Economics HL - Global Economics

Free Trade: Definition

No barriers to trade; goods & services flow freely across borders

Free Trade: Benefits

• Easier acquisition of resources → decreased costs of production → lower prices for consumers

• Efficient resource allocation: (specialization by comparative advantage = advantage over others in producing a particular good)

• More efficient production: access to cheaper raw materials, produce more cheaply and efficiently

• Access to larger markets, more consumers, sell more

• More consumer choice, greater variety of goods and services to choose from

• Increased competition, firms pursue the least costly method of production → ↑ efficiency, innovation

• Lower prices

• Foreign exchange earnings, provides countries with the opportunity to access hard currencies (currency that is not likely to depreciate suddenly or to fluctuate greatly in value)

• World Trade Organization: maintains stability and peace

• Economies of scale (cost per unit of production decreases as the volume of output increases, spread fixed costs across more units of output)

Free Trade: Disadvantages

• Corporations relocate → job losses in higher-wage countries

• Exploitation of low-wage workers (weak labor rights)

• Sunset industries decline, face structural unemployment

• Domestic labor in some industries are hurt; lower costs to compete, wages may drop

• Infant industries struggle without government subsidies and support

Dumping: Definition

• Selling below production cost abroad

• Subsidize things → lower prices → gives it an unfair advantage in international trade

Trade Liberalization: Definition

Removing import barriers to promote trade going into a country

US-China Trade War Example

• China: Tariffs on US chicken (accused US of dumping)

• US: Tariffs on Chinese goods (e.g., ribbons)

  • Impact: Cycle of retaliation; both economies harmed

Protectionism: Definition

Barriers to protect domestic industries; opposite of free trade

Protectionism: Tools

• Tariffs: Taxes on imports → raise domestic competitiveness

• Quotas: Limits on imports

• Subsidies: Support for domestic industries

• Administrative Barriers: Regulations & standards applied to foreign firms

• Health/Safety/Environmental Standards: Restrict imports

• Voluntary Export Restraints (VERs): Exporting country self-limits (e.g., China’s rare earths)

• Embargoes: Complete ban on trade

• Foreign Exchange Controls: Currency manipulation to influence trade

• Nationalistic Campaigns: Encourage consumers to buy domestic goods

Opportunity Cost: Definition

Loss of potential gain from other alternatives when one alternative is chosen

• What must be given up to produce something

Absolute Advantage: Definition

A country can produce more output (higher quantity/quality) with the same resources compared to another country

• efficiency in output

Comparative Advantage: Definition

• A country can produce a good at a lower opportunity cost than another country

  • Trade benefits arise when countries specialize in goods with the lowest opportunity cost

  • Leads to more output, variety, and improved welfare

• Sources

  • Factor Endowments: Natural resources, climate, land, labor, capital

    • Example: China’s large labor supply; USA’s capital

  • Technology: Increases productivity

    • Example: Japan’s robotic car assembly, China’s push for 6G-enabled automation

Efficiency in opportunity cost → foundation of trade theory

Theory of Comparative Advantage: Assumptions vs Realistic

Assumptions	Realistic
There are only two countries	Some goods have inputs from multiple factories in many different countries Ex: iPhone contains a camera from Japan, RAM from South Korea and is assembled in China
They only produce two goods	Goods are not perfectly identical, and consumers are prepared to pay more for quality
There is full employment of resources in the best way (all who are able and willing to work are employed, all factors of production are fully utilised)	No country can entirely specialise in the production of a single good without significant resources being wasted or left unused
There is perfect information (all participants have complete knowledge of prices, quality of goods, and number of sellers, and consumers have perfect knowledge of their own potential utility and satisfaction)	Perfect knowledge is almost impossible to attain, as some things are simply unknowable, or what economists call fundamental uncertainty
Technology is constant	Countries invest in research and development to create more efficient production techniques that will potentially improve the way that their economies run
There are zero transport costs	Transport costs may increase costs so much as to eliminate the comparative advantage

Comparative Advantage: Russia vs Scotland

• Opportunity Costs:

  • Russia: 1 whiskey = ¼ oil; 1 oil = 4 whiskey

  • Scotland: 1 whiskey = 4 oil; 1 oil = ¼ whiskey

• Specialization:

  • Russia → oil

  • Scotland → whiskey

• Outcome: Trade expands production possibilities for both countries

Globalization: Definition

Spread of products, tech, jobs & culture across borders; nations become interdependent through trade

• Better communication

• Advances in transport & automation

  • Rising levels of international trade

Multilateral Trade Agreements: Definition

• Agreements between 3+ countries to reduce barriers, cover wider issues (IP, labor, dispute resolution)

  • Treaties between three or more countries that aim to reduce trade barriers, standardize rules, and promote economic integration and cooperation among participants

  • Agreements go beyond tariffs to cover intellectual property, labor standards, and dispute resolution, fostering a more globalized and equitable trading system

    • Ex: World Trade Organization (WTO)

Trade Blocs: Definition

• Group of countries that agree to reduce or eliminate trade barriers, such as tariffs and quotas, among themselves to promote economic integration and cooperation

  • Ex: ASEAN

✅ Increased trade

✅ Foreign direct investment: member countries more attractive for foreign direct investment, leading to job creation, infrastructure development, and economic growth

✅ Enhanced political influence for members

❌ Potential trade diversion

❌ Increased economic interdependence

❌ Loss of national sovereignty (Monetary Union)

Trade Blocs: Stages

1. Preferential Trading Area (PTA)

2. Free Trade Area (FTA)

3. Customs Union

4. Common Market

5. Monetary Union

6. Full Economic Integration

1. Preferential Trading Area (PTA)

A trade bloc that allows countries within the agreement to have a “preferential” access to certain products

✅ Increased trade on selected goods → more income & export revenues

✅ Encourages early-stage cooperation without full commitment

✅ Can support development by boosting low-income countries’ exports

❌ Limited benefits — only for selected goods

❌ Local industries may struggle to compete even with partial liberalization

Ex: European Union and its former colonies (Africa, Carribean, Pacific ACP)

2. Free Trade Area (FTA)

Agreement between countries where there is a free movement of goods and services between countries

✅ Lower prices for consumers (price competition)

✅ Firms gain larger markets → economies of scale

✅ Encourages efficiency and innovation

❌ Trade deflection (importing through lowest tariff country, then re-exporting)

❌ Job losses in high-cost countries (e.g., U.S. factories relocating to Mexico under NAFTA)

❌ Risk of informal/shadow trade and smuggling

Ex: North American Free Trade Agreements (NAFTA now USMCA)

• Cheaper labor in Mexico

• Cheaper products for US and Canada

• US and Canadian factory jobs reopened in Mexico

• Smuggling and illicit activities become more prevalent

3. Customs Union

Common barriers of trade (tariffs, standards, quotas)

✅ Same benefits as FTA plus simplified trade policy for external partners (uniform tariffs)

✅ Greater collective bargaining power in global trade deals

✅ Attracts foreign direct investment (FDI) — companies want access to entire bloc

❌ Lopsided development — industries concentrate in strategically located areas (ports, larger economies)

❌ Loss of national control over trade policy

Ex: MERCOSUR and the European Union (not Eurozone)

4. Common Market

Free movement of goods, service, capital, and labor as well as common regulations on products

✅ Free movement of labor & capital → workers fill labor shortages; businesses access funds more easily

✅ Increases economic dynamism — resources move to most productive areas

❌ Brain drain — skilled labor migrates to richer member states

❌ Domestic resentment over job competition from foreign workers

❌ Differences in education & qualifications complicate labor mobility

Ex: East African Common Market

5. Monetary Union

Common market with common currency

✅ No exchange rate fluctuations → boosts cross-border trade & investment confidence

✅ Lower transaction costs → easier tourism & business operations

❌ Loss of monetary policy independence — countries cannot adjust interest rates or devalue currency during crises (e.g., Greece in Eurozone debt crisis)

❌ One-size-fits-all policies may not suit all economies

Ex: Eurozone

• Greece’s sovereign debt crisis (2009)

  • triggered by the turmoil of the worldwide Great Recession, structural weaknesses in the Greek economy, and a lack of monetary policy flexibility as a member of the eurozone

6. Full Economic Integration

Common tax system to fund fiscal policies

✅ Maximized efficiency — completely unified markets, policies, and taxation

✅ Stronger geopolitical influence — act as a single global power (e.g., USA)

❌ Full loss of sovereignty — countries surrender control over taxes, laws, borders

❌ Resistance from populations due to national identity concerns

Ex: United States of America