International Trade

• To gain from international specialization (absolute/comparative advantage - discussed below)
  • Increased output
  • Lower prices
  • Greater efficiency
• To gain from international economies of scale
• To gain from increased variety of goods and services
• To gain from increased globalization and communication
  • Leads to research and development
• To reduce international tensions (vested interests)
• To increase export revenue / sell to larger markets

When a country enters into trade with the world, it will find that its domestic prices may be different to prices on the world market.

Because the world market for most goods and services is so big, we draw it as being perfectly elastic. What this means is that we have no power over it and must accept the price that is offered by it.

Only a few countries have real market power over internationally traded goods, and for that reason we assume world supply to be perfectly elastic in most cases - whatever we do domestically does not influence the enormous international supply.

As a result, world price is the same as world supply (that is to say, if we increased supply - a shift downwards - we would thus reduce price)

If a country entered into trade and found that world price was lower than domestic price, then this would mean they cannot compete on the world market.

Consumers will now buy the cheaper foreign goods instead of the more expensive domestic goods.

As a result, the domestic producers will be forced into closing. Only those that can compete (the portion of the supply curve below world price) will stay in business.

However, at world price, demand exceeds domestic supply. To satisfy this demand the excess must be imported.

If a country entered into trade and found that world price was higherthan domestic price, then this would mean they have an advantage on the world market.

They thus have 2 choices: either they can satisfy all of the domestic demand at the current prices OR they can decide to increase their prices and sell on the world market.

Clearly, the second choice would create more revenue (dependant on elasticities) so they therefore raise prices to where world price is.

At this price some domestic consumers decide not to buy the product (contraction in demand) but there is an extension in supply. This excess supply is thus sold on the world market.

The World Trade Organisation - previously known as the General Agreement for Tariffs and Trade (GATT) set up post-WW2 to combat rising global protectionism.

Objectives:

1. Facilitation of Free Trade
2. Regulation of fair competition
3. Equality amongst member nations in trade
4. Promotion of developing countries

Benefits of the WTO

1. Enables countries to solve trade disputes peacefully
2. Encourages free trade which brings
   • Lower prices
   • Greater consumer surplus
   • Greater diversity of products
   • Better quality of products
   • Higher incomes
3. Reduces corruption as protectionism often leads to this
4. Has no power and is optional to join but this encourages transparency and honesty
5. Can help developing countries out of the poverty trap

The Tokyo Rounds

The Uruguay Rounds

The Doha Rounds

We can therefore see that specialization as a result of identifying absolute advantage leads to:

• Greater output of both products

• Increased specialization and efficiency

• Increased revenue from exports

• Increased trade

• Works on a two-good-two-country basis
• Assumes goods have a similar value

1. Tariffs

These are the most common form of protectionism. They are essentially a tax on imported goods and services per unit.

Effects:

• Increase in price / fall in world supply
• Loss of consumer surplus
• Reduction in imports
• Increase in government revenue (if government is importing)
• Increase in domestic producer surplus
• Extension of domestic supply

2. Subsidies

If a government subsidizes domestic firms this makes their costs of production lower and thus they are able to produce more at a lower price. This has the effect of shifting the domestic Supply curve outwards.

Effects (considering it is a fairly small subsidy):

• No price change
• No change in consumer surplus
• Reduction in imports
• Loss of in government revenue (through subsidy) but gain through less imports
• Increase in domestic supply

3. Quotas

If a government decides to limit the physical amount of goods/services entering its country, this would be a quota.

If domestic price is higher than world price and a quota is imposed, the quota will act as a 'fake' domestic supply. For example, if Nigeria was importing 100 000 TVs from the USA at $100 per unit, and Nigeria put a quota of 50 000 TVs then the USA would have a choice. Either they could sell all of their TVs at $100 as before, or they could sell at the higher domestic price.

Clearly they would choose to do this (as they know all of their TVs will sell since there is excess demand for them). This decision makes the quota part of domestic supply, causing a new equilibrium to be found (lower than previous domestic equilibrium but higher than previous world equilibrium).

Effects:

• Higher prices for consumers
• Loss of consumer surplus
• Reduction in imports
• No change in government revenue
• No change in real domestic supply

4. VERs

If a government decides to voluntarily limit the physical amount of goods/services it is exporting this would be a voluntary export restraints. They have the same effect as a quota.

Effects:

• Higher prices for consumers
• Loss of consumer surplus
• Reduction in imports
• No change in government revenue
• No change in real domestic supply

• To protect against dumping
• To protect 'infant industries'
• To protect 'sunset industries'
• To reduce the budget deficit
• To encourage self-sufficiency
• Political reasons
• To encourage diversification
• Strategic trade policy
• To boost domestic employment

• Loss of consumer surplus in all cases (aside from subsidies)
• Encouragement of inefficiency
• Lack of choice for consumers
• Potential for retaliation
• Restriction to benefits of specialisation
• Worsening income inequalities

These are essentially the benefits of international specialization

• Benefits of absolute and comparative advantage
• Increased output
• Lower prices through economies of scale
• Allocative efficiency
• Increased variety of goods and services
• Increased economic globalisation

There are many reasons why exchange rates may appreciate or depreciate.

1) Speculation - this is the process by which people known as 'speculators' seek to make profit on buying and selling currencies. The idea is that they will buy currencies they feel to be undervalued or about to appreciate, and then sell them when they have appreciated to a peak. To buy a currency they are increasing demand for it (and increasing supply of another currency) and when they sell it they increase supply of that currency (and increase demand of another). A famous example comes with George Sorros who famously bet against the Pound (he thought it was overvalued) and made one billion pounds sterling.... in a day.

2) Demand for Imports or Exports - fashion for a country's goods will cause demand for its currency to rise; for example if the USA produces iPods then demand for them may be very high, causing an appreciation as people must first buy their currency. This works for imports or exports.

3) Inflation - high levels of inflation in a country (whether demand-pull, cost-push or printed) will cause domestic prices to rise. This will lead to less demand for this country's products, as they are relatively more expensive than elswhere, and so demand for their currency will also fall, causing a depreciation.

4) Interest Rates - when a central bank partakes in increasing interest rates, this causes foreigners to want more of that currency since it will give better returns than saving domestically. At the same time, increasing interest rates will cause people to save domestically, which leads to an inwards shift of AD, causing goods to be cheaper (prices fall), and thus the exchange rate will appreciate in both ways. This is true the other way round.

5) Protectionism - this causes a limit on imports owing to tariffs, quotas, VERs, embargos or subsidies. As a result, less is spent abroad, meaning less of the currency can be supplied. The extent to which occurs depends on the level of protectionism.

6) Productivity - if a country finds a way of producing a good more efficiently than any other country, then its products will be cheaper. As a result AS in that country will increase, causing prices to fall. More countries will demand their goods, causing the exchange rate to appreciate.

The Balance of Payments should, in theory always equal to zero.

If we are in an overall surplus:

• Surplus credit is money wasted. A country will not just leave a surplus of say $10m lying around.
• Instead it will invest it or spend it. This will go down as a debit on one of the accounts.

If we are in overall deficit:

We can therefore rely on interventionist measures:

• a) Central Bank Reserve Selling - For example, if a country was -$10 in deficit on the current account, the government could sell off some dollars in order take out a loan in its own currency. This would go down as a $10m credit on the financial account.
• b) Exchange Rate Manipulation- By changing how expensive imports and exports are, a country could change how many credits and debits enter the country.
• c) Protectionism - again any form of protectionism (or lack of protectionism) will influence the level of defecit or surplus.

1. Preferential Trade Agreements

• This is when certain countries agree to reduce or eliminate tariffs between certain good or services together.
• It is usually done through a trade pact, ratified by the WTO
• Mulitlateral Preferential Trade Agreements are those created between more than one country e.g. The South Asian Preferential Trade Agreement
• Bilateral Trade Agreements are those created between two countries or two bodies e.g. India-Afghanistan 2003.

2. Free Trade

• Loose group of countries
• Agree to reduce protectionist barriers between members
• Countries can create their own policies to non-members
• No collective bargaining
• E.g. NAFTA

3. Customs Union

• Group of countries that set firmer rules
• Countries agree to abolish protectionism between members
• Countries adopt a common policy with protectionism to non-members
• Collective bargaining with non-members in trade deals
• E.g. CEFTA

4. Common Market

• Countries have fulfilled no protectionist rules between them
• Collective bargaining /common external policy toward non members
• All factors of production are free to move without hinderance
• E.g. EEC

5. Economic and Monetary Union

• A central bank is created - fiscal and monetary policies are set by the central bank
• National soveriegnty is still upheld
• All factors of production are free to move without hinderance
• Example: European Monetary Union (Euro)
• Note: no full Economic Union exists as they don't get tax revenue from national banks

Theory

• If a country formerly set tariffs but needed a certain good, it would buy at the price of lowest cost producer + tariff.
• If this country then decided to start a customs union (or any other trade bloc) with the lowest cost producer, they would aim at eliminating tariffs. They would now buy at the lowest cost price.
• As a result of this, they will increase imports from Q1-Q2 to Q3-Q4.
• At the same time, the same thing is happening for a good that the country is exporting to their new trade bloc member. They are thus exporting a greater amount too.
• We can therefore say that trade has been created between the two countries as a result of the elimination of tariffs.

Effects

• Lower prices for consumers in both countries
• Greater trade (more imports and exports)
• Loss of government revenue (unless it is exporting goods)
• Greater income equalities
• Increased specialization (countries produce the good they have comparative advantage in)
• Increased gains from economies of scale as a result of specialization
• Less domestic supply for certain goods

Best remembered as TROL.W

• 1) The rise of the BRICS economies -the rapid industrialisation of these economies has led for massive demand for hard commodities such as iron, copper, bauxite. Countries that export these raw materials subsequently find that their prices have risen rapidly. Indeed, Australia (not a developing country) has also benefited greatly from the BRICS industrialisation.
  
• 2) Renewable resources movement - developed economies have been slowly moving into renewable energy - the USA for example ordered that a certain amount of production must be undertaken with these. Ethanol is a common renewable source of energy. This is made from corn and sugar cane. As a result, demand for commodities such as corn and sugar cane have increased rapidly, causing exporting countries to benefit greatly from increased prices.
• 3) OPEC and oil prices - the production of commodities is generally capital-intensive, so when oil prices rise (owing to OPECs oligopoly power), then so too do export prices for commodity growing countries. However this may soon be reversed with the development of shale fracking (a process of extracting oil from the ground) in the USA and UK.
• 4) Luxury item availability -as countries get richer, their demand for luxury items grows greatly. However, smart technology (e.g. laptops, ipads, smart phones) require very unusual metals in their production - such as Neodymium  and Dysprosium. Countries that export these goods thus have faced massively increased demand, as this article shows: http://www.telegraph.co.uk/finance/comment/ambroseevans
  _pritchard/9951299/Japan-breaks- Chinas-stranglehold-on-rare-metals-with-sea-mud-bonanza.html
• 5) Weather -the last few decades have seen quite a few weather disasters which cause supply to shift inwards and prices to rise. Droughts in the Horn of Africa, floods in Australia and fires in Borneo have all contributed to this.