Transcript Trade and absolute/comparative advantage

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?
UK Exports
Oil exporters
3%
Other OECD
6%
Rest of
World
11%
North America
18%
Other Europe
4%
EU
58%
And what about imports?
UK Imports
Oil exporters
2%
Rest of World
18%
Other OECD
8%
North America
15%
Other Europe
5%
EU
52%
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
Bread
Bananas
200
200
160
80
TOTAL
360
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?
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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
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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
DD
Domestic
Supply
Price
WS1
P1
World Supply
P
DS
0
B
D
C
Real GDP
A
Q
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