Download absolute advantage - LPS Business Department

2.6.2 Trade
Did you know 10 multinational corporations control nearly
everything you buy?
Can you name them?
AQA 2.6 T HE
INTERNATIONAL ECONOMY
2.6.2 W HAT
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YOU NEED TO KNOW
The model of comparative advantage
A simple numerical example to illustrate the principle of comparative advantage and the
associated benefits of trade
The distinction between comparative and absolute advantage
The model shows that specialisation and trade can increase total output
Other economic benefits of trade, such as the ability to exploit economies of scale and
increased competition
The costs of international trade
The reasons for changes in the pattern of trade between the UK and the rest of the
world
The nature of protectionist policies, such as: tariffs, quotas and export subsidies
How to illustrate the effects of imposing a tariff on imports
The causes and consequences of countries adopting protectionist policies
The main features of a customs union
The main characteristics of the Single European Market (SEM)
The consequences for the UK of its membership of the European Union (EU)
The arguments for and against the UK’s membership of the EU
The role of the World Trade Organisation (WTO)
A BSOLUTE A DVANTAGE
Absolute advantage is a situation where a country can produce a
good or service using fewer resources than that of another
country. In other words, it can produce more of that good or service
more cheaply. This is best illustrated with an example:
 Imagine two countries who only produce two goods – cars and
bicycles
 Assume they split their resources equally between cars and
bicycles
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Cars
Bicycles
Country A
6,000
3,600
Country B
5,000
1,000
TOTAL OUTPUT
11,000
4,600
Country A has an absolute advantage in the production of both
cars and bicycles
C OMPARATIVE A DVANTAGE
Economist David Ricardo noted however that it was possible for a country not to have an
absolute advantage in the production of a good, but through specialisation could gain
from international trade if they had a lower opportunity cost
 Comparative advantage is therefore where a country can produce a good at a lower
opportunity cost than that of another
 Using the previous example, we can calculate the opportunity cost of each country’s
production in terms of cars and bicycles
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Cars
Bicycles
Opportunity Cost
Country A
6,000
3,600
1 car = 0.6 bicycles 1 bicycle = 1.7 cars
Country B
5,000
1,000
1 car = 0.2 bicycles 1 bicycle = 5 cars
TOTAL OUTPUT
11,000
4,600
Even though Country A is better at producing both goods, it is 1.2 times better than
Country B at producing cars, but 3.6 times better at producing bicycles
 Or put another way, if Country A wants to produce 1 extra bicycle, it must forego 1.7
cars, whereas Country B would need to forego 5 cars for the same decision
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C OMPARATIVE A DVANTAGE
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So, Country A has a comparative advantage in the production of bicycles and Country B has a
comparative advantage in the production of cars. Therefore, it makes sense for Country A to
specialise in the production of bicycles, whilst Country B specialises in the production of cars
Lets assume that due to its low production of bicycles, Country B decides to put all its resources
into cars. However, Country A decides to mainly specialise in bicycles, but still maintain 25% of its
total production capacity in cars. So it halves car production and puts this into the production of
bicycles.
Cars
Bicycles
*Calculation
Country A
3,000
5,400*
3,600 + (3,000 x 0.6)
Country B
10,000*
0
5,000 + (1,000 x 5)
TOTAL OUTPUT
13,000
5,400
As a consequence, total output of cars has increased from 11,000 to 13,000 and the output of
bicycles has increased from 4,600 to 5,400, which demonstrates an improvement in economic
welfare for all
Thus, we can see that whilst Country B has the ability to produce bicycles, it makes little sense in
doing so because the opportunity cost in terms of cars is so high, therefore Country B should
import bicycles from Country A using profits generated from its sale of cars to Country A
B ENEFITS
OF TRADE
 Increased overall global output
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As a result of comparative advantage
 Greater competition
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How important is
trading to the UK car
market and the UK
economy?
Trade opens international borders, promoting a greater
degree of competition
 Employment opportunities
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Export industries create employment through the
expansion of aggregate demand
 Encouragement of specialisation, leading to greater
efficiency
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If a country is to trade effectively it needs to specialise in
order to compete, which drives down costs and unit
prices
 Improved quality of goods and services
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Via increased competition and dynamic efficiency, the
overall quality of goods and services can be enhanced
H OW
IMPORTANT IS TRADE TO THE
UK?
C OSTS
OF TRADE
 Over-specialisation
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If a country aims to engage in trade, it will need to specialise,
however if world demand falls, this can give an economy significant
problems
 Structural unemployment
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Over-specialisation may create structural unemployment, which may
be magnified in particular regions in the UK
 Infant industries
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Some countries are concerned that infant and new industries
struggle to compete with MNCs, thus creating local problems and
limited employment opportunities as firms struggle to establish
themselves
 Dumping
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Countries that enjoy significant absolute advantages in the
production of certain goods, often agricultural, may sell their
surpluses at very low prices, and drive local producers out of the
market
 Environmental concerns
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The process of transporting large quantities of goods around the
world is costly and uses up significant quantities of scarce resources
PATTERNS
Trading blocs in
numbers.
OF
T RADE
Whilst international trade has in general terms increased, around
730% over the last 30 years, the pattern of trade has altered
significantly. The most significant changes have been:
 The growth of trading blocs
 The formation and growth of trading blocs such as the EU
and NAFTA which encourage greater free trade amongst
members, whilst discouraging trade outside the bloc, has led
to significant trade creation across the globe
 The majority of leading economic nations operate within a
trading bloc and have several agreements with other nations
Emergence of Middle Income Countries (MIC’s)
 Countries such as India and China have become significant
global players in terms of all aspects of trade
 The collapse of communism in Russia and other Eastern bloc
states has opened up global markets significantly
PATTERNS OF T RADE
 Deindustrialisation
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The future of UK
exports.
Traditional western nations, including the UK, have seen a
period of deindustrialisation occur as comparative advantage
in the production of many goods has shifted to China, India
and the Far East
However, this has been replaced with growth in the provision
of financial services and other tertiary markets
The UK now experiences a deficit on the balance of
payments current account in terms of goods, but a surplus in
terms of services
Strictly Come Dancing's format has been sold to 43
countries but what does Britain’s biggest cultural
export tell the world?
P ROTECTIONIST P OLICIES
Policies designed to
protect domestic
industries.
India faces criticism
for blocking global
trade deal, but is it
justified?
Tariffs
 Taxes placed on imported goods that are not applied to domestic goods
Quotas
 A physical limit on the volume of imports entering a country
 For example, Thailand has imposed a quota of 54,440 tonnes of corn on
China
Embargoes
 A total ban on imported products
 For example, the USA has had an embargo on products from Cuba since 1959
 The UK has imposed embargos on Syrian oil exports as a political measure
Subsidies
 Government payments to domestic firms to help reduce production costs
and improve competitiveness
Administrative barriers
 Countries might employ measures such as complex legal forms, health and
safety inspections and specific product specifications to discourage imports by
raising costs
P ROTECTIONIST P OLICIES : TARIFFS
Price
Domestic Supply
Problems of Tariffs:
Consumers face a
higher price of P1 and
consumer surplus falls
by A+B+C+D indicating
a fall in overall welfare.
P1
A
B
C
World Price +
Tariff
D
P
World Price
Q1
Q2
Q3
Q4
Quantity
Before the tariff is imposed domestic supply is Q1 and domestic demand Q4, but after the tariff,
domestic supply extends to Q2, whilst demand contracts to Q3, so imports have been reduced
from Q1-Q4 to Q2-Q3.
Area C is the revenue
gained from the tariff,
which may invite
retaliation from other
countries.
Areas B and D
represent a net loss to
society, as they are not
collected by any
economic agent in the
process.
C AUSES AND C ONSEQUENCES OF
P ROTECTIONIST P OLICIES
We have seen that through comparative advantage and empirical data,
there are strong economic reasons for international trade to occur.
However, developed and developing nations may benefit in different ways,
or not at all. As a result, there are a number of arguments that might
justify the implementation of protectionist measures. These include:
 Infant industries
 Young industries are unlikely to be able to compete against
established MNCs in developed countries, thus require protection,
at least in the short term
 To prevent ‘dumping’
 Over-production in developed countries may be released into
markets of developing nations, which undercuts domestic prices
and domestic producers may be forced to leave the market
 Domestic employment
 Protectionist measures might help to protect domestic jobs if
infant industries are allowed to grow or local firms aren’t undercut
by MNCs from developed countries
C AUSES
AND
C ONSEQUENCES
OF
P ROTECTIONIST
P OLICIES
 Externalities
 Some goods, such as illegal drugs and weapons may be
considered to have significant harmful effects on society, and
should be blocked from domestic markets
 Balance of Payments
 Placing restrictions on imports may help to reduce a balance of
payments deficit on current account
D ISCUSSION /D EBATE
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What are the
necessary
conditions for free
trade?
Is protectionism ever justified? Support your
answer with the articles below and your own
research into current political opinion.
Margaret Thatcher’s view of protectionism.
Is this still a valid political argument today?
What are Donald Trump’s views?
Does it depend on the economic climate?
C USTOMS U NIONS
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What’s the
difference
between a single
market and a free
trade agreement?
A customs union has the following core features:
1. A common set of import duty rates applied on goods from third
countries i.e. a Common External Tariff (CET)
2. Duty-free and quota-free movement of tradable goods among
members
3. Common safety measures for regulating the importation of goods
from third parties e.g. food standards
4. A common trade policy that guides the trading relationships with
third countries/trading blocs outside the Customs Union
 The EU is the biggest customs union in the world
 Each member of the customs union cannot pursue their own
international trade policy. Instead, trade negotiations are conducted
on behalf of all member states, unlike a free trade area where each
member is allowed to set their own tariffs against non-members
T HE S INGLE E UROPEAN M ARKET (SEM)
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It is important to differentiate a customs union from the Single European
Market (SEM)
In addition to having no internal trade barriers and a common external tariff,
the SEM also involves the free movement of goods, services, capital and
labour which promotes deeper economic integration and market
liberalisation
SEM Fact 1:
The SEM has a 23% share of global GDP
SEM Fact 2:
It is estimated that the SEM has boosted
GDP by around 2-3% for its members
SEM Fact 3:
Around 3% of the EU labour force work in
a different member state
SEM Fact 4:
In 2015, exports to the SEM accounted for
44% of all trade
T HE U K
AND THE
E UROPEA N U NION (EU )
The Single market has 28 member states and is a major world trading power. As an economic force,
it is larger than the USA. The UK voted to leave in 2016.
Advantages
Disadvantages
Trade creation
Trade is encouraged within member states because
there are no barriers, so additional trade is created
within the bloc.
Trade diversion
The existence of the common external tariff, diverts
trade away from the EU. Goods within the SEM may be
more expensive, and this could damage consumer
welfare.
Competition
Stronger competitive forces within the SEM can drive
productive and dynamic efficiency, which will benefit
consumers.
Monopolies
In some markets e.g. gas and electricity, tariffs have seen
significant merger activity and the creation of large
monopolies seeking to exploit the available economies
of scale.
Access to markets
The SEM creates a market of 28 countries and a
population of over 500m, offering significant scope for
businesses to expand.
Unemployment
In some countries, workers may lose their jobs as
production is transferred to member states with lower
labour costs.
Freedom of movement
There is the right to live and work anywhere within the
SEM without restriction which boosts labour mobility.
Cost
Membership of the SEM costs the UK around £15b per
year.
B REXIT
The specification
requires you to be
able to analyse the
consequences for the
UK of its membership
of the EU, so by
definition, you should
also consider the
consequences of
Brexit.
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A referendum was held on Thursday 23 June 2016, to decide whether
the UK should leave or remain in the European Union
Leave won by 52% to 48%
The referendum turnout was 71.8%, with more than 30 million
people voting
However, the UK will remain a member of the EU until Article 50 of
the Lisbon Treaty is invoked, which gives the UK and the EU two years
to agree the terms of the split
There remains a great deal of uncertainty as to how the full process
will work because the decision by a member country to leave the EU
is unprecedented
In the interim however, any EU law still stands in the UK and the UK
will continue to abide by all previously established treaties and
agreements, but it will not take part in any current decision making
T HE W ORLD T RADE O RGANISATION (WTO)
The WTO’s mission
statement:
“The WTO is the
international
organisation whose
primary purpose is
to open trade for
the benefit of all.”
WTO’s $1trn deal
in 2013.
Progress towards complete trade liberalisation has increased in
recent years. One of the main organisations involved in this has
been the World Trade Organisation.
 Established in 1995, its purpose is to promote free trade by
persuading countries to abolish import tariffs and other barriers
 The WTO is the only international agency overseeing the rules
of international trade
 It polices free trade agreements and settles trade disputes
between governments and organises trade negotiations
 WTO decisions are absolute and every member must abide by
its rulings
 There are currently 160 members
 Most Favoured Nation (MFN) status is required for all members
providing trade advantages such as reduced tariffs
R ESEARCH TASK
Whilst the WTO has made progress towards complete
free trade, it has been criticised for favouring western
developed nations.
Find out some examples of current trading disputes
between nations and what role the WTO is currently
playing.
Do you think the WTO is successful in meeting the aims
of its mission statement?