International trade Learning outcome AE Explain the reasons for international trade Define free trade Explain the benefits of free trade Explain the theory of comparative advantage using a numerical example Explain the methods of protectionism Evaluate protectionism Explain, with the aid of price-quantity diagrams, the reasons for changes in the value of currency in a floating exchange rate system Reading: Units 14, 39 & 40

International trade There are a number of reason for trade including: Availability- some goods can only be produced in certain countries i.e. oil, diamonds Product differentiation- provides more choice for consumers Price- some countries can produce goods relatively cheaper than others (absolute and comparative advantage)

Absolute advantage When a country is able to produce a good more cheaply in absolute terms than another country

Absolute advantage (example) Cost per unit (worker hours) Italy France Oranges 10 15 Wine 20 Italy can produce one unit of oranges cheaper than France France can produce one unit of wine cheaper than Italy If France produce wine and Italy oranges and they trade they will both be better off

Comparative advantage When a country is able to produce a good more cheaply relative to other goods produced domestically than another country

Comparative advantage (example) Cost per unit (worker hours) Italy France Oranges 20 15 Wine 25 10 France produces wine and oranges cheaper than Italy Italy however is less worse at producing oranges If France produce wine and Italy oranges and they trade they will both be better off

Free Trade International trade conducted without the existence of barriers to trade

Benefits of free trade Specialisation The theory of comparative advantage shows that two counties are better off if they trade, if all countries engage in trade then the world will be better off (greater output) Economies of scale If countries specialize then they can achieve greater economies of scale and increase their comparative advantage in production of certain goods

Benefits of free trade Choice Trade provides consumers with greater choice and they are therefore better off Innovation Free trade creates competition which leads to innovation as firms have to compete against companies from all over the world

Promotion of Free Trade International organisations such as the World Trade Organisation (WTO) promote free trade between nations They work to reduce or remove trade barriers and promote freer international trade