ECS 1601

Study Unit 4A: The foreign

sector

Lets venture out to

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Content
In this study unit you will learn
more about:
Why countries trade
Trade policy
The balance of payments
Exchange rates
Terms of trade

Read section
17.1 in
textbook
pg. 371-376

4.1 Why countries trade

A country is self-sufficient if it makes everything it

consumes within the borders of the country.
But Adam Smith said it is better to specialise in a
couple of goods and services and trade with other
countries because countries have different
resources
For example, South Africa has a lot of gold and
platinum but not a lot of computer factories. Therefore,
South Africa specialises in mining gold and platinum,
exporting the surplus and importing computers from
America and Japan.

Countries could have a absolute or comparative

advantage in trade

Absolute Advantage

Watch 1601
DVD, for more
on absolute
advantage

Catching
fish

Climbing
trees for
coconuts

Man

20
10

6
3

Woman

8
4

10
5

The
woman
in
A
man
and
abetter
If
they
trade.
The
mando
is not
aisbetter
climbing
trees.
In one
swimmer
and
catches
And
each
spend
woman
are
hour
she
gets
10 The
20 fish
in
ancatching
hour.
30min
on
stranded
onman
a
coconuts.
The
woman only
catchesonly
fish
and
30min
on
island.
They
need
gets
She
an
8.He 6.
has
anhas
absolute
coconuts.
Then
they
absolute
in
fish
andadvantage
coconuts
advantage
in
catching
getting
coconuts
will
have
the
fishsurvive.
to
following

Absolute Advantage
If they
eachin the
Lets
write
Compare
how
specialise
corner
howand
muchif
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have
trade thehave
rest, if
they
they will
trade to the
then do
they
will have
they
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innot
thetrade
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coconuts and
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more fish!
remember).

Man

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fish
(Not
trade=10)

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20

(Not
trade=4)

Woman

Watch 1601
DVD, for more
on absolute
advantage

Climbing
trees for
coconuts

(Not
trade=3)

(Not
trade=5)

10
5

Study Box
17-2 in text
book on
page 374

Watch 1601
DVD, for more
on
comparative
advantage

Comparative Advantage

Yes!
Lets
look
at the
A
year
later
the
Now,
the
woman
The
man
has
a higher
Now
the
man
has
a
opportunity
cost.ill
In the
man
became
had
absolute
In theatime
it takes
(opportunity)
cost inthe
COMPARATIVE
time it takes the woman
man was
to fish.
catch
one
fish,
getting
Itin
will
be
and
not
able
advantage
both
to catch one fish,
she
advantage
in
he could
have
gotten
better
for
themore.
man
to 3
fishing
and
swim
any
could have
gotten 1.25
getting
coconuts.
coconuts
get
the coconuts
and
coconuts.
Do you
coconuts.
Now
he
could
only
for the woman to fish.
think they
should
catch
2 fish
in a
still trade?
hour.

Man

Woman

Catching
fish

20
2

Climbing
trees for
coconuts

8
1

=3

10

= 1.25

Where does a comparative

advantage come from?
Technology
Japan is a high tech country and therefore produce
certain things, such as computers, more efficient.

Resource Endowments
South Africa has a lot of mineral such as platinum
which other countries do not have. They have to
trade to get it!

Different tastes or demand

Holland is good in producing bicycles
because they have a long history
in producing bicycles!

Read section
17.2 IMPORT
TARIFFS in
textbook
pg. 376-377

4.2 Trade policy:

Import tariffs

Watch 1601
DVD, for
more on
import tariffs

IMPORT TARIFFS: Is a tax or duty levied on the

products that are imported to a country.
Protective tariffs:
When the government wants to protect a local
industry from cheap imports, they can impose a
tariff on imports to make the products more
expensive
Revenue tariffs:
Even is there is no local industry to protect, but
the government wants to make extra income,
they can make income from taxing imports.

4.2 Trade policy:

Import tariffs
Two categories of import tariffs are:
Specific tariffs:
A specific amount taxed on each unit
imported. For example: R1 000 tariff
should be paid on each car imported.
Ad Valorem tariffs:
A percentage of the value is taxed.
For example a tariff of 20% on the
price of all new imported cars.

4.2 Economic Impact of a tariff

S

Price of cars (P)

See the following market for

cars. With no foreign trade.
The equilibrium price is Pd,
and the equilibrium
quantity is Q3. Equilibrium is
Ed.
Due to other countries that
have a comparative
advantage in producing
cars, the WORLD PRICE of
cars are shown by the line
PW

Pd

Ed

PW
D
0

Q3
Quantity cars (Q)

4.2 Economic Impact of a tariff

If the trade opens and the
new price for a car is PW,
then supply of cars in the
local industry will fall to Q1
and the demand in the
local country will increase
to Q5
Meaning, the shortage in
domestic supply will be
filled with imports.
New equilibrium is at EW.
With a price PW and
quantity of Q5

Price of cars (P)

Ed

Pd

EW

PW

D
0

Q1

Q3

Q5

Quantity cars (Q)

4.2 Economic Impact of a tariff

If the government imposes
a tariff. Then the price will
increase by the amount of
the tariff
At a price of PT, local
supplier will supply Q2
and consumers will
demand Q4.
The imported amount is
now Q2 Q4
Equilibrium is ET, with a
price of PT and quantity of
Q4

Price of cars (P)

Ed

Pd

ET
EW

P
PWT

D
0

Q1

Q2

Q3

Q4

Q5

Quantity cars (Q)

Read section
17.2 OTHER
MEASURES in
textbook
pg. 379

4.2 Trade policy:

Other measures

Import quotas
A restriction on the amount of a certain import
allowed.

Subsidies
Instead of taxing the overseas companies with a
tariff, the government can give the money to the
local companies.

Non-tariff barriers
Rules and regulation set on the standard
of imports, such as how food should
be packed or the size of fruit.

4.2 Trade policy:

Other measures
Exchange controls
Foreign currency is needed for foreign trade,
by restricting foreign currency, foreign trade is
restricted.

Exchange rate policy

Exchange rates influences trade. Exchange
rate policy can therefore influence trade.

General comments
The main aim of trade policies, is to protect
and support local producers from cheap
international brands

Read section
17.2 Arguments
for and against
trade barriers in
textbook
pg. 380-382

Arguments for
trade barriers

The balance of payments

If import decrease it will improve the balance of payments

Dumping
Dumping is when a foreign firm sells his products much cheaper here than
in his own country.

Export subsidies
Foreign companies are often subsidised, and that makes it difficult to
compete with.

Infant industry
The government helps a company to start-up initially

Employment
Employment falls if local firms closes down due to foreign competition

Government revenue
The government makes an income from tariffs

National security
Politically it is necessary to ensure that too much of certain products (such
as weapons) do not enter the country

Arguments against
trade barriers
Retaliation by trade partners
If South Africa imposes a tariff on a certain country,
TRADE
they might imposeRead
another
tariff on RSA.

POLICY IN
Welfare costs to society

SOUTH
AFRICA
Tariffs increases prices,
which
can have a
ripple effect on other
industries that wants to
in textbook
use those products.
Plus
consumers
pg.
382
-383 have to
pay more

Inefficiency
Other countries produces goods cheaper
because they are more efficient, by
restricting trade from those countries, local
companies keep on producing inefficiently.

Read
section 4.6
in the
textbook on
pg. 46- 71

4.3 The balance of

payments

The balance of payments is a record

each country keep on its transactions
with the rest of the world