INTERNATIONAL TRADE

Q Effects of trade restrictions on surpluses ?

Ans :Trade barriers, such as tariffs, have been demonstrated to cause more economic
harm than benefit; they raise prices and reduce availability of goods and services,
thus resulting, on net, in lower income, reduced employment, and lower economic
output.

Q Internal and external economies of scale

Ans : Internal economies of scale are firm-specific, or caused internally, while
external economies of scale occur based on larger changes outside of the firm. ...
Another type occurs when firms purchase in bulk and receive discounts for their large
purchases, or a lower cost per unit of input.

BASIS
INTERNAL EXTERNAL
FOR
ECONOMIES OF ECONOMIES OF
COMPA
SCALE SCALE
RISON

Meaning Internal economies of External economies

scale are those that
arise on account of an
increase in the scale of
production and plant-
size.
of scale are those
that arise outside the
entity and accrue to
the growing entities.

Long run Falls due to the Shifts downward

average expansion in output due to the expansion
cost curve by the firm up to a in size of the
certain extent. industry or economy
as a whole up to a
certain extent.

Reflected Movement along the Shift of the LAC

as LAC curve. curve.
• Countries selling goods and services to
each other almost always generates mutual
benefits.

Effects of Government Policies on

Trade
•Policy makers affect the amount of trade through
–tariffs
: a tax on imports or exports,
–quotas:
a quantity restriction on imports or exports,
–export subsidies
: a payment to producers that export,
–or through other regulations (ex., product specifications)
that exclude foreign products from the market, but still allow
domestic products.

Exchange Rate Determination

•Exchange rates measure how much domestic
currency can be exchanged for foreign currency and
thus affect:
–how much goods denominated in foreign currency
(imports) cost in the domestic country.
–how much goods denominated in domestic currency
(exports) cost in foreign markets.
•Some exchange rates change continually (float)
while others are fixed for periods of time.

Impediments to Trade: Distance, imp

Barriers, and Borders
Other things besides size matter for trade:
1.Distance
between markets influences transportation costs and therefore
the cost of imports and exports.
2.Cultural affinity
: close cultural ties, such as a common language, usually
lead to strong economic ties.
3.Geography
: ocean harbors and a lack of mountain barriers make
transportation and trade easier.
4.Multinational corporations
: corporations spread across different nations
import and export many goods between their divisions.
5.Borders: crossing borders involves formalities that take time, often
different currencies need to be exchanged, and perhaps monetary costs
like tariffs reduce trade.

What is comparative advantage?

• Comparative advantage is an economic term that refers to an economy's ability
to produce goods and services at a lower opportunity cost than that of trade
partners. A comparative advantage gives a company the ability to sell goods and
services at a lower price than its competitors and realize stronger sales margins.

how do countries use absolute advantage?

A country has an absolute advantage in those products in which it has a
productivity edge over other countries; it takes fewer resources to produce a product

• .How does trade make us wealthier? Trade makes societies wealthier by

moving goods to people who value them the most. Trade also increases the
quantity and variety of goods and lowers the cost of goods.
Trade in the Ricardian Model (cont.)
•
A country can be more efficient in
producing both goods, but it will have a
comparative advantage in only one good.
•
Even if a country is the most (or least)
efficient producer of all goods, it still can
benefit from trade.

• What are gains from international trade?

International trade confers a good deal of benefits on the trading countries. ...
Static gains from trade refer to the increase in production or welfare of the people of
the trading countries as a result of the optimum allocation their given factor-
endowments, if they specialise on the basis of their comparative costs.
• Misconceptions About Comparative
Advantage
1.Free trade is beneficial only if a country is more
productive than foreign countries.

- But even an unproductive country benefits from free trade by avoiding the high
costs for goods that it would otherwise have to produce domestically.
–High costs derive from inefficient use of resources.
–The benefits of free trade do not depend on absolute advantage, rather they depend
on comparative advantage: specialising in industries that use resources most
efficiently.
2.Free trade with countries that pay low wages hurts high wage countries.
–While trade may reduce wages for someworkers, thereby affecting the distribution
of income within a country, trade benefits consumers and other workers.
–Consumers benefit because they can purchase goods more cheaply.
–Producers/workers benefit by earning a higher income in
the industries that use resources more efficiently,
allowing them to earn higher prices and wages.

3.Free trade exploits less productive countries.

–While labor standards in some countries are less than exemplary compared to
Western standards, they are so with or without trade.
–Are high wages and safe labor practices alternatives to trade? Deeper poverty and
exploitation (ex., involuntary prostitution) may result without export production.
–Consumers benefit from free trade by having access to cheaply (efficiently)
produced goods.
–Producers/workers benefit from having higher
profits/wages—higher compared to the alternative.

Transportation Costs and Non-traded Goods

•The Ricardian model predicts that
countries completely specialize in
production.
•But this rarely happens for three main reasons:
1.More than one factor of production reduces the tendency of specialization (Chapter
4).
2.Protectionism (Chapters 8–11).
3.Transportation costs reduce or prevent trade, which may cause each country to
produce the same good or service.

- Why is the production possibilities frontier

curved?
–Diminishing returns to labor in each sector cause
the opportunity cost to rise when an economy
produces more of a good.
–Opportunity cost of cloth in terms of food is the
slope of the production possibilities frontier – the
slope becomes steeper as an economy produces
more cloth.

• What is production possibility curve explain with diagram?

Production Possibility Curve – (With Diagram) ... In other words, production
possibility curve can be defined as a graph that represents different combinations of
quantities of two goods that can be produced by an economy under the condition of
limited available resources.
How do tariffs affect supply?
Tariffs increase the prices of imported goods. ... Because the price
has increased, more domestic companies are willing to produce the
good, so Qd moves right. This also shifts Qw left. The overall effect
is a reduction in imports, increased domestic production, and higher
consumer prices.


What are the effects of tariffs?

The main effect of a tariff is to raise the price, and reduce the
volume, of imports. The higher price protects the domestic industry
from competition, but it harms consumers—including businesses
that buy the product as an input. By reducing mutually beneficial
trade, tariffs are harmful to the economy as a whole.

How do tariffs and subsidies affect international trade?

Another common barrier to trade is a government subsidy to a
particular domestic industry. Subsidies make those goods cheaper
to produce than in foreign markets. This results in a lower domestic
price. Both tariffs and subsidies raise the price of foreign goods
relative to domestic goods, which reduces imports.

Implications of Terms of Trade

Effects: Who Gains and Who Loses?
•
The standard trade model predicts that
–
an import tariff by the home country can increase domestic
welfare at the expense of the foreign country.
–
an export subsidy by the home country reduces domestic
welfare to the benefit of the foreign country.
Additional effects of tariffs and subsidies that can
occur in a world with many countries and many
goods:
–
A foreign country may subsidize the export of a good
that
the U.S. also exports, which will reduce the price for the
U.S. in world markets and decrease its terms of trade.

The Theory of Imperfect

Competition
•In imperfect competition, firms are aware that they
can influence the prices of their products and that
they can sell more only by reducing their price.
•This situation occurs when there are only a few
major producers of a particular good or when each
firm produces a good that is differentiated from
that of rival firms.
•Each firm views itself as a price setter, choosing the
price of its product.

Imp Multinationals and Outsourcing

(cont.)
•Greenfield FDI is when a company builds a
new production facility abroad.
•Brownfield FDI (or cross-border mergers
and acquisitions) is when a domestic firm
buys a controlling stake in a foreign firm.
•Greenfield FDI has tended to be more
stable, while cross-border mergers and
acquisitions tend to occur in surges.
•Developed countries have been the biggest
recipients of inward FDI.
–much more volatile than FDI going to developing
and transition economies.
•Steady expansion in the share of FDI
flowing to developing and transition
countries.
–Accounted for half of worldwide FDI flows since
2009.
•Sales of FDI affiliates are often used as a
measure of multinational activity.

Two main types of FDI: imp

–Horizontal FDI
when the affiliate replicates the
production process (that the parent firm
undertakes in its domestic facilities) elsewhere
in the world.
–Vertical FDI
when the production chain is
broken up, and parts of the production
processes are transferred to the affiliate location.

•Horizontal FDI is dominated by flows

between developed countries.
–Both the multinational parent and the affiliates
are usually located in developed countries.

•The main reason for this type of FDI is to

locate production near a firms large customer bases.
–Hence, trade and transport costs play a much
more important role than production cost
differences for these FDI decisions.
The Firms Decision Regarding
Foreign Direct Investment
1.Technology transfers: transfer of knowledge or another form of
technology may be easier within a single organization than through
a market transaction between separate organizations.

2. Vertical integration involves consolidation of different stages of a

production process.

•Foreign direct investment should benefit the countries

involved for reasons similar to why international trade
generates gains.

TARIFS
Consumer and Producer Surplus
•Consumer surplus measures the amount
that consumers gain from purchases by
computing the difference in the price actually paid from the
maximum price they
would be willing to pay for each unit
consumed.

•Producer surplus measures the amount that producers gain

from sales by computing the difference in the price received from the
minimum price at which they would be willing to sell.
Measuring the Costs and Benefits
of Tariffs (cont.)
•For a Large country, whose imports and exports
affect world prices, the welfare effect of a tariff is
ambiguous.
•The triangles b and d represent the efficiency loss
.
–The tariff distorts production and consumption decisions:
producers produce too much and consumers consume too
little.
•The rectangle e represents the terms of trade gain
.

Part of government revenue (rectangle e) represents

the terms of trade gain, and part (rectangle c)
represents some of the loss in consumer surplus.
–The government gains at the expense of consumers and
foreigners.
•If the terms of trade gain exceed the efficiency
loss, then national welfare will increase under a
tariff, at the expense of foreign countries.
• Tariffs can lead trading partners to retaliate with their
own tariffs, thus hurting exporters in the country that
first adopted the tariff.
•Tariffs can be hard to remove and large tariffs may
induce producers to engage in wasteful activities to
avoid paying tariffs.

The Effects of Trade Policy

•For each trade policy, the price rises in the Home
country adopting the policy.
–Home producers supply more and gain.
–Home consumers demand less and lose.
•The world price falls when Home is a “large”country that affects
world prices.
•Tariffs generate government revenue; export
subsidies drain it; import quotas do not affect
government revenue.
•All these trade policies create production and
consumption distortions.

WTO

The Cases for Free Trade (cont.)

•Free trade allows firms or industry to take
advantage of
economies of scale
.
•Protected markets limit gains from external
economies of scale by inhibiting the
concentration of industries:
–Too many firms to enter the protected
industry.
–The scale of production of each firm
becomes inefficient.

- Free trade provides competition and opportunities for

innovation (dynamic
benefits).
•By providing entrepreneurs with an
incentive to seek new ways to export or
compete with imports, free trade offers
more opportunities for learning and
innovation.

Free trade avoids the loss of resources

through rent seeking

.The political argument for free trade

says that free trade is the best feasible
political policy, even though there may be
better policies in principle.

Definition of ‘Monopoly’
A market structure characterized by a single seller, selling a unique
product in the market. In a monopoly market, the seller faces no
competition, as he is the sole seller of goods with no close
substitute.

In a monopoly market, factors like government license, ownership

of resources, copyright and patent and high starting cost make an
entity a single seller of goods. All these factors restrict the entry of
other sellers in the market. Monopolies also possess some
information that is not known to other sellers.
Characteristics associated with a monopoly market make the single
seller the market controller as well as the price maker. He enjoys
the power of setting the price for his goods

Monopolistic Competition
When there are multiple sellers in an industry with many
similar substitutes for the goods being produced and
companies retain some power in the market, it's referred to as
monopolistic competition.

In a monopolistic competitive industry, barriers to entry and

exit are typically low, and companies try to differentiate
themselves through price cuts and marketing efforts.

Oligopoly
An oligopoly is a market form wherein a market or industry is dominated by a
small number of large sellers. Oligopolies can result from various forms of
collusion which reduce competition and lead to higher prices for consumers.
Oligopolies have their own market structure