why do countries trade.doc

why do countries trade?The Advantages of International Trade Countries need to export goods and services to finance imports of those products they cannot produce in this country. Exports represent an injection of demand into the circular flow of incomeThere is an improvement in economic welfare if countries specialize in the products in which they have an comparative advantage and then trade with other nations Trade allows firms to exploit scale economies by operating in larger markets - the European Union has over 450 million consumers with a massive purchasing power. Economies of scale lead to lower average costs of production that might be passed onto consumers International competition stimulates higher efficiency - particularly for domestic monopolies. Free trade provides greater choice for consumers and competition helps keep prices down Imports can help to satisfy excess demand from consumers - acting as a safety valve for the economy. A trade deficit during an economic boom helps to reduce demand-pull inflation Trade in ideas stimulates product and process innovations that generates better products Gains from trade using supply and demand analysisThe diagram shows Japan can produce camcorders at lower costs - its supply curve is lower than the UK. This means that Japan has a comparative advantage in producing camcorders. In the absence of international trade between the two countries, British consumers would have to buy at a higher equilibrium price than Japanese consumers. Since Japan is more efficient, it makes sense for Japan to specialise in production of camcorders and export their surplus output to the UK at a lower free trade price. At the intermediate price shown in the diagram, (the free trade price) Japan sells exports to the UK for a higher price but this is still lower than the UK equilibrium price. Japan receives revenue from the sale of these exports. UK consumers can now buy more camcorders at a lower price and have more choice in the market We are ignoring transportation costs between the two countries and we are assuming that the resources that were previously allocated to producing camcorders in the UK can be reallocated to other industries (i.e. resources are assumed to be occupationally mobile). economic arguments for imposing import controls Infant Industry Argument Certain industries possess a potential comparative advantage but have not yet exploited the potential economies of scale. Short term protection from established foreign competition allows the infant industry to develop its comparative advantage. At this point the protection could be relaxed, leaving the industry to trade freely on the international market. The danger of this form of protection is that the industry, free of the disciplines of foreign competition, will never achieve full efficiency. Protection against “ dumping” Dumping refers to the sale of a good below its cost of production. In the short term, consumers benefit from the low prices of the foreign goods, but in the longer term, persistent undercutting of domestic prices will force the domestic industry out of business and allow the foreign firm to establish itself as a monopoly. Once this is achieved the foreign owned monopoly is free to increase its prices and exploit the consumer. Therefore protection, via tariffs on dumped goods can be justified to prevent the long term exploitation of the consumer. Improving the balance of payments in goods and servicesTrade barriers might be viewed as one vehicle to control the growth of demand for imports and therefore improve the overall balance of trade in goods and services. The main problem with this is that import controls do not address fundamental issues of a lack of international competitiveness - and that trade barriers simply as a device for controlling a trade deficit do not wash with the World Trade Organisation.Externalities and Import Controls Protectionism can also be used to take account of externalities and dealing with de-merit goods. Goods such as alcohol, tobacco and narcotic drugs have adverse social effects and are termed de-merit goods. protectionism can safeguarding society from the importation of these goods, by imposing high tariff barriers or by banning the importation of the good altogether. Non Economic Reasons Other arguments have been forward for protection, which although they may be valid are not purely economic Countries may wish not to over-specialise in the goods in which they possess a comparative advantage. One of the potential dangers of over-specialisation is that unemployment may rise quickly if an industry moves into structural decline as new international competition emerges at lower costs The Government may also wish to protect against high levels of imports to protect domestic employment Protection may also be used to prevent trade with certain countries on political grounds. The UK government currently has trade sanctions with numerous countries, including Iraq, Nigeria and in certain commodities with the former Soviet bloc countries. PROBLEMS WITH IMPORT PROTECTION Loss of economic welfare Welfare is reduced through higher prices and restricted consumer choice. Firms that are protected from competi