International Trade & Protectionism
1. What is International Trade?
Definition: International trade = buying & selling of goods and services between countries. Two kinds:
Why do countries trade? (board notes)
- Factor endowment differs — every country has a different mix of natural resources + human resources. So a country suits the production of some goods/services and is totally unsuited to others (e.g. climate — some crops simply can't be grown in some countries).
- Specialisation — trade lets a nation specialise in goods it can produce most cheaply and efficiently.
- A country can consume more than it could produce if it relied only on its own resources.
- It enlarges the potential market for a country's goods — trade has always been the major force behind economic relations between nations.
- Revenue — a major source of revenue for countries whose exports are worth more than imports; used for economic growth & development.
- Competition — the more open a country, the more competition home producers face ⇒ they must be more efficient (good in economic sense) and consumers may enjoy lower prices.
- Bigger platform for firms to introduce goods/services ⇒ larger market ⇒ economies of scale (fall in per-unit cost, e.g. raw materials bought cheaper in bulk).
2. Free Trade & Balance of Trade
Free trade (board) means:
- No barriers for entry / exit
- No trade diversions
- No trade barriers
Advantage of free trade → Comparative advantage and Absolute advantage (sections 5–6).
AD = C + I + G + (X − m)
3. Advantages & Disadvantages of Free Trade
| Advantages ✓ | Disadvantages ✗ |
|---|---|
|
|
Infant industry = a new industry that can't yet compete with established foreign firms · Sunset industry = an old, declining industry. (plain-English glosses added for revision)
4. Bilateral Trade & Specialisation
Definition: Bilateral trade = 2 countries producing 2 goods (Good X and Good Y). Each is specialised — if one country specialises in producing one good, the other country specialises in producing the other good. They specialise to produce efficiently / effectively.
5. Absolute Advantage
Principle: a country has an absolute advantage over its trading partner if it can produce more of a good or service with the same amount of resources.
To identify: find the country which can produce more of a good than the other country. Board hook: Absolute advantage → QUANTITY — "which country is able to produce more goods than another country".
Where does absolute advantage come from? — factors of production (board examples):
| Factor | Country (board example) |
|---|---|
| 1) Land | Australia |
| 2) Labour | China |
| 3) Capital | Japan |
| 4) Enterprise | Malaysia |
6. Comparative Advantage
Principle: to identify the country with comparative advantage you must work out the opportunity-cost ratios. The country with the lower opportunity-cost ratio than the other country has the comparative advantage.
Board hook: Comparative advantage → "Quality" → less forgone → lower opportunity-cost ratio.
Y : X → 1Y : output of Xoutput of Y X
7. When does trade take place?
Trade is done on the basis of the exchange rate (i.e. the trade-off ratio between goods in the two countries).
8. Worked Examples — Which country has the advantage?
Example 1
| Country A | Country B | |
|---|---|---|
| Good X | 200 | 300 |
| Good Y | 400 | 600 |
Q: Find which country has absolute / comparative advantage.
Country B has absolute advantage in producing both goods (300 > 200, 600 > 400).
Example 2
| Country A | Country B | |
|---|---|---|
| Good X | 400 | 200 |
| Good Y | 800 | 600 |
Q: Find which country has absolute / comparative advantage.
Country A has absolute advantage in producing both Good X and Good Y (400 > 200, 800 > 600).
Protectionism
9. What is Protectionism?
Protectionism → moves away from free trade → uses trade barriers.
Aim: to protect our domestic industry from foreign competition.
Protectionism tools (the board's list):
| ① | Tariff | tax on imported goods |
| ② | Quota | physical limit on quantity of imports |
| ③ | Voluntary export restraint (VER) | limit on quantity — specific category of goods |
| ④ | Embargo | ban on certain goods / between countries |
| ⑤ | Subsidy | → “dumping” (below-cost price) |
| ⑥ | Devaluation | M price ↑ · X price ↓ |
| ⑦ | Exchange controls | (defined on board at the end — see ⑦ below) |
10. ① Tariff
Tariff = a tax on imported goods. Effects (board flow):
| Elastic demand ★ | Inelastic demand | |
|---|---|---|
| Import price | M price ↑ | M price ↑ |
| Import quantity | M qty ↓ (a lot) | M qty ↓ (a little) |
| Import spending | MTE ↓ | MTE ↑ |
| Demand (board numbers) | 10% → 50% | 50% → 10% |
| Substitutes | substitutes ↑ | substitutes ↓ |
| Type of product | luxury product | necessity product |
| Knock-on | — | cost ↑ → AS ↓ → shortage → price ↑ ⇒ imported inflation |
Reading of "10% / 50%": first number = % change in price, second = % change in quantity demanded (so elastic: price +10% ⇒ quantity −50%; inelastic: price +50% ⇒ quantity −10%). Interpretation of the board's shorthand.
Switch to domestic goods (the other branch)
Tariff diagram — price of imported goods
- Before tariff: price WP ⇒ domestic supply QS (point b), demand QD (point a) ⇒ imports = QD − QS.
- After tariff: price WP + T ⇒ domestic supply ↑ to QS₁ (b → d), demand ↓ to QD₁ (a → c) ⇒ imports = QD₁ − QS₁ — smaller. Arrows on the board: QS → QS₁ (right), QD → QD₁ (left).
11. Other protectionism tools
② Quota
Definition: a physical limit on the quantity of imported goods — it also increases their price.
③ Voluntary export restraint (VER)
Definition: a government-imposed limit on quantity of some specific category of goods that can be exported to a specific country over a specified period of time. Sometimes called an “Export Visa”.
④ Embargo
Embargo = a ban on certain goods, or a ban between different countries.
⑤ Subsidy → Dumping
Subsidy: a grant or cash payment given by the government to the producer which reduces cost of production and makes the domestic good more competitive.
Dumping: a kind of predatory pricing, especially in international trade. It occurs when a manufacturer exports a good to another country below the cost price (“destroyer pricing”).
⑥ Devaluation
Cheaper exports + dearer imports ⇒ a more favourable trade position — so it works as a protectionist tool.
⑦ Exchange controls
Definition: government restrictions on the purchase and sale of currency. These controls give a country a degree of economic stability by limiting the amount of exchange-rate variability.
12. Quick Recap — Whole Chapter
- Goods = visible/tangible · services = invisible/intangible
- BoT = XTR − MTE ; surplus XTR > MTE ; deficit MTE > XTR ; AD = C + I + G + (X − m)
- Free trade = no entry/exit barriers, no trade diversions, no trade barriers
- Pros: economies of scale, GDP ↑, world output ↑, jobs ↑, tax ↑, competition ↑ → prices ↓, more choice, BoT/BoP positive
- Cons: diseconomies of scale, domestic/infant/sunset industries suffer, resource depletion, BoT deficit / BoP −ve
- Absolute adv = produce more (quantity) · Comparative adv = lower opportunity-cost ratio (less forgone)
- OC ratio: 1X : (Y ÷ X output) Y ; same ratio ⇒ trade ceases ; different ⇒ beneficial
- Protectionism = away from free trade, trade barriers, protect domestic industry
- Tariff: tax on imports → M price ↑, M qty ↓ → MTE depends on PED (elastic ↓ ★ / inelastic ↑ + imported inflation)
- Tariff also: switch to domestic goods → C ↑ AD ↑ → output ↑ → labour demand ↑ → unemployment ↓ (SR mild inflation, LR hyper)
- Quota = physical limit on import quantity (raises price) · VER = limit on exports of a category to a country ("export visa")
- Embargo = ban · Subsidy = grant to producers (→ dumping below cost, "destroyer pricing")
- Devaluation: M price ↑ M qty ↓ MTE ↓ ; X price ↓ X qty ↑ XTR ↑ ; BoT surplus, BoP positive
- Exchange controls = restrictions on buying/selling currency → stability