International Trade

Different countries have different factor endowments and that international mobility of these
factors is severely limited. Eg. Food, clothes, jewellery, oil.
Benefits from Trade
1. Producers- local producers gain from trade when their goods and services are purchased by
foreigners. This allows these local producers to increase their incomes even though there is an
increase in risk from exporting overseas. Exporting to foreign countries has political risk in the
sense that some countries may be unstable due to political problems. There is also country risk in
that in these overseas countries, the economies maybe weak and some foreign companies may
lack the ability to make payments at times.
2. Consumers- may have access to goods and services which they may not have had otherwise.
This maybe so because some local companies may lack the abilities and capabilities to produce
these goods. Therefore, trade can foster a wider variety of goods on local market than without
trade. These additional goods on the local market may even lead to lower prices.
3. Innovation- trade promotes innovation within an economy. An economy that is closed to trade
is one in which inefficient industries and firms are well protected. Barriers to trade are major
obstacles and countries that are closed to trade tend to be the poorest in the world. Countries that
have reduced trade barriers and which increase the share of imports and exports in their
economies tend to be among the fastest growing nations and possess more technical innovation.
4. Country- This is so because benefits of comparative advantage are proportional to the
difference between the relative prices in world markets and the relative prices that would prevail
in home market without trade. If that difference is large, then a country earns a large advantage
from trade. Small countries are more likely than large countries to find that relative prices in the
world market differ significantly from what would prevail in their home markets.
5. Global- it enhances efficiency, through new technology. It adds to the productive capacity of
all countries that engage in trade. Some efficiency comes from taking advantage of increasing
returns. Therefore, international trade leads to efficiency- all countries tend to be better of with
international trade than without it. Income of countries increase with international trade and such
countries tend to be more developed than countries with low levels of trade.
6. Foreign exchange- an economy earns increased amounts of foreign exchange through
international trade. This facilitates growth and development of countries. This increase in foreign
exchange allows citizens of countries to afford more and to venture overseas. It allows countries
to be able to even import and invest in technology for further economic growth and development.
Increased foreign exchange also allows for stability of a country’s currency which will mean that
it will not devalue or depreciate in the short run.
Disadvantages of trade
1. Economic interdependence
2. Political interdependence
3. Deplete a nation’s reserve

Trade Protection and Promotion Measures

Governments can implement several measures in order to protect and promote trade in their
country. Some of these measures are as follows:
1. Tariffs- are duties imposed on imports. When tariffs are imposed, the prices of imports would
increase to the extent of the tariff. The increased prices will reduce the demand for imported
goods and, at the same time, induce domestic producers to produce more of import substitutes.
2. Quotas- the gov’t may fix and permit the maximum quantity or value of a commodity to be
imported during a given period. By restricting imports through the quota system, the trade deficit
is reduced and the balance of payments position is improved. They are more effective than tariffs
as they are easier to implement and more flexible than tariffs as quotas are subject to less legal
and complicated requirements while tariffs, on the other hand, are subject to legislative
sanctions.
3. Export Promotion- the gov’t can adopt export promotion measures to correct disequilibrium in
the balance of payments. This includes substitutes, tax concessions to exporters, marketing
facilities, credit and incentives to exporters. The gov’t may also help to promote export through,
exhibition, trade fairs, conducting marketing research and by providing the required
administrative and diplomatic help to tap into potential markets.
4. Import Substitution- a country to resort to import substitution to reduce the volume of imports
and make it self-reliant. Industries which produce import substitutes require special attention in
the form of various concessions, which include tax concession, technical assistance, subsidies
and providing scarce inputs. Gov’ts identify those products that account for the bulk of its import
bill and can focus attention on these in an effort to produce these locally in an attempt to reduce
the country’s import bill. This is another way in which to protect trade.
Advantages of Protectionism
1. Protection of infant- industry- By protecting new domestic industries from established foreign
competitors, a tariff can give a struggling industry time to become an effective competitor. This
is an attempt to protect small local industries. The imposition of a tariff is an attempt to prevent
or reduce cheaper foreign goods on the local market in an attempt to boost small local industries.
2. Job protection- unions say that tariffs should be used to keep foreign labour from taking away
local jobs.
3. To raise revenue for the gov’t- tariffs can also raise revenue for the gov’t. When a gov’t
imposes a tariff in order to reduce imports in an attempt to solve the balance of payments
disequilibrium, this is also revenue to the central gov’t. This will be particularly important for
developing countries such as Caribbean countries which may lack avenues for additional
revenues.
4. Lower or prevent balance of payment deficits- tariffs are usually one of the main instruments
used by countries to solve balance of payments problems. Tariffs are used in order to assist in
reducing imports relative to exports in order to bring equilibrium in the country’s BOP. Again,
this is mainly used by developing countries as in the Caribbean which are non-competitive in the
international export market.
5. To prevent dumping- is a kind of predatory pricing, especially in the context of international
trade. It occurs when manufacturers export a product to another country at a price either below
the price charged in their home market or below its cost of production. For many small countries,
this can have the effect of affecting their ability to be competitive with the overall effect of
reducing their exports. Eventually, this can cause BOP problems. The imposition of a tariff can
assist in making the prices of these cheap foreign goods equal to the prices or even more
expensive than the local goods.
The Law of Absolute Advantage
The law of absolute advantage states that a country should specialize in the production of a good
which they are more efficient in producing. More efficient implies they can produce the same
amount of goods using fewer resources.
Specialization- a country will concentrate its efforts and resources in the production of a good
which they are advantageous at producing while other countries do the same. Thereafter, they
can trade with each other.
Good A Good B
Country X 3 6
Country Y 1 9
Total 4 15

1. For Good A, one unit of resource is producing 3 units of output in country X but only 1 unit of
output in country Y
2. For Good B, one unit of resource is producing 9 units of output in country Y but only 6 units
of output in country X
3. Country X is more efficient at producing Good A, therefore has the absolute advantage in the
production of Good A. Country X should specialise in the production of Good A.
4. Country Y is more efficient at producing Good B therefore has the absolute advantage in the
production of Good B. Country Y should specialize in the production of Good B.
Assume resources in each country are allocated equally between Good A and Good B, the
countries will now specialize in the good for which they have absolute advantage in and stop
producing the other good
Good A Good B
Country X 3 (+3) 6 (0)
Country Y 1(0) 9 (+9)
Total 4 15
Total after Specialization 6 18
Gain 2 3

After specialization, countries will trade. As a result of specialization, there is an overall gain in
the production of Good A and Good B.
N.B it is possible for one country to have the absolute advantage in the production of both goods.
The Law of Comparative Advantage
The law of Comparative advantage states that countries should specialize where they can
produce the same goods at a lower opportunity cost. i.e it can produce the same amount of one
good by giving up less of the other good.
Good A Good B
Country X 800 1: 1600 2
Country Y 600 1: 1800 3
Total 1400 3400

Good A
X= 1A=2B
Y= 1A = 3B

Good B
X= 1B= 0.5 A
Y= 1B = 0.333A
Country X- 800 Good A and 1600 Good B. The ratio of A to B is 800 to 1600
A:B = 800:1600. This can be simplified as A:B= 1:2. This means that country X has to give up 1
unit of Good A to get 2 units of Good B. Conversely, they have to give up 2 units of Good B to
get 1 unit of Good A.
Country Y- 600 Good A and 1800 Good B. The ratio of A to B is 600 to 1800
A:B= 600:1800. This can be simplified as A:B=1:3. This means that country Y has to give up 1
unit of Good A to get 3 units of Good B. Conversely, they have to give up 3 units of Good B to
get 1 unit of Good A.
Country X should specialize in Good A since it has to give up 2 Good B to get one Good A
while country Y will have to give up 3 Good B to get 1 Good A. Country X has to give up less
Good B to get 1 Good A.
Country Y should specialize in Good B since when they give up 1 Good A they get an additional
3 Good B while Country X will only get 2 Good B when they give up 1 Good A.

Good A Good B
Country X 800(+800) 1600 (0)
Country Y 600 (0) 1800(+1800)
Total Before Specialization 1400 3400
Total After Specialization 1600 3600
Gain 200 200

Free Trade/ Trade Liberalization- implies the absence of restrictions from engaging in
international trade i.e. goods are free to move among nations without barriers.
Terms of Trade (TOT) – the terms of trade is the ratio of export prices to import prices.
TOT= Export price index * 100
Import price index
It is how much imports you can buy with your exports. If you can buy more imports with your
exports, the TOT improved. However if you can buy less imports with your exports, TOT is
deteriorated.
TOT>100: Favourable
TOT<100: Unfavourable
Factors Affecting the Terms of Trade
Increase the price of Exports
1.As the demand of exports increase so too will the price causing the TOT to move in a
favourable direction
2. As the supply of exports decrease, the price will increase causing the TOT to move in a
favourable direction
Decrease the Price of Exports
1. As the demand for exports decrease, so too will the price causing the TOT to move in an
unfavourable direction.
2. As the supply of exports increase, the price will decrease causing the TOT to move in an
unfavourable direction.
Increase in the Price of Imports
1. As the demand for imports increase, so too will the price causing the TOT to move in an
unfavourable direction.
2. As the supply imports decrease, the price will increase causing the TOT to move in an
unfavourable direction
3. As the exchange rate depreciates, the price of imports in domestic currency increases causing
the TOT to move in an unfavourable direction.
Decrease in the Price of Imports
1. As the demand for imports decrease, so too will the price causing the TOT to move in a
favourable direction.
2. As the supply of imports increase, the price will decrease causing the TOT to move in
favourable direction.
3. As the exchange rate appreciates, the price of imports in domestic currency decreases causing
the TOT to move in a favourable direction.