12 International trade (W9 L16 and L17)

What are the main reasons countries trade?

1. Countries differ in technologies and endowments (capital, labour, natural resources) and in consumer tastes.

2. They export goods they produce relatively efficiently and import goods their partners specialise in.

What two arguments did Adam Smith make about the invisible hand?

1. It maximises welfare because it encourages specialisation of labour (which grows the pie), and

2. Free trade is welfare improving since freely trading shows you are better off.

What is the Ricardian model of trade based on?

Differences in technologies between countries. It is an extended version of Adam Smith’s argument.

What does the production possibilities frontier (PPF) show?

The combinations of two goods an economy can produce with its resources and technology. Its slope is the opportunity cost.

What is the difference between autarky and free trade?

Autarky means no trade, and free trade allows trade.

What was Ricardo’s insight about absolute advantage?

Even a country that is better at producing everything (absolute advantage) still faces scarcity, so what matters is relative productivity.

What is opportunity cost?

The amount of the other good you give up producing in order to produce more of one good.

What is comparative advantage?

An economy has comparative advantage in a good if it can produce that good at a lower opportunity cost than the other good.

What happens if countries specialise according to comparative advantage?

Global output is maximised (“grow the pie”).

How do you decide whether to produce or buy a good in the trade example?

Compare the opportunity cost of producing it with the cost of buying it at the world price. Produce the good with the lower opportunity cost and buy the other.

What are the gains from trade?

Trade works like a new technology, allowing scarce resources to be used more efficiently. Countries gain in aggregate, but the gains are not shared equally between or within countries.

What decides the direction of trade?

A country imports goods whose world price is lower than its autarky price and exports goods whose world price is higher than its autarky price.

Who are the winners and losers from trade in the computers and minerals example?

Winners are domestic consumers of computers (lower prices) and domestic mining producers (higher prices, more output). Losers are domestic consumers of minerals (higher prices) and domestic computer producers (lower prices, less output).

What are consumer surplus, producer surplus and economic surplus?

Consumer surplus is the difference between the maximum price a consumer would pay and the price paid. Producer surplus is the difference between the price received and the minimum price a producer will accept. Economic surplus is the sum of both.

What happens to economic surplus when an economy opens to trade?

It rises, because the winners’ gains are larger than the losers’ losses.

Why do industries call for protection from trade?

Benefits are diffuse (lower prices for all consumers) while costs are concentrated (job losses in particular industries).

What is a tariff and what does it do?

A tax on imported goods that raises the price from the world price pW to pT. It reduces imports and increases domestic production.

What is the WTO?

The only international organisation dealing with the rules of trade between nations. It aims to use trade to improve living standards, with 166 members covering 98% of world trade.