in Asia, may produce goods with significantly lower labor costs, making domestic products uncompetitive.
- Protectionism shields local industries from unfair competition, supporting higher-wage jobs domestically.
To improve the current account deficit
- High levels of imports can worsen a current account deficit, harming the overall economy.
- Restricting imports encourages consumers to buy domestically, reducing the deficit.
To reduce the risk of overspecialisation
- Relying too heavily on one sector or industry makes an economy vulnerable to shocks.
- Protectionism diversifies production by encouraging other industries, making the economy more resilient to external changes.
what is protectionism
policies that restrict international trade
evaluation points for comparative advantage
- Imperfect knowledge
- Producers and consumers may lack accurate information on global markets and costs.
- This could lead to inefficient resource allocation and the failure to fully exploit comparative advantages.
Transport costs are not considered
- High transportation costs can negate the cost advantage of producing in a lower-cost country.
- This could distort trade patterns, making it less efficient or less profitable to trade based on comparative advantage.
Economies of scale not included
- Larger firms may benefit from economies of scale, which can alter their cost structures and comparative advantage.
- This omission means the model may not reflect real-world cost advantages that come from scaling production.
Rates of inflation ignored
- Countries with high inflation may lose competitiveness over time, affecting their comparative advantage.
- Ignoring inflation could lead to trade imbalances and distort long-term trade benefits.
Import controls not included
- Tariffs, quotas, and other import controls may restrict the flow of goods, preventing countries from fully benefiting from comparative advantage.
- This leads to reduced efficiency and higher costs for consumers.
Non-price competitiveness is ignored
- Factors like quality, brand reputation, and customer service also play a role in trade.
- The model overlooks these aspects, focusing solely on price, which can give an incomplete picture of trade dynamics.
Exchange rate movements are ignored
- Fluctuations in exchange rates can alter the relative cost of imports and exports, affecting comparative advantage.
- This could lead to sudden shifts in trade patterns, making it difficult for countries to maintain a consistent advantage.
R&D investment ignored
- Investment in research and development can shift comparative advantage by improving productivity or creating new technologies.
- Countries that innovate may outperform those relying solely on natural comparative advantages, which the model doesn’t account for.
what is a tariff
a tax on imports
describe a tariff diagram
wordle supply shifts up
- the vertical distance between the two supply curves is the actual value of the tariff
- raises price in the market
- theres an extension of supply and a contraction in demand
- the top box represents the revenue generated from the tariff
- triangle on the right represents deadweight welfare loss of consumer surplus
- triangle on the left represents deadweight welfare loss of world effeciency
- resources are being provided to more inefficient producers when they shouldnt be
impacts of a tariff
price - Consumers face higher prices for both imported and domestic goods.
domestic demand - decreases
disadvantages of a tariff
- Tariffs distort the efficient allocation of resources.
- Resources are diverted towards less efficient domestic industries instead of being allocated based on comparative advantage.
- Global economic welfare decreases, and countries may lose out on potential gains from trade. - Tariffs raise prices and reduce consumer choice.
- Consumers face fewer options as imports become more expensive
- Consumer surplus decreases as they pay more and access fewer goods, - Tariffs protect inefficient domestic industries.
- Domestic producers, shielded from foreign competition, may lack the incentive to innovate or reduce costs.
- Domestic firms may operate inefficiently, increasing long-term production costs and reducing competitiveness. - Tariffs can provoke retaliation from other countries.
- Other nations may impose tariffs on exports from the tariff-imposing country in response.
- Retaliatory trade barriers harm global trade relations, potentially reducing exports and economic growth in both countries.
5.Tariffs disproportionately hurt lower-income households. They are regressive
- Since tariffs increase the prices of essential goods, lower-income consumers spend a larger portion of their income on these higher-priced goods.
- Tariffs act as a regressive tax, worsening inequality and reducing affordability for vulnerable groups.
- The effect of tariffs is influenced by how elastic supply and demand are.
- If domestic supply is highly elastic, producers can quickly increase output to meet demand, reducing inefficiency. If demand is inelastic, higher prices won’t drastically lower consumption.
- The negative effects of tariffs may be less severe if domestic markets can adjust efficiently to higher prices.
what is a quota
a quantity limit placed on the number of imports coming into a country
quota diagram explanation
- set your quota in between q1 and q2
- creates an excess demand. (normally, excess demand in free trade is satisfied by imports but we cant import anymore)
- excess demand puts alot of pressure of the price, which causes it to increase
- contraction of demand and extension of supply
- right triangle is the deadweight welfare loss of cs
- left triangle is DWL of world efficiency
what is a trade subsidy
a subsidy given to domestic suppliers in order to reduce their cost of production and pass that lower price on through lower prices
the value of the subsidy is…
the vertical distance between the two supply curve
advantages of trade subsidies
- Increased Competitiveness
- Subsidies reduce the production costs for domestic firms, allowing them to sell goods at lower prices.
- This improves their competitiveness in domestic markets, increasing their market share. - Protection of Infant Industries
- Subsidies can support infant industries that may struggle to compete with established foreign firms.
- This allows them time to grow and achieve economies of scale, becoming more efficient and competitive in the long term. - Encourages Innovation
- Subsidies provide financial stability for firms, allowing them to invest in research and development.
- This leads to product innovation, technological advancements, and improvements in productivity. dynamic efficiency
Disadvantages of Trade Subsidies to Domestic Firms
- Market Distortion
- Subsidies can distort the free market, leading to inefficient allocation of resources.
- Domestic firms may become dependent on subsidies and fail to improve productivity or innovate, which leads to long-term inefficiency. - Opportunity Cost for Government
- Subsidies require significant government spending, which diverts funds from other critical areas like healthcare or education.
- This can lead to budget deficits or higher taxes, negatively impacting the overall economy. - Retaliation and Trade Wars
- Trade subsidies can provoke retaliation from other countries, leading to trade disputes or tariffs on domestic exports.
- This can reduce access to international markets, hurting domestic firms in the long run. - Inequity Across Sectors
- Subsidies often benefit specific industries, leading to inequity and favouring certain sectors over others.
- This can distort economic growth and lead to over-reliance on subsidized industries, while non-subsidized sectors may suffer
what is the WTO(World trade organisation)
an international organisation that promotes world trade
- promotes trade liberalisation
- settles global trade disputes
- 164 member states
according to the WTO, ideal trade would be….
- non discriminatory
- free from barriers
- predictable
- promoting fair competition
- beneficial for developing countries through special provisions
functions of the world trade organisation
- set and enforce rules on international trade
- monitor further trade liberalisation
- provide a forum for negotiating
- resolve trade disputes
- to increase transparency of the decision making process
- ## to help developing countries benefit fully from global trade
advantages of WTO
- they promote free trade
- the WTO reduces trade barriers, making international trade more accessible
- helps boost economic growth, increases market access for exporters, and provides consumers with more choice and lower prices - Resolve disputes
- the wto provides a platform to settle trade disputes between countries through an impartial process
- this reduces the chances of trade wars, ensuring stability and predictability in global trade relationships - encourages fair competition
- by promoting transparency and standard rules, wto ensures countries do not engage in unfair practices like dumping or excessive subsidies.
- this leads to a more level playing field, protecting smaller economies from being exploited - supports developing countries
- the WTO offers special provisions for developing nations, allowing them more time to adjust to free trade policies and providing technical assistance
- this helps these countries integrate into the global economy and benefit from trade
disadvantages of wto
- favours wealthy nations
- wealthier countries with more resources often dominate negotiations, pushing agreements that benefit their interests
- this can lead to policies that marginalise developing nations and limit their economic growth - reduces national sovereignty
- the WTO requires countries to follow global trade rules, which can conflict with domestic policies aimed at protecting local industries
- governments may lose the ability to independently manage their economies, particularly in sensitive sectors like agriculture
3 trade disputes can be lengthy
- the dispute resolution process can be slow, as majority of countries need to vote for a law to be passed and some countries can veto last minute
- this delay can hurt industries involved in disputes, reducing their competitiveness while waiting for outcomes
how would a reduction in tariffs lead to increased GDP
- countries specialise in the goods in which they have comparative advantage(lower opportunity costs)
- through trade, each country can now consume more in total as they focus on what they can produce more efficiently
- countries would then be consuming/producing more so this means an increase in GDP
examples and impacts of non tariff barriers
- import licensing
- requires importers to obtain authorisation before bringing goods into the country
- can create administrative hurdles that discourage imports
- may benefit local businesses , but can increase costs for importers, leading to inefficiences in the supply chain and higher prices in the long run
2.standards and regulations
- by imposing high standards that foreign producers must meet, countries can limit the imports of goods that do not comply
- these can encourage domestic producers and protect consumer safety. however they can also restrict market access for foreign competitors, resulting in lower CS
- local content requirements
- local content requirements state that a certain percentage of a product must be produced domestically
- this encourages companies to source materials and labour from within a country, thereby supporting local industries
- this can strengthen the domestic economy but also lead to higher production costs and limited availability of certain goods if businesses struggle to find suitable local suppliers
