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TRADE
BENEFITS OF TRADE

ABSOLUTE ADVANTAGE

CHOICE
Can consume foreign and domestic goods and
services
 Allows consumption outside a country’s PPC
curve
 INCREASED COMPETITION
 More competition from foreign firms
 Pressure to become more efficient could reduce
prices in the long run
 LOWER PRICES
 Incentivise domestic firms to reduce prices, or
consumers buy from cheaper foreign markets
 Domestic firms will increase output due to larger
demand – decreased prices
 INCREASED MARKET FOR DOMESTIC FORMS
 Increase in employment
 Specialisation due to greater economies of scale
– use less resources
 Allows more of the good or service to be
consumed
 ACCESS TO RESOURCES
 If you can’t produce it you can trade it e
...
food
and electricity in Dubai
 Increase access to resources consumers AND
producers need e
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e it is the most efficient producer
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ABSOLUTE ADVANTAGE
COMPARATIVE ADVANTAGE

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A country has an absolute advantage in the production
of a good or service if it is able to produce it at a lower
opportunity cost than the other country
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COMPARATIVE ADVANTAGE

Countries will trade the products they have
absolute advantage with, allows countries to
specialise with their production and produce it
most efficiently, world benefits
If the curves on the graph overlap – absolute
advantage

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If one country has absolute advantage with two
goods, the worst country will produce the good
where the difference is the smallest
LOOK AT NOTES TABLE FOR CALCULATING
RELATIVE COMPARATIVE ADVANTAGE

PROTECTIONISM
PROTECTIONISM

Government policies designed to protect domestic
industries from foreign competition e
...
tariffs, subsidies
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ARGUMENTS IN FAVOUR OF
PROTECTIONISM

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WHY IS WORLD SUPPLY PERFECTLY ELASTIC
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PROTECTIONISM EVALUATION
TARIFFS

Protect domestic employment
Overcoming a balance of payments deficit - (XM), protectionism decreases M, increases AD
improves employment
Tariffs are a source of domestic employment
Anti-dumping measure – can legally impose a
tariff on a country if can prove they are selling
below their costs of production, WTO will allow
protectionism in this instance
To protect infant industries – can’t compete
with potentially subsidised economies of scale of
foreign firms
National security – food, energy
Environmental concerns/product standards e
...

when the French banned British beef due to foot
n mouth
Assumed as long as domestic consumers pay
world price world producers will supply as much
as they want
Receive constant returns to scale
Therefore perfectly elastic

A tax placed on imported goods or services with the aim
of increasing the price

TARIFF
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CONSUMERS
Lose, tariff increased price and decreased
quantity, less of good or service consumed
Can’t tell if total consumer spending has
increased or decreased as this depends on
elasticities
DOMESTIC PRODUCERS
Win, sell more at a higher price, increased
revenue of g + a + b + c + h
WORLD PRODUCERS
Lose at expensive of domestic producers,
receive less – DON’T RECEIVE TARIFF
GOVERNMENT
Win, before received 0 now receive tariff on
foreign produced output
F Is loss of consumer surplus
C is loss of allocative efficiency
Both are deadweight loss or loss of social surplus
There is a disincentive for firms to innovate as
they are being protected
Redistribution of income between consumers
and firms, tax is regressive
AD shifts right as consumption increased and
imports decreased

SUBSIDIES
SUBSIDIES

The amount of money the government gives to
producers per unit of output to reduce costs of
production and increase production
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QUOTA
QUOTAS

CONSUMERS
No effect on consumers as consuming the same
amount of good or service at the same price
Pay for subsidy through opportunity cost or
taxing
DOMESTIC PRODUCERS
Revenue increases from a to a +b+e+f+g
FOREIGN PRODUCERS
Revenue drops from b+c+d to c+d
GOVERNMENT
Go from spending 0 to e+f+g
Opportunity cost
Increase in domestic employment/employment
protected
G is loss of allocative efficiency
No loss of consumer surplus

A physical limit on the quantity of a good or service that
can be imported into a country
 CONSUMER
 Price increased from Pw to P1, consumption
decreased from q1 to q4

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(ADMINISTRATIVE BARRIERS)

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Problem if the good is socially useful
DOMESTIC PRODUCERS
Originally receive A now receive A+C+D+F+I+J
Increased revenue, win
FOREIGN PRODUCERS
Cant tell if better or worse off due to elasticities
of supply/demand
Use to receive B+C+D+E now receive B+G+H
GOVERNMENT
No change as no tax or subsidy
K Loss of consumer surplus J loss of allocative
efficiency
Should lead to decrease in imports but cant be
sure due to elasticities
RED TAPE – BUREAUCRACY
Extensive paperwork, rules and regulations
make it more difficult for firms to import, more
expensive, disincentive
HEALTH AND ENVIRONMENTAL STANDARDS
Set a standard for a product before it is ablet o
be imported, e
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fireworks, emissions on cars
Makes it more difficult, time consuming,
expensive to import
Can be justified in some cases, if to protect
interest of consumers and country justified, if
just to keep exports out not
EMBARGOES
When you refuse all trade with a country – most
extreme
EU don’t trade with North Korea
Political punishment, economic sanction
Typically decided by EU or UN

CURRENCY
EXCHANGE RATES

The value of one currency expressed in terms of
another
...
g £1 equals $1
...
g tourism
 CHANGES IN DEMAND FOR IMPORTS
 Increased demand for imports – increased
supply of domestic currency abroad –

FACTORS AFFECTING CURRENCY
VALUE

CURRENCY INTERVENTION
MANAGED EXCHANGE RATE

PEGGED CURRENCY

FIXED EXCHANGE RATES
REVALUATION
DEVALUATION

HOW GOVERNMENTS CAN
INTERVENE

depreciation
 RELATIVE INFLATION RATES
 Higher inflation rates in foreign countries makes
domestic exports more competitive, higher
demand for domestic currency, appreciation
 RELATIVE INTEREST RATES
 Domestic interest rates are higher, foreign
countries more likely to save here, increase in
domestic currency, appreciation
 FOREIGN INVESTMENT
 Foreign Direct Investment and Portfolio
Investment: increase in these investments will
increase the demand for domestic currency
 SPECULATION predict appreciation, demand +
Where the value of a country’s currency is allowed to
freely float i
...

Governments will intervene to keep it within the
acceptable range
When a currency is fixed to another currency, typically
the dollar – typically done by LEDCs to reduce
uncertainty in the value of their currency, build currency
in their currency and economy
Where the value of a currency is fixed to the value of
another currency, the average value of a group or
number of currencies or to the value of a commodity
such as gold
Where the value of a currency in a fixed exchange rate
system is raised against the currency that it is fixed to
Where the value of a currency in a fixed exchange rate
system is lowered against the currency that it is fixed to
 USING FOREIGN CURRENCY RESERVES
 Government affects supply and demand for
currency by buying and supplying foreign
currency
 Get rid of excess supply by buying it, excess
demand by selling it
 INTEREST RATES
 Increase demand for currency – increase
interest rates
 Reduces needs for foreign currency reserves
 BUT long term will affect AD – investment and
durable consumption, clashes between foreign
policy and AD?
 Low interest rates depreciate currency, imports
become more expensive so costs of production
increase, SRAS shifts left, double inflation
through AD shift and LRAS
 CONTROLLING THE AMOUNT THAT CAN BE
EXCHANGED
 By controlling the amount by which demand and
supply can be increased – makes intervention
easier

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EXCHANGE RATE
IMPLICATIONS

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EFFECTS OF LOW EXCHANGE RATES

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EFFECTS OF HIGH EXCHANGE RATES

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RESTRICTIONS ON TRADE
Quotas, embargoes, restrict amount of currency
being sold to buy imports by restricting amount
of imports
Will affect macro
Reducing imports through protectionism –
expenditure switching – through contractionary
fiscal policy – expenditure reducing policies
INFLATION
Make imports more expensive – can switch to
domestic goods and services
Exports more competitive so AD shifts right
Costs of production increase shifting SRAS left
Problem to countries which depend on imports
ECONOMIC GROWTH
Determined by whether marshall-lerver
condition satisfied
EMPLOYMENT
Increase in employment in exporting industries s
exports more competitive
Domestic industries should get an increase in
employment as imports are less competitive so
firms will switch to domestic goods
Some increase in unemployment in import
reliant industries as cost of production increases
could offset first two increases – depends on
relative size of the market, but would expect to
see an overall increase
INFLATION
Imports are less expensive, costs of production
decrease so SRAS shifts right
As imports increase and exports become less
competitive, X-M will decrease so AD shifts left
EMPLOYMENT
Exports are less competitive so export less,
therefore decrease in employment in exporting
industries
Imports more competitive so consumers switch
from domestic product to imported product,
decrease in domestic production and increase in
unemployment
Firms which rely on imports for FOPs will face
lower costs of production, slight increase in
employment in these industries
Overall see a net decrease in employment
ECONOMIC GROWTH
See notes on Marshall Lerner account and J
curve
CURRENT ACCOUNT
See notes on Marshall Lerner account and J
curve
INCREASE IN IMPORTS
Advantage for a country which relies on
importing for necessities
Some developing countries rely heavily on

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EVALUATION OF EXCHANGE
RATES
DEGREE OF CERTAINTY FOR
STAKEHOLDERS

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ROLE OF FOREIGN CURRENCY
RESERVES

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EASE OF ADJUSTMENT
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exports so won’t want a high exchange rate –
can use extra money from higher export rate if
low exchange rate to import more
EFFECT ON EFFICIENCY
Domestic markets now face more competition,
leads to them being more efficient – (Perfect
competition efficient, monopoly inefficient)
FIXED EXCHANGE RATE
High degree of certainty for firms consumer and
government as they will know what it will be in
the future
Firms - Can plan future investments both
domestically and abroad, predict costs of
imports and future sales
Consumers – Better plan travelling abroad,
purchasing of imported goods and services and
financial investments abroad
Governments – Similarly can plan activities
involving foreign transactions
Speculation is limited, removes a cause of
currency instability
Increase confidence
FLOATING EXCHANGE RATE
Can cause uncertainty as stakeholders are
unsure of value in the future
Firms - Negative effects on trade and investment
due to inability to plan for the future
Consumers – Inability to plan
Government – Large and abrupt exchange rate
changes can cause problems for countries that
depend heavily on exports
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g
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If these are unavailable country must resort to
contractionary policies, trade protection or
exchange controls, all with serious negative

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FLEXIBILITY OFFERED TO POLICY
MAKERS

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EVALUATION OF A MANAGED FLOAT

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BALANCE OF PAYMENTS
BALANCE OF PAYMENTS

STRUCTURE OF THE BALANCE OF
PAYMENTS

repercussions
...
g
Interest Rate Increases – Attracts foreign
investments but have contractionary effects in
domestic economy
Borrowing From Abroad – Increases inflows of
funds, but extensive borrowing leads to high
levels of debt
Contractionary fiscal and monetary policies – to
limit imports may create a recession and
unemployment in domestic economy
Trade Protection – To limit imports results in
increased inefficiency in production, increased
global misallocation of resources and may result
in retaliation
FLOATING EXCHANGE RATE
Greater flexibility to policy makers
Domestic economic policy doesn’t need to
respond to balance of payment problems
E
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g
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g
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A
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If the condition is satisfied, the current
account deficit will improve, if not it will deteriorate
PEDX + PEDM > 1
 Inelastic demand for exports and imports means
depreciation of exchange rates won’t necessarily
increase exports or reduce imports (the reason
depreciating exchange rates supposed to help
C
...
D)
 Therefore Q won’t change much for exports, Q
won’t change much for imports so therefore
results in paying more on imports, increasing
CAD
 Therefore initially makes situation worse
 PED becomes more elastic as time goes by as it
takes people time to realise what is cheaper etc
 Eventually demand becomes elastic enough to
satisfy condition and CAD improves
 PEDX + PEDM > 1
 In a freely floating exchange rate CAD causes
depreciation, so current account deficit should
sort itself
 Due to interest rates and central banks freely
floating doesn’t exist, so CAD won’t correct itself
 NB – Appreciation or revaluation in a surplus
would have opposite effect
 CURRENCY
 Likely to result in upwards pressure as high
demand for exports therefore high demand for
currency
 Demand less imports mean smaller supply of
currency, therefore upward pressure
 LOWER DOMESTIC CONSUMPTION
 Surplus suggests a high level of exports for that
economy, this will reduce availability of products
in domestic markets, reducing the level of
consumption i
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domestic spending
 FAIL IN DOMESTIC INVESTMENT
 A CAS results in a financial account deficit
 Results in significant finances leaving the
economy, e
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FDI and Portfolio investment
 Likely to reduce domestic investment within an
economy due to lack of confidence
 REDUCED EXPORT COMPETITIVENESS
 Currency appreciates, exports become more
expensive, in free market would reduce surplus
Refers to economic co-operation between countries and
co-ordination of economic policies, leading to increased
economic links and numerous benefits
An agreement which lowers barriers on particular
products between 2 or more countries
Bilateral – Two countries
Multilateral – Multiple countries
Regional – Geographical region

TRADE BLOCS

FREE TRADE AREA

CUSTOMS AREA

COMMON MARKET

A group of countries who have decided to reduce tariffs
and other barriers to encourage trade
A group of countries which gradually eliminate barriers
for member countries, some products may still be
protected while free trade on others e
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ASCAN or
NAFTA
When countries in a Free Trade Area also adopt
common policies towards non-member countries, i
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act as one
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g SACU South African Customs Union
When countries in a customs union remove all trade
barriers between member countries
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g
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g
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It analyses how many imports a
country can buy with a given quantity of a country’s
exports

IMPROVEMENT IN TERMS OF TRADE

Where a country is able to buy more imports with the
revenue received from a given quantity of its exports
...
Happens
because exports have decreased in price and or imports
have increased in price
 Many developing countries rely on export of
primary products
 Price of commodities has decreased over the
last 30 years
 Technology
 Developments in Technology have helped
finding, extracting, growing (GM) and creating
primary products
 Have increased supply of them and decreased
the price
 Globalisation
 Increase in the amount of countries trading with
each other
 Increased supply of commodities
 Reductions in Protectionism
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g reduced size of computers
mean less demand for copper
 YED
 Commodities are income inelastic, as the world
gets richer demand for commodities don’t
increase as much as expected
 Instead increase for secondary and tertiary
products which use less commodities

CAUSES OF CHANGES IN THE
TERMS OF TRADE DEVELOPMENT SPECIFIC
SUPPLY FACTORS FOR THE
DECREASED PRICE OF COMMODITIES

DEMAND FACTORS FOR THE
DECREASED PRICE OF COMMODITIES

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SHORT TERM CHANGES IN THE
TERMS OF TRADE

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Changes in demand and supply for
imports/exports
This doesn’t have to be specific to domestic
demand and supply, e

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