Absolute advantage
A country can produce a product using fewer factors of production than another country
Comparative advantage
A country should specialise in the goods or services it can produce as the the lowest opportunity cost
Theory of comparative advantage
Global output will increase if countries specialise in the good in which they have a comparative advantage
Assumptions of the theory of comparative advantage
- Cost of production is constant
- Constant returns to scale
Benefits of trade
- Comparative advantage - allocative efficiency
- Lower prices & higher quant - ECONOMIES OF SCALE so costs fall
- Int’l competitiveness
- Higher economic growth - boost exports & AD
Costs of trade
- Over-specialisation: too reliant on output of one narrow sector (demand/supply shock to that industry?)
- Unemployment: industries w/o comparative advantage are unsuccessful (deindustrialisation)
- CAD: some countries will M>X -> deficit
- Environmental trade offs: air pollution, resource depletion
- External shocks: shocks in other country have knock on effect due to interdependence as effect of trade - Russia war on Ukraine created global shockwaves in energy market
What are macro effects of free trade
- Economic growth (comparative adv)
- Unemployment
- inflation (low costs, so lower cost push inflation)
- Current Account
- Inward FDI if trade deals
Reasons for changes in pattern of trade
- COMPARATIVE ADVANTAGE
- Changes in exchange rates
- Protectionism
- Trading blocs and agreements (EU, NAFTA - free trade)
- Inflation rate
UK’s comparative advantages
- Power turbines
- Pharmaceutical products
- Aircraft
- Financial services
What are UK’s most imported goods/services
- Cars
- Gas and oil
- Clothing
- Fruits and veg
Reasons for protectionist policies
- Protect infant firms (unlike to be successful is global competition)
- Sunset industry - declining & govt support
- Protect against unemployment
- Current account deficit: when M>X
Consequences of protectionism
- Reduced choice (reduces quantity & quality of goods/services)
- Increases prices
- Increased costs : manufacturers who rely on imported raw material -> higher
- Retaliation
- Less competitiveness
- Domestic Inefficiency - less productively
Trade barriers
A restriction placed by the govt on the import of foreign goods
Tariff
Taxes paid on imports
Impacts of standard of living due to tariffs
- The standards of living for consumers worsen as the value of their income is eroded as they are paying higher prices
OR - Domestic forms that benefit from increased production may increase employees wages
Quotas
A physical limit on imports
- in June 2022 the UK extended its quota on steel imports for a further two yrs to protect employment in the domestic steel industry
Export subsidy
Lowers the cost of production for domestic firms and encourage them to increase their output so they are more int’l competitive
Economic integration
When countries reduce trading barriers between themselves and become more interdependent
Trading bloc
Countries come together to form a bloc of countries and agree to remove trade barriers, this increased trade
- trading blocs have increased economic integration
Types of trading blocs
- Free Trade Area (CUSMA)
- Customs Union
- Common Market
- Monetary Union
Customs Union
An agreement between countries in which all goods/services produced by members are trade barriers free
- members have a Common External Tariff from non member countries
- this gives consumers access to wider choice of goods and services at he lowest possible prices
Is the EU a customs union?
The EU started off as a customs union but is now a common market and has elements of economic and political unions
Common Market
Similar to customs unions, goods/services are traded freely
- The four factors of production flow freely between member countries
- In order to improve allocation of resources between themselves common market member
- Labour can move freely and ppl can live and work in any member country
Example of a common market
The Single European Market (SEM), created in 1993
- all members of e EU, + Iceland, Norway, Switz & Yekstinzine
