Terms in this set (28)
What is Absolute and Comparative Advantage? Define a Trade-off
Absolute Advantage- refers to a country's ability to produce a certain good more efficiently than another country. The real world is far more complicated than this. David Ricardo, an early 19th century British economist argues that these simple principles can be used to explain International Trade. Countries can be rational operators and eventually produce products in which they have a comparative advantage thus having a comparatively low opportunity cost.
Comparative Advantage- refers to a country's ability that specializes in the production of a good that they are relatively efficient in producing in comparison to another country.
Trade-off- The exchange of one thing for another, trade-offs create opportunity costs.
Define Imports, Exports, Visibles, Invisibles, Onshore services and Offshore services
Imports- The movement of commodities into the country.
Exports- The movement of commodities out of the country.
Visibles- tangible products, goods.
Invisibles- intangible products, services.
Onshore services- provided by the exporting country to foreign buyers who must come to the country that created them to consume them e.g. Tourism
Offshore services- provided by the exporting country to individuals overseas.
Why has trade developed?
Trade has developed due to specialization: regions/countries focus on producing goods they have an advantage in.
Interdependence- countries rely on each other to produce goods they need or can't produce efficiently.
- A surplus of goods causing exports in a country. Little incentive to produce at domestic price as the world price ensures profit.
- A shortage of goods in a country thus we import.
Define Trade and Free Trade
Trade- the exchange of goods and services between countries.
Free Trade- occurs when there are no barriers to imports or exports. Trade occurs unhindered without interference.
What are the advantages of Free Trade?
- The exploitation of a country's comparative advantage.
- Increase in economic growth, as the countries involved are more competitive.
- Increases economies of scale as a country produces a narrow range of goods and services
- Increased competition means entrepreneurs are motivated to innovate thus increasing employment
- Transfer of skills and technology
- Increase income means more savings and investment
- Production increases, utilizing unused resources. More income in the domestic economy, hence more spending.
What are the disadvantages of Free Trade?
- Price of primary exports decrease relative to the price of manufacturing goods, income inelastic.
- Increased domestic economy instability
- Producers of manufacturing goods hold a monopoly- use this to maintain a high price.
- Production occurs with inappropriate resources- abundant labour.
- Over-specialization occurs: local producers suffer due to cheaper imports.
- Difficulty for new industries to be established
- Increase cost of production
- Pollution and environmental problems
- Companies fail to include their costs in the price of goods as they compete with other firms.
What is protectionism?
Protectionism- Occurs when a government protects its domestic firms against foreign competition.
Types of protectionism include: Tarrifs, Quotas, Subsidies and Embargoes.
What are Tariffs?
Tariffs- A tax on imports to make imports more expensive and encourage consumers to switch to domestic goods and services.
- Domestic producers gain as they get higher prices and sell larger quantities.
- Higher domestic production leads to higher domestic employment
- Government gains revenue from tariffs.
- Tariffs are regressive thus worsen income distribution
- Exporting countries lose due to fall in exports.
What are Quotas?
Quotas- a limit on the number of foreign goods and services allowed into a country
- Leads to a reduction in the quantity imported.
- Increases market price of imported goods: consumers pay more and domestic producers gain as they sell more at a higher price.
- Domestic production increases and consumption falls
- Domestic employment increases as domestic production rises.
- Government gets Quota revenues and exporting countries lose revenue.
- Domestic society is worse off due to decrease in consumption and production by less efficient producers.
What are Subsidies?
Subsidies- A payment to domestic producers who export goods abroad.
- Reduces price rather then restricting consumer choice.
- Taxpayers lose as the revenue gained from the tax is being used on subsidies politically unpopular.
- Domestic producers gain in production
- Increased employment as domestic production occurs
- Global misallocations of resources as inefficient producers are now producing.
What are Embargoes and Exchange Control?
Embargoes- The prohibition of commerce and trade with a certain country, no trade is allowed:
- Often done due to political reasons.
Exchange control- a limit on the amount of money, which can be changed into foreign currency:
- Prevents excessive imports
- Importers can't pay to full extent of the domestic demand causing imports to fall- consumers suffer.
What are the advantages of protectionism?
- Self-sufficiency: to limit overspecialization
- Externalities and import control: to deal with demerit goods/negative externalities.
- Political reasons: a country might not want to trade due to political differences.
- Prevent imports of harmful goods.
- Protect employment: to protect domestic industries and stop unemployment as an industry can move into a structural decline as a new international cooperation emerges at lower costs. Along with preventing the exploitation of labour in developing economies
How does protectionism protect infant industries and prevent dumping?
Protection of Infant Industries:
- infant industry (sunrise industry)- firms in early stages of development.
- They need to be protected to give them time to expand and gain economies of scale allowing them to compete on an international basis.
- Dumping- occurs when foreign producers sell goods at a price below its cost of production.
- The aim of dumping is to destroy competition
- in the short-term consumers benefit from low prices
- in the long term the persistent undercutting of domestic prices forces the domestic industry out of business- this harms the domestic industry and the importing country might resort to protectionist measures such as Tariffs to control dumping of these goods.
- Foreign firms are able to establish itself as a monopoly. It is then free to increase its prices and exploit consumers
What are the disadvantages of Protectionism?
- It is difficult to predict which industries is likely to survive thus which should the government help is an arising question.
Misallocation of resources: protectionism supports inefficient producers and with tariffs and quotas, consumer surplus is scarified.
Trade Wars: Continuous protectionism can lead other countries to retaliate and they might also put protectionist measures on imports.
- Potential for corruption
- Industries may not become efficient due to subsidy inefficiency.
Increased Cost of Production: a lack of competition and constant production of domestic producers creates inefficiency and lack of initiative to control costs.
- This could further make firms inefficient in the terms of cost and technology thus they might become uncompetitive in the export market.
- Higher prices for domestic consumers.
- Imported goods become more expensive leading to imported inflation.
What is economic integration, a trade agreement and a trade bloc?
Economic Integration- refers to Trade Unification between different states.
Trade Agreement- A contract/pact between 2 or more nations outlining how they will work together to ensure mutual benefit.
Trade Bloc- Type of intergovernmental agreement with a group of countries to reduce protectionist measures among the participating states.
What is a Free Trade Area?
Free Trade Area- a trade bloc where member countries have signed a free trade area
- Loosest form of organisation
- Eliminates the systematic removal of trade restrictions e.g. tariffs and quotas on internal trade.
- Members are allowed to charge whatever tariffs they wish against non-member countries.
- Preferences on most goods and services traded between them
- No export or import restrictions.
What is a Customs Union?
- Free trade between member countries
- Members must charge a common external barrier against non-member countries interested in exporting to these countries.
- Examples include the European Union.
Gains of Custom Unions:
- Internal economies of scale- firms operate in a larger market and may be able to increase output and sales thus reducing unit cost.
- Greater competition can improve efficiency.
- Union as a whole has more bargaining power to get better trade terms.
- Cost of administrating the union can be large
- Diseconomy of scale is likely.
What is an Economic Union?
Economic Union- A trading bloc that has a common market between members.
- Involves the removal of restrictions on Factors of Production between members
- Common trade policy towards non-members but where members are free to pursue independent macroeconomic policies.
What is a Monetary Union?
Monetary Union- First major step towards macro-economic integration enabling economies to converge more closely.
- Involves scrapping individual currencies and adopting a single shared currency e.g. The Euro
- Common monetary policy including interest rates and regulation of the quantity of money, and a single central bank.
- Example includes the European Central Bank or East Caribbean Central Bank.
What are the benefits of one currency?
- Easier to compare prices of suppliers leading to greater price competition and lower input prices
- Greater transparency for consumers choosing between brands
- Inward investment may encourage foreign firms to base themselves in this one to avoid exchange rate fluctuations and uncertainty.
- Reduces transaction costs exchange rate risk
- Economies of scale occur as more trade is encouraged.
What are the disadvantages of one currency?
Transition costs: Various costs to transfer to the Euro e.g. producing new price lists.
- Interest rates may be increased at a time when a particular domestic government might want them to fall.
- Causes political problems
- Reduced freedom over fiscal policy: constrained by deficit.
- Loss of option to devalue domestic currency to produce a short-term boost of international competitiveness.
- Richer countries of the same currency may have to finance poorer ones to reduce structural economic inequalities.
What are the advantages of Trade Blocs?
- Greater specialization and economies of scale
- Access to a greater 'home' enabling more efficient producers to produce and sell on a larger scale, thus to benefit from lower unit costs.
- Greater competition - more efficient firms will be able to compete more fairly and successfully in a bigger market.
- More exports: benefits of greater economies of scale and greater competition to make union firms more competitive and enable them to export more to non-members.
- More financial assistance due to more funds being available to poorer regions.
- Trade creation: a switch to cheaper supplies with union tariffs removed.
- Efficient resource allocation.
What are the disadvantages of Trade Blocs?
- Possibility of diseconomies of scale due to over-expansion and problems within firms such as control, communication and coordination
- Unemployment- less efficient firms or high-cost regions may suffer as competition increases.
- Administrative costs could be high
- Trade diversion: because of common tariffs against non-members a country may switch away from a previous supplier to one with the union and be paying more than before (paying without tariff).
What are the Terms of Trade?
Terms of Trade- a measure of a country's export prices in relation to its import prices:
(average export prices (index))/(average import prices (index)) × 100
Favorable movement- If export prices increase compared to import prices, the terms of trade improve.
Adverse movement- if export prices fall relative to import prices or do not decrease as much then the Terms of Trade has worsened.
- If a country's ToT is greater than the base year index then the country is receiving relatively better prices for it's exports than it is having to pay for another's imports.
- If a country's ToT is less than the base year index then the country has to pay a relatively higher price for imports than it is receiving for its own exports.
What are the Balance of Payments?
Balance of Payments- A record of a country's monetary transactions with the rest of the world at a specific time.
- Includes all trade conducted by both the private and public sectors are accounted to determine how much money is going in and out of a country.
What goes in the Current Account?
The Current Account- Records payment for the purchase and sale of goods and services, it has 3 parts:
Balance on Trade- measures the value of imports and the value of exports.
- Exports are a positive entry to the Balance of Payments as it brings money into the country while imports are a negative entry as it is money going out.
- Balance of trade can be further split into: Trade in Goods (Visibles), Trade in Services (Invisibles), Income- compromises income earned by the country's citizens who own assets overseas
- Includes profits, dividends and investments abroad and interests
International transfers- money transfers between central governments (who lend and borrow money to each other) or grants.
- Current account deficit- the money leaving the country is greater than the value of money entering the country. If more money goes in than out, this is a surplus.
What is the Capital Account?
- Involves transfers of money by immigrants and emigrants. If immigration increases, this increases the surplus on the account, as immigrants become part of the country's assets.
- Government transfers regarding debt repayments or subsidies with other countries.
- The capital account refers to transactions in fixed assets and is relatively small.
What is the Financial Account?
The Financial Account- records the flow of money in and out of a country, made up of:
- Foreign direct investment e.g. funds coming into a country from abroad to finance a takeover.
- Portfolio investment includes money flows to buy shares and buying bonds and debt issues by firms and governments.
- Other investments such as purchases of currency and loans.
- Long term money flows (Assets and liabilities).