AS Economics

International Trade

Tutor2u & Mrs G

Aims
To recap the knowledge of Balance of Payments
To understand the positive and negative implications of international trade To consider short run & long impact of international trade

To discuss whether a BoP deficit/surplus can cause problems

How to resolve a BoP deficit/surplus

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What is meant by
Trade?

Trade

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Trade (2)

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What is Free Trade?

Free trade represents trade between countries without the introduction of artificial barriers
International trade reflects exchange and specialization
Exchange: countries supply goods and services that they can produce relatively cheaply and buy products from other countries that they would find relatively expensive to produce Specialisation: benefits from trade are increased if there are economies of scale from production and if countries specialise their resources in producing certain commodities

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What is Free Trade?

In an open economy, one nation trades openly with other
Trade in goods Trade in services

Free flow of financial capital

Free flow of labour resources
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Intra-Firm Trade
Intra-firm trade is becoming increasingly important
For example a USA fruit drinks manufacturer might export some of its raw materials to the UK to produce fruit juices that are manufactured / bottled and distributed to the UK and Western European markets

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Why trade?

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The Potential Advantages from Trade (1)

Competition:
Increased competition for suppliers Greater pressure on businesses to keep their costs and prices down Increased competition can lead to a dilution of monopoly power which reduces the potential for exploiting consumers

This leads to an improvement in the allocative efficiency of scarce resources

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The Potential Advantages from Trade (2)

Comparative Advantage:
If other countries can supply certain goods and services more efficiently it makes economic sense for them to do so This makes use of the principle of comparative advantage It also leads to an improvement in overall productive efficiency

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The Potential Advantages from Trade (3)

Improvements in dynamic efficiency
Trade tends to speed up the pace of technological progress and innovation across different industries Trade provides more choice for consumers Dynamic efficiency gains become apparent over time for example improvements in the quality and performance of products at a given price

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The Potential Advantages from Trade (4)

Economies of scale (lower LRAC) representing gains in productive efficiency and leading to higher profits and lower prices for consumers

Could you draw me an economies of scale diagram?

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Economies of scale
ILLUSTRATING ECONOMIES AND DISECONOMIES OF SCALE

Costs SRAC1

Productive efficiency in the long run is achieved when output is produced at the bottom of the long run average cost curve
SRAC3 SRAC2

AC1

LRAC AC2 AC3

Q1

Q2

Q3

Output (Q)

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The Potential Advantages from Trade (5)

Trade is seen as a stimulant to short term aggregate demand and long run economic growth
Exports are an injection of aggregate demand A boost to exports will have multiplier effects on the level of equilibrium national income There may be extra supply-side improvements from increased capital investment between companies and countries engaged in international trade

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Micro and Macroeconomic Gains

Injection of AD Export led growth multiplier effects Imports of new technology LRAS effect Employment creation in growth sectors

International Trade

Stimulates new capital investment and innovation tutor2u

Makes domestic markets more contestable

Transfer of ideas and best practice benchmarking

Concept of Comparative Advantage

First developed by David Ricardo, one of the founding fathers of classical economics, in 1817
Comparative advantage exists when for a country
The opportunity cost of production is lower
A country is more productively efficient than another Countries will tend to specialise in and then export products which use intensively the factors which it is best endowed Exports used to finance imports of other products

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Importance of trade for developing countries

Diversification into manufacturing

Less dependence on volatile primary industries

Imports of investment goods boosts LRAS

Importance of trade for developing countries

Exploitation of comparative advantage tutor2u

Transfer of technology and ideas

Employment and higher real wages in export sectors

Balance of Payments

Does a BoP Deficit cause problems?

It depends on the size and nature of the deficit!
The larger the deficit, over a longer period of time the greater the problems will be! If its cheap imports & an increase in M???

If its the UK not being competitive and there is a fall in X???

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Short run V long run deficit!

In the Short run.
A deficit might mean that UK households have a better standard of living

In the Long run

A deficit might cause UK businesses to suffer, rising unemployment . and falling standards of living!

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Curing BoP deficit

Deflation
Direct controls
The 3 Ds
All have issues with use!

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Devaluation

Can a surplus BoP cause problems?

A surplus suggests lots of economic success
Exporting more than Importing! Again it depends on the size of the surplus! And if one country is more successful than others then this can cause other countries to act to reduce their deficit and use direct controls!

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Surplus can cause inflation as an increase in X = an injection = outward shift in AD!

Curing BoP surplus

Reflation

The 3 Rs

Remove import controls

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Revaluation

All have issues with use!

Whos in the top 5 for .

Surplus Deficit

There are 164 countries 64 are in a surplus & 100 in a deficit

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Surplus
Rank Country Current account balance (million US$) 1China
2Germany 3Japan

$ 368,200,000,000 2008 est.

$ 267,100,000,000 2008 est. $ 187,800,000,000 2008 est.

4Saudi Arabia
5Russia

$ 141,000,000,000 2008 est.

$ 97,600,000,000

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Deficit
Rank Country Current account balance (million US$) 5
4 3

Turkey
Italy

$ -51,680,000,000 2008 est.

$ -68,820,000,000 2008 est.

United Kingdom $ -72,540,000,000 2008 est.

2
1

Spain

$ -152,500,000,000 2008 est.

United States $ -568,800,000,000 2008 est.

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Global Current account position

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Exchange rates
The value of the

s
s

Learn this acronym.

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 Strong
Pound

Imports
Cheap Exports
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Dear

A strong pound pros

A high pound leads to lower import prices -

How??????

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How does a fall in the pound / sterling affect inflation?

(1) Weaker pound drives up import prices Higher import prices drive up firms costs But these are only one element (wages more important) (2) Higher import prices feed directly into retail basket E.g. prices of imported computers, cars, household furniture (3) Weaker pound leads to stronger aggregate demand growth Faster growth of exports and a slower growth of imports (4) Negative income effect lower real incomes for consumers (5) Positive substitution effect cheaper relative prices of UK output Stronger aggregate demand increases inflationary pressure depending on the amount of spare capacity in the economy

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A strong pound pros

A high pound leads to lower import prices This boosts the real living standards of consumers at least in the short run Cheaper to import raw materials, components and capital inputs good news for businesses that rely on imported components or who are wishing to increase their investment of new technology from overseas countries

A strong exchange rate helps to control inflation because domestic producers face stiffer international competition from cheaper imports and will look to cut their costs accordingly
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A strong pound cons

Cheaper imports leads to rising import penetration and a larger trade deficit
Exporters lose price competitiveness and market share this can damage profits and employment in some sectors. If exports fall, this has a negative impact on economic growth. Some regions of the economy are affected by this more than others

In the North east for example, manufacturing industry accounts for over 28% of regional GDP whereas the percentage for the UK as a whole is just 19%.
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EXAM SKILL

 EXAM PAPER FOR YOU TO DO!

past papers\AQA-ECN22-W-QP-JAN08.pdf

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AQA old exam paper Jan 2008.

Using Extract C, identify two main features in the balance of payments on current account in the economies shown for the period 2005 to 2007. (4 marks)
(b) Extract D (lines 2224) refers to deflation in the Japanese economy allowing exports to become an important driver for economic growth. Explain how falling prices might help to stimulate the economic growth of a country in this way. (6 marks)

(c) Using the data and your economic knowledge, evaluate the possible consequences for UK macroeconomic performance if the euro area and the US seek to reduce their balance of payments deficits on current account. (15 marks)

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