Unit 6, The reasons for international trade and protectionism flashcards

factor endowment

the availability of capital, enterprise, labour and land in an economy

absolute advantage

a situation where, for a given set of resources, one country can produce more of a particular product than another country

opportunity cost ratio

the quantity of one product compared to the quantity of another product that has to be sacrificed to produce it

comparative advantage

a situation where a country can produce a product at a lower opportunity cost than another country

basic reason for international trade

international trade takes place because countries have different factor  endowments, and the differences in factor endowment affect the type of products countries produce and quantity and quality of the products, as well as the cost of production

free trade

international trade not restricted by taxes on imports and other policy tools designed to give domestic producers protection from competition from imports

benefits of free trade

free trade allows for an efficient allocation of resources with countries being able to specialise on producing those products they have a comparative advantage in, the competition from free trade can put pressure on firms to keep their prices and costs down and raise the quality of their products, firms may also be able to buy raw materials and capital at lower prices

trading possibility curve

a diagram showing the effects of a country specialising and trading

imports

goods and services purchased from another country

exports

goods and services sold to other countries

terms of trade

the ratio of a country's export prices to its import prices, expressed as an index number, index of export prices / index of import prices x 100

causes of changes in the terms of trade

changes in the demand for and supply of exports and imports, the price level and the exchange rate

Prebisch-Singer hypothesis

the terms of trade tend to move against countries that produce primary products

impact of changes in the terms of trade

if the price of exports increases due to a rise in demand, it is likely to be beneficial as more domestic products will be sold, however if it is due to a rise in costs of production, demand for the country’s products will fall and export revenue may decline

impact of PED on terms of trade movements on BOP

If demand for exports and imports is elastic, the fall in export prices relative to import prices should increase export revenue relative to import expenditure and reduce a deficit on the current account of the balance of payments

Limitations of the theory of absolute and comparative advantage

some governments may want to avoid specialisation, high transport costs may offset the comparative advantage, the exchange rate may not lie between the opportunity cost ratios, other governments may impose trade restrictions, theory of comparative advantage assumes resources are mobile and there are constant returns, countries do not always adapt to changes in comparative advantage

protectionism

protecting domestic producers from foreign competition

tools of protectionism

tariffs, import quotas, export subisidies, embargoes and excessive administrative burdens

tariffs

a tax imposed on imports, and may sometimes be imposed on exports, can be an ad valorem or specific tax

reasons to impose import tariffs

to discourage consumption of imports, to raise tax revenue

ideal conditions for a tariff

price inelastic demand if it is imposed to raise tax revenue, price elastic demand if it is used to protect domestic industry

reasons to impose export tariffs

to raise government revenue, to ensure an adequate supply of the product on the home market

absolute poverty

a condition where people’s income is too low to enable them to meet their basic needs

quota

a limit on imports

export subsidies

financial assistance provided by governments to domestic producers to encourage exports

recipients of export subsidies

exporters, domestic firms that compete with imports

impact of export subsidies on consumers

consumers may benefit from lower prices in the short run, but may lose out in the long run if more efficient foreign firms are driven out of business and subsidised domestic firms raise their prices

embargo

a ban on imports and/or exports

voluntary export restraint

a limit placed on imports reached with the agreement of the supplying country

exchange control

restrictions on the purchase of foreign currency

arguments for protectionism

to protect infant industries, to protect declining industries, to protect strategic industries, to prevent dumping, to improve the terms of trade, to improve the balance of payments, to provide protection from cheap labour

protectionism to protect infant industries

firms in a new industry may find it difficult to survive when faced with competition from more established, larger foreign firms, either due to foreign firms taking advantage of economies of scale or benefiting from their names being well-known or both, so the industry is given time to grow and benefit from economies of scale and gain an international reputation

issues with protectionism to protect infant industries

it is difficult to identify which new industries will develop a comparative advantage, which would justify the protectionism, and there is a risk that the infant industry may become dependent on protection

protectionism to protect declining industries

providing support to industries that have lost their comparative advantage and would otherwise go out of business quickly, then slowing gradually removing the protection, in order to avoid a sudden and large rise in unemployment and allow workers to retire or leave for jobs in other industries

issues with protectionism to protect declining industries

the industry may resist reductions in the protection it receives, leading to considerable inefficiency

protectionism to protect strategic industries

some governments seek to protect industries that produce products regarded as strategic, such as weapons, fuel and food, avoiding dependency on foreign suppliers for these products

issues with protectionism to protect strategic industries

Includes the protectionism of home industries regardless of whether they are relatively inefficient or not

protectionism to prevent dumping

some governments use protectionism to prevent foreign firms dumping, driving out domestic firms and possibly gaining a monopoly, then raising prices

infant industries

new industries that have a low output and a high average cost

dumping

selling products in a foreign market below their cost of production

monopoly

where one firm dominates the market due to having a large market share; a pure monopoly is a single seller with 100% market share

protectionism to improve the terms of trade

a country may impose trade restrictions on imports to reduce the demand for these products, lowering their prices if demand for the product within the country is significant and improving the economy’s terms of trade, or if a country accounts for a significant proportion of the world’s supply of a product, quotas on its exports may improve its terms of trade

issues with protectionism to improve the terms of trade

distorts trade and is likely to reduce global output and could provoke retaliatory measures from trading partners.

protectionism to improve the balance of payments

a government may impose tariffs to encourage consumers to switch from buying imports to buying domestic products, improving its current account position

current account

a record of the trade in goods, trade in services, primary income and secondary income

protectionism to provide protection from cheap labour

trade restrictions placed on products from countries where wages are low, to prevent domestic wages and living standards from falling

issues with protectionism to provide protection from cheap labour

low wages do not always mean that a country will always be able to produce products more cheaply as labour productivity may be low and so labour costs may actually be relatively high, additionally if low wages are linked to low costs it may indicate that the countries have a comparative advantage

other reasons for protectionism

to raise revenue, to try to persuade another government to reduce its trade protection, if a government is concerned that certain imports do not meet health and safety standards, to seek to protect a range of industries to avoid the risks attached to overspecialisation

arguments against protectionism

prevents countries from specialising in the products in which they have a comparative advantage - possibly lowering global output and living standards, reduces international competition and so increases prices and lowers the quality of products, reduces the choice of products available to consumers, lowers the size of firms’ markets and so reduce their ability to take advantage of economies of scale, redices firms’ choice of raw materials and capital goods which may increase costs of production, results in a trade war with tariffs pushing up prices