International Trade

Why trade?

• Discuss reasons why the UK trades with other countries

Why trade?

• Discuss reasons why the UK trades with other countries

• Sell surplus goods and services• To export goods and services for money• Import goods and services which other

countries specialise in producing• Import goods and services which we cannot

produce

Who does the UK export to?

And what about imports?

Is trade new?

• No!• Countries have been trading for many years• However, the speed of travel, improved

communication and migration has meant that different goods and services are in wider supply and demand now

Free trade and protectionism

• Free trade – the exchange of products across national frontiers without restrictions or special taxes

• Protectionism – a range of measures which can be used to protect an economy from imports and/or to make exports more attractive

What are the benefits of international trade?

What are the benefits of international trade?

• Higher output – e.g. for export• Higher consumption e.g. importing goods that

people demand• Specialising in goods that a country has a

comparative advantage in, meaning increased efficiency and higher living standards

• Better international relations?

Absolute and comparative advantage

• Absolute advantage – the ability to produce good more efficiently

• Comparative advantage – the ability to produce a good relatively more efficiently i.e. at a lower opportunity cost.

• The theory of comparative advantage indicates that global resources can be used more efficiently when countries specialise in producing those goods and resources in which they have a comparative advantage.

Comparative advantage

• Calculate the ratio of bread to bananas for both countries below

Georgeland Martinland TOTAL

Bread 200 160 360

Bananas 200 80 280

Comparative advantage• Calculate the ratio of bread to bananas for both

countries below• Georgeland bread:bananas = 1:1• Georgeland bananas:bread = 1:1• Martinland bread:bananas = 1:0.5• Martinland bananas:bread = 1:2

Georgeland Martinland TOTALBread 200 160 360

Bananas 200 80 280

Comparative advantage

• Martinland has a comparative advantage in bread as to produce 1 more unit of bread it only has to give up 0.5 bananas – whereas to produce more bananas it has to give up 2 units of bread.

• It would make sense for Martinland to produce bread and Georgeland to produce bananas – they can trade the surplus and world output would be higher

However….

Assumptions underlying the concept of comparative advantage•Perfect occupational mobility of factors of production - resources used in one industry can be switched into another without any loss of efficiency•Constant returns to scale (i.e. doubling the inputs in each country leads to a doubling of total output)•No externalities arising from production and/or consumption•Transportation costs are ignored

What determines comparative advantage? • Comparative advantage is a dynamic concept. It can and does change over time.• For a country, the following factors are important in determining the relative costs of

production:• The quantity and quality of factors of production available (e.g. the size and efficiency of

the available labour force and the productivity of the existing stock of capital inputs). If an economy can improve the quality of its labour force and increase the stock of capital available it can expand the productive potential in industries in which it has an advantage.

• Investment in research & development • Movements in the exchange rate. An appreciation of the exchange rate can cause exports

from a country to increase in price. This makes them less competitive in international markets.

• Long-term rates of inflation compared to other countries. For example if average inflation in Country X is 4% whilst in Country B it is 8% over a number of years, the goods and services produced by Country X will become relatively more expensive over time. This worsens their competitiveness and causes a switch in comparative advantage.

• Import controls such as tariffs and quotas • Non-price competitiveness of producers

Protectionist measures

• Tariffs • Quotas • Embargo • Exchange controls• Regulations • Subsidies

Why use protectionist measures?

• To protect – sunrise industries– sunset industries– strategic industries– domestic employment– from low wage competition– from unfair competition

• Improve balance of payments position

The Effects of Imposing a Tariff

B D C AQ

DS

DD

0

P

P1

Domestic SupplyPrice

WS1

World Supply

Real GDP

When the country engages in free international trade the price (P) is set where domestic demand equals world supply. Domestic consumers buy A amount at this price. Of this quantity, 0-B amount is bought from domestic suppliers and B-A is imported. The imposition of a tariff causes a decrease in foreign products sold in the home market, shifting world supply to WS1. Domestic consumption falls to C, of which 0-D comes from domestic suppliers and D-C is imported.

Effect of A Quota

If the exporting country is prepared to sell at price Pft then Dft represents domestic demand, of this domestic demand Sft is supplied by domestic producers. And the remainder (Dft – Sft) is imported from the exporting country.

WTO

• Aims to reduce, or even eliminate, all barriers to trade

• They conduct;– Trade negotiations– Implementation and monitoring– Dispute settlement

The EU

The EU

• Member states in the EU act as ONE country in terms of international trade, with a Common External Tariff (CET) against other countries

• ANY protectionist measure between EU members, including subsidies, are ILLEGAL under EU law

Other Free Trade Areas

NAFTA

Other Free Trade Areas

ASEAN

Other Free Trade Areas

EFTA

Other Free Trade Areas

COMESA