1. INTERNATIONAL TRADE

2. International Trade
International trade occurs when nations buy, sell or trade goods and services with one another.
Many small and open economies are dependent on international trade to maintain standards of living, e.g. Singapore, Australia.

3. International Trade
No country is capable of being totally self sufficient. There are several reasons why international trade is necessary, such as the uneven distribution of natural resources and climatic factors.
Economics should therefore utilise the resource with which they are endowed and specialise in those areas. Then they simply swap their production for the products that they require.

4. Why Nations Trade
Specialisation has enabled countries to become far more productive. To take advantage of this productivity, it is essential that the surplus production be exchanged with others for the desired produce. This forms a basis for international trade.
There are two theories for the basis of international trade – absolute advantage and comparative advantage.

5. Absolute Advantage
A country is said to have an absolute advantage in the production of a product if it can produce that product more efficiently than another country. More efficiently means producing more from the same amount of resources or the same from fewer resources.
Assumptions to the theory of absolute advantage:
- only two countries
- only two products
- perfect mobility of resources
- no transportation costs

6. Absolute Advantage The model below illustrates the absolute advantage:
The countries can produce anywhere along the production possibility frontier. The actual production will be determined by consumer demand.
France
Radios
Bananas
Canada
100
Or 32
France 30
Or 86
Bananas
Canada
Radios

7. Absolute Advantage
For the purposes of illustration, let us consider the situation when the countries devote half of their resources to each product, and if they specialise completely in the product which they have the absolute advantage (Canada has absolute advantage in radios, France in bananas):
Radios
Bananas
Canada 50 16
France 15 43
Total Output 65 59
Radios
Bananas
Canada
100
France 86
Total Output
50% resource split
100% specialisation

8. Absolute Advantage
For countries to benefit from trade, they must get at least the same volume of product in both items and more in one. The countries will negotiate an exchange rate which relates to opportunity cost and then engage in trade. The following situation represents an after-trade scenario where both countries are better off in both products:
Radios
Bananas
Canada 60 34
France 40 52
Total Output
100 86

9. Absolute Advantage
The benefits from absolute advantage are very clear. It is likely however, that a nation may have the absolute advantage in the production of both products. Despite this, trade can still prove to be beneficial.

10. Comparative Advantage
A comparative advantage occurs when a country is relatively better at producing one product rather than another. A country may not have an absolute advantage in producing either product but can still have a comparative advantage at producing one of the products. This can be illustrate using the following example:
Radios
Bananas
Canada 12 18
France 20

11. Comparative Advantage
From these figures, we can establish the opportunity cost of each item within the country and then compare the relative opportunity cost:
Radios
Bananas
Canada
0.66 bananas
1.5 radios
France
1 banana
1 radio
Table showing
opportunity costs
In comparison to France, Canada has a comparative advantage in producing radios France has a comparative advantage in producing bananas.

12. Comparative Advantage
To examine the gains from comparative advantage, we are assuming that each country devotes 50% of its resources to each product. This need not actually be the case but forms a good basis for comparison:
Radios
Bananas
Canada 6 9
France 10
Total Output 16 19

13. Comparative Advantage
In order to increase global output, the weaker country should have a 100% specialisation in its comparative advantage and the stronger country part specialises mainly where it has its comparative advantage:
Both countries will gain from specialising in their comparative advantage and trading their produce.
Radios
Bananas
Canada 18
France 2
Total Output 29

14. Trade Restrictions
Despite the benefits of trading on the international market, nations can also impose trade restrictions.
This protection of a nation’s economic interests can vary in form depending on what economic goals need to be achieved.
Examples of trade restrictions are:
Tariffs - Subsidies
Quotas - Embargoes

15. Tariffs reduce the quantity sold of an import
Tariffs are taxes imposed on imported goods. It raises the price of imports and allows domestic producers to expand their share of the domestic market at the expense of foreigners. S
Tariffs raise revenue for the government as it is simply a tax added onto the cost of an import P2
Tariffs raise the price of imports P1 D Q1 Q2 Q2 Q1
Tariffs reduce the quantity sold of an import

16. Subsidies
Subsidies are payments made by the government to domestic firms to encourage production. The subsidy reduces a firm’s running costs and allows them to sell their products at a cheaper price. S S 1 2
Subsidies lower the price of domestic products P1
Subsidies are an expense for the government as they are financing domestic firms in an attempt to lower their opportunity costs P2 D Q1 Q2
Subsidies increase the quantity sold of a domestically produced good or service

17. Quotas and Embargoes
Import Quotas are specific restrictions on the quantity of a product imported. This forces up the price of the product and allows domestic producers to be more competitive.
Embargoes are total bans on an imported product, usually for legal, political, economic or moral reasons. This means that consumers can only buy that product locally. If it is not produced domestically, then consumers will not be able to buy it at all.

18. Arguments for Trade Restrictions
Infant industries argument - domestic firms that are only just starting to develop must be protected against established foreign competition.
They simply cannot compete as the average cost per unit sold is higher for infant industries than overseas competitors.
The argument follows the notion that until the infant industries achieve economies of scale, they should be protected so as to be able to compete with the overseas firms.

19. Arguments for Trade Restrictions
Jobs and income argument - communities generally demand that the government protect domestic jobs and wage levels.
The government can use protection measures and campaigns, such as the ‘Buy Locally Made’ advertisements, to help achieve this.

20. Arguments for Trade Restrictions
However, the government must not introduce too many protection measures as other countries may retaliate to protect their domestic jobs, thus losing the potential gains from international trade.

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