International trade. Comparative advantage.
The principle of comparative advantages: Total output will be greatest when each good is produced by that nation which has the lowest domestic opportunity cost for that good.
Comparative advantage: Suppose the word economy is composed of just 2 nations: Russia and Brazil. The “word” clearly is not economizing in the use of its resources, if a specific product is produced by high-cost producer, when it could have been produced by low-cost producer.
Specialization according to comparative advantage results in:
- a more efficient allocation of word resources
- larger outputs of both products and therefore available to both nations
International trade: trade barriers
• It allows nations to:
– Specialize;
– Increase the productivity of their resources;
– Obtain more goods and services.
Trade barriers:
1. Tariffs are excise taxes on imported goods.
Purposes:
- to obtain revenue – a revenue tariff – for providing the Government with revenues. Rates are modest.
- to protect domestic firms – a protective tariff – it puts foreign producers at a competitive disadvantages in selling in domestic markets.
2. An import quota specifies the maximum amount of a commodity which may be imported in any period.
Low quotas completely prohibit imports (more efficient than tariffs)
A nontariff barrier (NTB)is a licensing requirement, standards pertaining to product quality and safety.
A voluntary export restriction (VER)– a trade barrier by which foreign firms “voluntary” limit the amount of their exports to a particular country. VERs are agreed to by exporters in the hope of avoiding more stringent trade barriers
International trade: cases and costs of protection.
The case for protection:
The arguments that protectionists make to justify trade barriers:
Military self-sufficiency argument – tariffs are needed to strengthen industries which produce goods for national defense.
Diversification for stability argument – highly specialized economies are very dependent on international markets for their incomes. So, recessions abroad, international political developments, etc. can cause deep declines in export revenue. Tariff and quota protection are needed to enable greater industrial diversification.
Infant industry argument – protective tariffs are needed to allow new domestic industries to establish themselves.
Cheap foreign labor argument – domestic firms and workers must be shielded from from the competition of countries where wages are low.
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Increased domestic employment argument – reducing imports will divert spending on another nation’s output. Thus, domestic output and employment will rise.
BUT there are some shortcomings:
– Job creation from imports(imports may eliminate some jobs, but they create others )
– Fallacy of composition(the export of one country must be import of another. The tariffs achieve short-run domestic goals by making trading partners poorer.)
– Possibility of retaliation(“trade barrier war”)
– Long-run feedbacks(the long-run impact of tariffs is not to increase employment but to reallocate workers away from export industries and to protected domestic industries.)
Cost of protection:
• The consumer cost of trade restrictions can be calculated by determining the effect they have on the prices of protected goods.
• Protection raises the price of a product in three ways:
• The price of imported product goes up.
• The higher price of imports causes some consumers to shift their purchases to higher priced domestically produced goods.
• The prices domestically produced goods rise because import competition has declined.
Import restrictions affect low-income families proportionately more than high-income families.
Because tariffs and quotas act much like sales taxes, these trade restrictions are highly regressive.
This “overcharge” associated with trade protection falls as a percentage of income as income increases.
The balance of payments.
-Is the sum of all transactions which take place between its residents and the residents of all foreign nations.
These transactions include:
-Merchandise exports and imports,
- imports of goods and services,
-tourist expenditures,
-interest and dividends received or pay abroad,
-purchases and sales of financial or real assets abroad.
Exchange rates: types.
•Types:
–A flexible or floating exchange-rate system. The rates at which national currencies are exchanged for one another are determined by demand and supply and in which no government intervention occurs.
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- A fixed exchange-rate system. Governments determine the rates at which currencies are exchanged and make necessary adjustments in their economies to ensure that these rates continue.
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