Unit 4: Chapter 1 - Why trade? Flashcards
What is free trade?
This occurs when there are no barriers to trade
What is an example of a barrier to trade?
Taxes on imported goods AKA tariffs
What is a benefit of free trade in terms of comparative advantage?
World output can be increased if countries specialise
What is a benefit to free trade in terms of economies of scale?
Trade allows economies of scale to be maximised therefore costs per unit are reduced as small countries can buy goods in bulk - at the same time they can produce and export goods where they have developed economies of scale
What is a benefit of free trade in terms of choice?
Can choose a wider range of goods therefore consumer welfare is increased
What is a benefit of free trade in terms of innovation?
More competition with firms abroad which provides a powerful incentive to innovate - consumer welfare increases again, firms will compete to find production methods which cut costs and improve quality
How does specialisation encourage innovation?
Countries become experts in their fields
What does a lack of free trade lead to?
Domestic markets being dominated by a few firms
What is a benefit of free trade in terms of PPFs?
It allows countries to have more than their PPFs allow
What is a cost of free trade in terms of overdependence?
Countries can become overdependent on foreign trade e.g. small countries can become overdependent on one or two commodities they are exporting, if the price of these commodities were to fall then these countries could suffer a big fall in GDP - this is known as primary product dependency
What is a cost of free trade in terms of jobs?
Changes in demand can lead to unemployment
What is a cost of free trade in terms of risk?
Demand for a country’s exports may fall or supplies can be cut by a foreign country, there can be credit crises which cut off finance for a country
What is a cost of free trade in terms of the environment?
Trade and increased output can lead to environmental degradation and unsustainable development which leads to negative externalities
What is a cost of free trade in terms of income distribution?
The benefits of trade may go mainly to the rich elite within a nation thus widening inequality and if the benefits of trade go mostly to another country then a nation may find itself less well off
What is the theory of absolute advantage?
All nations could gain simultaneously if they practiced free trade and specialised in the production of goods they were ‘best’ at producing
When is a country said to have an absolute advantage over another country?
If it can produce more of a good using the same amount of resources
What is the opposite of the theory of absolute advantage?
Mercantilism which encourages protectionism and self-sufficiency
With what condition would both countries (involved in the theory of absolute advantage) be better off through specialisation?
Provided they were willing to trade those goods in which they had a natural or acquired advantage
What is the theory of comparative advantage?
Even when one country has an absolute advantage in the production of both goods, it is still possible for trade to be beneficial for both countries
When is a country said to have a comparative advantage over another in the production of a good?
If it can produce it at a lower opportunity cost
What are different opportunity costs represented by graphically?
Different gradients
What does the theory of comparative advantage allow for?
A country to consume on a point outside its own PPF and a more efficient use of scarce resources
What is the circumstance in which trade is not viable?
When both countries have identical opportunity costs as the slopes of the PPFs would be identical and therefore no comparative advantage would exist
What are the factors that affect a nation’s comparative advantage and competitiveness?
Training, research and development, tax regimes, wages, exchange rates
What could ever-increasing specialisation lead to?
Diminishing returns which limits the gains from specialisation
What is a natural limitation that prevents a country from exploiting the gains of trade?
Transport costs
How have transport costs become less of a limitation of exploiting the gains of free trade?
The costs of moving freight by air or sea continue to fall
Why may countries be unwilling to become too specialised?
Fear that this will make them too dependent on other countries
Why could specialisation become a particularly acute problem?
If political tensions arise between countries or at the extreme, in the event of war
What are some evaluation points on the theories of absolute and comparative advantage?
Transport, strength of the exchange rate, the type of goods that are being exchanged e.g. perishable and single buyer/seller leads to distorted power
What is protectionism?
The implementation of barriers to trade between states through methods such as tariffs, restrictive quotas, subsidies and administrative controls
Why do governments engage in protectionism in terms of new-born industries?
To protect these industries that would not be able to cope with the fierce international competition of established firms as they have not experienced economies of scale yet
Why would governments want to engage in protectionism in terms of revenue?
It increases government revenue
Why do governments engage in protectionism in terms of senile industries?
They want to protect industries in decline due to more competitive industries abroad, they want to preserve cultural industry as want to maintain heritage
Why do governments engage in protectionism in terms of the balance of payments?
If a country is experiencing balance of payment difficulties then it may engage in protectionism if other measures fail to correct a current account deficit
Why do governments engage in protectionism in terms of employment?
Cheap imports will cause unemployment in the domestic economy and therefore protectionism will create unemployment
What is the effect of protecting domestic employment?
Could lead to a multiplier effect as employment increases
Why do governments engage in protectionism in terms of subsidies?
Products that have been subsidised by foreign governments might be restricted if dumping them on the domestic market will put domestic producers at a disadvantage - subsides may be viewed as unfair competition
What may be done to retaliate against those subsidised goods?
A tariff may be imposed on those subsidised imports to raise the competitiveness of the domestic alternative
Why do governments engage in protectionism in terms of strategic importance?
Key industries such as steel and weapons manufacturing may be of strategic importance during times of war so a government might want to retain these industries
Why do governments use sanctions?
They are used against some countries for political reasons
What are tariffs?
Tariffs are a percentage tax on the price of a good, the objective of the tariff is to raise the price of an imported good making the domestic alternative relatively competitive
What are the effects of tariffs?
Consumer surplus decreases, producer surplus increases and government revenue increases
What are some evaluation points on tariffs?
What is the size of the tariff and the effects depend on the relative elasticities
What does the rise in price due to tariffs cause?
An expansion in domestic production which may have inflationary consequences
What effect does a tariff have on employment?
It may lead to the employment of more workers
How does a tariff affect the current account?
It reduces the levels of imports which improves a current account deficit
What effect does a tariff have on the budget deficit?
It raises government revenue which could be used to reduce the government’s budget deficit
Why is there a loss of consumer surplus with a tariff?
Consumers will face higher prices
Why does producer surplus increase with a tariff?
Producers get a better price for their product therefore it is more profitable whereas without the tariff, they may have had to shut down
What are the indirect effects of tariffs?
Will distort comparative advantage and lead to a misallocation of resources, risk of retaliation from trading partners, will lead to cost-push inflation and higher prices will affect lower income groups disproportionately leading to greater inequality
What are quotas?
They limit the physical quantity of goods that can be imported into a country
What is the effect of quotas on consumer and producer surplus?
It reduces consumer surplus and increases producer surplus
Why is the net welfare loss with a quota greater?
It does not collect any revenue for the government
What would happen if the quota was set to zero?
The price would rise to the domestic equilibrium which has the same effect as a trade embargo on that good
What are exchange controls?
They deliberately limit the amount of foreign exchange available to individuals and firms wishing to import goods - this is basically restricting foreign currency in markets
What are administrative barriers?
A subtle way of protecting the economy and they can take the form of rejecting potential imports because they do not conform to certain heath and safety standards or the existence of unusually lengthy delays at customs posts
What do embargoes do?
They ban products that are deemed to be dangerous
What does a subsidy do?
A subsidy to domestic producers gives them a cost advantage over competitors, it lowers the cost of production for domestic producers and encourages supply
What is an example of a subsidy?
The common agricultural policy in the EU
What is an evaluation of protectionism in terms higher prices for consumers of imported goods?
Trade barriers in the form of tariffs push up the prices faced by consumers and insulate inefficient sectors from competition, they penalise foreign producers and encourage an inefficient allocation of resources, import controls impose costs on society that would not exist if there was completely free trade, protectionism prevents consumers from cheaper prices and denies the shift in acquired advantage
What is an evaluation of protectionism in terms of the reduction in market access for producers?
Export subsidies depress world prices while depriving efficient farmers’ overseas access to the world market
What is an evaluation of protectionism in terms of the deadweight loss?
This loss arises from the loss of allocative efficiency, welfare is reduced through higher prices and restricted consumer choice, the extent to which welfare is lost depends on then elasticity of the domestic supply and demand curves (there is a larger loss the more elastic the curves are)
What is an evaluation of protectionism in terms of the regressive effect on the distribution of income?
Higher prices from tariffs hit those on lower incomes the hardest, tariffs fall on products that lower income families spend a higher share of their income on, the allocation of scarce resources becomes less equitable, tariffs, non-tariff barriers and other forms of protection serve as a tax on domestic consumers
What is an evaluation of protectionism in terms of market distortion?
Protectionism has proved an ineffective and costly means of sustaining employment
What is an evaluation of protectionism in terms of trade wars?
There is the danger that one country imposing import controls will lead to retaliatory action by another leading to a decrease in world trade - retaliatory actions increase the costs of importing new technologies
What is an evaluation of protectionism in terms of jobs?
Protectionism prevents unemployment that might arise from a flood of cheap imports which puts domestic firms out of business, taxes lead to higher costs for firms meaning they may have to lay off some workers
In the long run, acquired advantage changes due to…
What should this induce a gradual shift in the pattern of?
An economy’s skills and capital and technology change,
this should induce a gradual shift in the pattern of employment
What types of unemployment could protectionism cause?
Structural and regional
What can the government do to avoid the types of unemployment that protectionism causes?
Can help people move into these new occupations via training but strategies to influence geographical mobility are more limited
What is the effect of economies having to adapt to the changes in acquired advantage?
One diminishing economy could lead to another growing as resources are shifted
What causes the changes in patterns of trade?
The ability to produce goods and services shifts globally, movements in relative prices of traded products in many international markets, the economic growth and development in particular countries and foreign investment decisions of multinational companies
How did the global financial crisis affect trade patterns in China?
There was a big rise in imports of goods into China and a sizeable reduction in their trade surplus
What has been the effect of the UK joining the EU?
The majority of UK trade in goods and services is with countries in the EU and the single market has led to the creation of trade within the EU and some diversion of trade away from countries outside the EU
What is de-coupling?
Stronger domestic consumption of goods and services and an economy less reliant on global trends and domestic shocks
Why is Africa not involved in world trade?
Low purchasing power, lack of openness to trade and many constraints to growth
