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Chapter 23 – Why do countries trade

What are gains from international trade
International trade: exchange of goods/services between countries. Gains include:
- Lower prices: buying goods/services at much lower prices and purchasing less
expensive raw materials. Prices may be lower in other countries because of their
access to resources, quality of labour, capital and technology
- Greater choice: Variety of products are available from a variety of countries
- Differences in resources: because some countries do not have access to many
resources they need to trade their goods to gain foreign currency to then buy the
products they need
o E.g., Singapore has to import everything, but in turn exports manufactures
goods/services
- Economies of scale: larger markets allow for larger production, specialization,
division of labour, gaining experience and expertise – generates efficiency and
competitiveness
- Increased competition: leads to greater efficiency and less expensive goods – quality
and variety of available goods increases
- Efficient allocation of resources: countries produce goods that they are best at
producing and do this at the lowest cost, thus being efficient – all the world’s
resources are thus being efficiently used
- Source of foreign exchange: trade enables other countries to receive foreign
currencies that they could then use to purchase goods from other countries
o Helpful for developing countries which have inconvertible currencies
Comparative advantage theory (HL)
Absolute advantage (HL)
- When a country can produce a good using fewer resources than another country -
output will be maximized when countries specialize – both will gain
- Reciprocal absolute advantage: occurs when each country has an absolute production
of one product
Comparative advantage (HL)
- When a country can produce a good at a lower opportunity cost than another country
– giving up fewer resources to produce the good

- France should specialize in wine because it gives up less kilos of cheese,

and Poland should specialize in cheese because it gives up 1/3 liter of
wine
- Comparative advantage for the more efficient producer – when distance
between possibilities is the greatest (a), for the less efficient – when
distance is least (b)
How is comparative advantage used to illustrate gains from specialization and trade (HL)
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- If there is a specialization a country can keep the good that it has not
exported and can import the good it is not good at producing – gain both
at lower costs – and vice versa
- Countries are able to consumer at a point beyond their PPCs – amount
of gain depends on exchange rates
Does the theory of comparative advantage always work (HL)
- Only works when there are different opportunity costs – if they are the
same there are no gains to be made from trade
What gives a country a comparative advantage (HL)
- Based on abundance of certain factors – land agriculture, unskilled
labour production of manufactured goods, educated labour
financial services, beaches tourism – price of factor is lower than the
price of other factors – making opportunity cost pf things using that
factor be lower than in other countries
Limitations of comparative advantage (HL)
- Assumption of perfect knowledge of where the least expensive goods
may be purchased
- Assumption that there are no transport costs – those costs may erode the comparative
advantage and eliminate its competitiveness
- Normally assumes that there are two economies producing two goods – this however
can be overcome with technology and simulations – comparative advantage may be
found in multiple countries
- Assumption that costs do not change – economies of scale, however, do exist – costs
fall
- Non-identical goods – consumer durables – are harder to compare and see if a country
has a comparative advantage or not
o E.g., Japan’s Toshiba television vs Phillips television
- Factors of production do not necessarily remain in the country that has the advantage
– capital may be moved to developing countries instead
- Free trade might not necessarily be present – government trade barriers may be placed
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Chapter 24 – Free trade and protectionism

What is free trade
- Takes place between countries with no barriers – goods/services are moved freely
Arguments in favour of protectionism
- Protecting domestic employment: small domestic industries will not be able to
compete against foreign industries and thus structural unemployment could occur
o Weak argument because protection might just prolong the fall of industry
rather than help it
- Protecting economy from low-cost labour: workers in developing workers might be
losing their jobs against workers with lower wages in emerging countries
o Comparative advantage concept however is lost – domestic consumers pay
more than if they would import – the government should apply policies to help
its laborers instead of applying barriers
- Protecting an infant industry: small industries do not have economies of scale and
need time for it to develop
o In developed countries however many new industries already start efficiently
and already gain economies of scale – only developing countries can use small
industries as a reason
E.g., Saudi Arabian petrochemical production – have being working
with Chevron, BP – became the largest in the world
- Avoid risks of over-specialization: when a country focuses on exporting one-two
(primary) products then any sudden changes in demand/supply can be harmful to the
economy
o E.g., Rubber production in Malaysia – harmed by synthetic rubber, coffee in
Ethiopia – harmed by overproduction of coffee worldwide
- Strategic reasons: protecting industries that may be needed in an emergency – steel,
power
o Even if war occurs and countries need those resources it is likely they will still
have access to them – this argument is just an excuse
- Prevent dumping: selling large quantities of a product at lower price than its
production price – this harms producers in developing countries – anti-dumping
measures are then imposed
o Hard to prove if dumping has occurred + subsidies may also count as dumping
because they don’t reflect real costs = these would be solved through talking
rather than barriers
E.g., China blames EU, USA for dumping rubber, USA blames China
for dumping aluminum sheets
- Protect product standards: imposing safety, health, environmental standards on
imports – approved by WTO if there is scientific evidence
o Some claims may not be backed up by strong evidence; the cost in meeting
standards might be hard for those in developing countries = documentation
costs, approvals, creation = STDF is made to help those
US and EU hormone treated beef quotas of 20000/year (2009) that
increased to 45000/year (2012) and was banned previously in 1980
- Raise government revenue: developing countries put tariffs to get revenue
o Means to raise revenue – burden falls onto the domestic consumers
E.g., Lesotho % of governmental revenue from tariffs – 41.4% (2017),
Senegal – 11.2% (2017)
- Correct balance of payments deficit: put tariffs to reduce import expenditure
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o Works in the short-run and the issue is not fixed + other countries may also
impose similar measures
Arguments against trade protection
- Raised prices to consumers and producers of imports
- Less choice for consumers
- Reduced competition, firms become inefficient, innovation is reduced, export
competitiveness may be reduced
- Comparative advantage is distorted – inefficient use of resources; specialization is
reduced
- Trade war
- Economic growth may be hindered (see previous reasons)
Main types of protectionism
Tariffs
- Tax charged on import goods – supply shift upward by amount of
tax (World Supply curve)
o When supply is shifted domestic producers receive more
revenue – from g to g+a+b+c+h and foreign producers
receive less, from h+i+j+k to i+j and government receives
d+e
o Dead-weight loss – loss of consumer surplus at point f
o Dead-weight loss – loss of producer surplus at h+c – inefficiency of the firms
against the export producers – more resources are used than necessary
- Importers pay higher prices – it would thus increase costs of production, forcing
consumers to pay more, and thus reducing international competitiveness
o E.g., Car production
- Can be used as an anti-dumping measure
International trade subsidies
- Subsidy to domestic producers to make them competitive – S shifts to the right
o Producers produce at point Q3, revenue increases from a
to a+b+e+f+g, Exporters Q3Q2 revenue falls from b+c+d
to c+d, government pays at points e+f+g
o Dead-weight lost at points b+g – inefficient production
and allocation of resources – other producers would
produce at point b
o No consumer loss however in long-term they might have
to pay higher taxes to fund those subsidies
Quotas
- Physical limit on number/value of imported goods
o A quota is imposed on Q1Q3 point – therefore all imports at points Q3Q2 are
not allowed to be imported
o As price at point Q3 is higher at Pquota domestic producers begin increasing
production shifting it – demand falls to point Q4
o Domestic producers’ revenue = from a to a+c+d+f+i+j
o Foreign producers’ revenue = from b+c+d+e to b+g+h
o Dead weight loss – consumer surplus loss at k
o Dead weight loss – domestic producers produce at c+d+j – inefficient
allocation of resources
Administrative barriers
- Red tape: administrative process for imported goods – ports that are hard to reach,
lengthy paperwork, legal work = slows down imports
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- Health, safety, environmental standards: restrictions on types of goods or on their

methods of production
- Embargoes: ban of imports – type of political punishment – normally sanctions are
put instead – one/few products that are limited to be exported/imported
o E.g., US embargoed Cuba, Crimea, Syria, Iran, North Korea
Nationalistic campaigns
- Marketing campaigns to encourage people to buy domestic products – moral suasion
– government links consumption of imports to creation of unemployment

HL – see page 376 for practice questions