4.1 Benefits of International Trade

Benefits of International Trade for Firms

Greater Profitability
Increase in Sales Revenue

• If they can reach the overseas market, they are more likely to make a higher level of revenue

• Due to the large number of potential customers overseas, the customer base is larger

• Revenue would rise as demand for the good rises

Decrease in Average Costs

• The output level of firms increases after being able to export overseas

This increased production allows firms to enjoy more economies of scale → fall in average cost

List the benefits of International Trade (for Consumers)

• lowers prices (since they enjoy more economies of scale)

• more choices of goods (some goods may not be available/too expensive domestically)

• increases market competition (need to compete with imported goods, so it incentivises them to improve efficiency and improve choice and quality)

Benefit of International Trade for the Economy

More efficient resource allocation

• When there is free trade (aka no government intervention), the countries that are the most efficient will produce that particular good/service

  • Taking advantage of their efficiency, these can be produced at the lowest cost

• ∴ More countries in free trade ⇒ more efficient world resource allocation

Benefit of International Trade for the Government

Source of foreign exchange

• International trade enables foreign exchange

  • If a country exports goods & services, the country is paid foreign currencies

  • E.g. Japan exports TVs to China, Chinese customers have to exchange RMB to JPY to buy the goods, so Japan earns RMB

More foreign currency → local government can adjust the exchange rate of its own currency in the foreign exchange market.

What is International Specialisation?

When a country only focuses on the production of a narrow scope of goods in order to gain greater efficiency (level of lowest opportunity cost)

What is absolute advantage?

When a country can produce more of a good than another country with the same amount of resources

What is comparative advantage?

When a country can produce the good with lower opportunity cost than another country

Model answer for comparative advantage

• Country A: lower opportunity cost in A = comparative advantage in A

  • Therefore should produce and export A, import B

• Country B: lower opportunity cost in B = comparative advantage in B

  • Therefore should produce and export B, import A

• You cannot have comparative advantage in both products

Definition of Terms of Trade

the amount of goods a country needs to export to get one unit of import

Definition of Gains from Trade

the difference between terms of trade and opportunity cost

Limitations of Comparative Advantages Theory

Assumption of…

• perfect information

  • so producers & consumers know which good has the least opportunity cost for production/consumption

• zero transport costs

  • transport costs may decrease comparative advantage and thus make international trading not worthwhile, since it may eliminate the international competitiveness of the good

• free trade between countries

  • it is assumed that there is no trade barrier between countries, but there are probably government-imposed barriers in many industries

• constant returns to scale

  • assumes that average costs do not change (so PPC is a straight line), and there are no economies and diseconomies of scale

• homogeneous features of goods

  • assumes the goods being traded are identical

  • may be true for agricultural goods, but harder for consumer durable goods (i.e. furniture, electrical appliances)