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
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
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 GeorgelandMartinlandTOTAL Bread200160360 Bananas20080280
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 GeorgelandMartinlandTOTAL Bread200160360 Bananas20080280
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
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 BDCAQAQ DS DD 0 P P1 Domestic Supply Price 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
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