Trade Flashcards
Define the law of comparative advantage
- It states that countries should specialise in goods and services that they can prodcue at a lower opportunity cost compared to another country.
- Together more can be produced from the same resources —> both countries benefit by consuming beyond their PPC with Q maximised & P low given the gains of specialisation
Countries specialising according to comparative advantage will mean …
An improvement in allocative efficiency
* As resources go to countries who are the most efficient producers
* Maximsing output and thus satisfy consumer demand as possible
Define absolute advantage
- Where one country is able to produce a greater quantity of a good or service compared to another country using the same quantity of factors of production.
- Therefore a country with absolute advantage can produce a good/service cheaply than another coutnry in absolute terms
A country can gain comparative due to…
Either greater quantities / better quality of FoP compared to another country
* e.g. a greater abundance/quality of natural resources, higher quantity/quality of labour/capital
Give a concern of comparative advantage
What can this result in?
Countries must be mindful of over-specialisation
* Results in import dependance, unbalanced growth and income inequality
Why can countries without comparative advantage producing at higher costs, charging higher prices, still survive and be successful?
What does this implying?
- Trade patterns in the world are not concentrated only to the country with a comparative advantage when purchasing goods and services as the law of comparative advantage suggests.
- Countries may import goods and services from more inefficient producers who lack comparative advantages, contradicting the theory.
- This being true, implies that some assumptions of comparative advantage theory may not fully apply in reality
- Explaining why countries without a comparative advantage producing at higher costs, charging higher prices, can still survive and be successful.
Give evaluative points for comparative advantage
1) It assumes perfect information for both producers and consumers. –> However, if consumers lack information of where the cheapest goods are being produced, they may buy from an inefficient producer allowing these businesses to survive and be profitable.
2) Transport costs are assumed to be zero –> This clearly does not hold in the real world. Large transport costs may erode a country’s comparative advantage and make it cheaper to import goods from a less efficient producer located closer.
3) It assumes no economies of scale advantages –> Countries may leverage economies of scale to compete with those possessing a comparative advantage, potentially leading to a shift in comparative advantage in production over time.
4) Ignores the impact of exchange rate changes. For example, a country with a comparative advantage will lose out to another less efficient producer if their exchange rate strengthens (SPICED). The other country will benefit from more competitive exports, eliminating a comparative advantage cost difference, and thus can be successful despite not being as efficient.
5) High inflation rates over time can erode the price competitiveness of goods and services produced in countries with a comparative advantage. If this persists in the long run, the comparative advantage might be lost.
6) Governments in countries with limited comparative advantage use protectionist measures like tariffs, quotas, subsidies, and non-tariff barriers to raise the prices of imports from countries with a comparative advantage. –> This helps domestic producers compete better in the market. –> However, these measures distort the natural balance of comparative advantage and impact how international trade operates.
7) Countries without the comparative advantage may be highly non-price competitive. –> This is because these countries might have focused more on service quality, branding, advertising etc –> providing them a strong consumer base to sell to despite being pricier than countries with the comparative advantage. –> Consumers do not only consume based on price but non-price factors –> Therefore, less efficient producers can still be profitable without the comparative advantage.
What is meant by free trade?
Trade without restrictions or regulations on imports or exports
List 5 arguments in favour of free trade
- Exploitation of comparative advantage
- Large economies of scale
- Increased competition and lower prices
- Increased choice for consumers and firms
- Higher rates of economic growth
Explain how the explotiation of comparative advantage can be used as an argument in favour of free trade
- Free trade enables countries to specialise in goods where they have a comparative advantage
- This increases economics welfare for all countries
- With greater free trade and specialisation, resources are allocated where countries have their comparative advantages (a cost advantage over other producers).
- As a consequence allocative efficiency is attained as resources go to countries who are the most efficient producers to maximise output and thus satisfy as much consumer demand as possible.
- With money to act as a means of exchange, the basic economic problem is solved maximising net benefit to both consumers and producers.
Explain how large economies of scale can be used as an argument in favour of free trade
- With a larger international market to access, firms have the potential to grow much larger and sell to many more consumers all around the world.
- With greater benefit from purchasing and technical economies for example, firms will lower their average costs of production increasing productive efficiency.
- Lower costs translate into higher profitability and potentially lower prices for the consumer.
Explain how increased competition and lower prices can be used as an argument in favour of free trade
- With a larger market to access, competition becomes global.
- This leads to allocative efficiency and great benefit to the consumer in the form of lower prices, higher quantity, higher quality, and greater choice.
- Furthermore, firms may be forced to re-invest and be innovative whereby consumers benefit from the best quality of goods/services.
Explain how increased choice for consumers and firms can be used as an argument in favour of free trade
- Firms can source raw materials from all around the world at the cheapest prices.
- Similarly, consumers can access a greater market to buy their goods and services from.
- Firms benefit from lower costs of production, which can lead to lower prices, and higher profits.
- For consumers, their welfare and living standards can improve.
Explain how increased higher rates of economic growth can be used as an argument in favour of free trade
- Greater market size and specialisation means higher export potential and government revenue generated from exports for countries with large comparative advantages.
- This increases AD thus economic growth will increase.
- Unemployment will decrease as labour is a derived demand, derived from the demand for goods and services.
- Therefore with more economic growth, firms will respond by hiring more labour, once more increasing incomes and living standards.
What is meant by protectionism?
Any barrier (e.g. quotas/tariffs) that restricts free trade to protect domestic prodcuers form foreign competetition
