Economics: Chapter 24

Absolute advantage

A country has an absolute advantage over another in the production of a good if it can produce it will less resources than the other country

Comparative advantage

A country has a comparative advantage over another in the production of a good if it can produce it at a lower opportunity cost: i.e. if it has to forgo less of other goods in order to produce it

Law of comparative advantage

 Trade can benefit all countries if they specialise in the goods in which they have a comparative advantage

Terms of trade

The price index of exports divided by the price index of imports and then expressed as a percentage. This means that the terms of trade will be 100 in the base year. (Note that the price index for both exports and imports is expressed in terms of the domestic currency)

Adv valorem tariffs

tariffs leveled as a percentage of the price of the import

Dumping

Where exports are sold at prices below marginal cost–often as a result of government subsidy

Infant industry

an industry that has a potential comparative advantage, but which is as yet too underdeveloped to be able to realise this potential

Strategic trade theory

the theory that protecting/supporting certain industries can enable them to compete more effectively with large monopolistic rivals abroad. The effect of the protection is to increase long-run competition and may enable the protected firms to exploit a comparative advantage that they could not have done otherwise

Optimum tariff

A tariff reduces the level of imports to the point where marginal social cost equals marginal social benefit

Preferential trading arrangements

A trade agreement whereby trade between the signatories is freer than trade with the rest of the world

Free trade area (FTA)

A group of countries with few or no trade barriers between themselves

Customs union

A free trade area with common external tariffs and quotas

Common market

A customs union where the member countries act as a single market with free movement of labor and capital, common taxes and common trade laws

Trade creation

Where a customs union leads to greater specialisation according to comparative advantage and thus a shift in production from higher cost to lower cost sources

Trade diversion

where customs union diverts consumption from goods produced at a lower cost outside the union to goods produced at a higher cost (but tariff free) within the union