A very in depth guide to unit 4 of higher level IB Economics, INCLUDING REAL WORLD EXAMPLES (e.g. tariffs and quotas) which are crucial to attaining a 7.
The Global Economy: UNIT 4
Rwe: https://www.bounomics.com/ib-econ/real-world-examples
Benefits of international trade:
- Increased competition
- Greater efficiency in production
- Lower prices for consumers
- Greater choice for consumers
- Acquiring needed resources, trade allows countries to import
- Source of foreign exchange, when countries export they acquire foreign currencies which
allows them to make other payments abroad (it improves ability to import)
- Access to larger markets, not limited to size of domestic market (so opportunity for
economies of scales)
- Economies of scale (lower average costs, so can lower prices, enjoy greater export
competitiveness)
- Specialisation (can increase quantity of output, can increase consumption of goods and
services as output can be exchanged for other output from other countries)
- More efficient allocation of resources, less waste of scarce resources
- Trade makes possible the flow of new ideas and technology (new skills can be transferred
from one country to another)
- Trade makes countries interdependent, reducing the possibilities of hostilities and violence (a
reason behind establishment of European economic community ECC was to eliminate
possibility of future wars between France and Germany)
- Trade as an “engine for growth”
Exporting under free trade:
- World price is greater than equilibrium, which incentivises producers to produce higher level
of output, hence domestic supply increases from Qe to Qs
,Importing under free trade:
- Pworld is lower than domestic equilibrium price
- So domestic firms cannot compete with lower prices
- Therefore, domestic supply contracts from Qe to Qs
ABSOLUTE and COMPARATIVE ADVANTAGE:
- Absolute advantage refers to ability of one country to produce a good using fewer resources
than another country
- Comparative advantage refers to a situation where one country has a lower opportunity cost
in the production of a good than another country
- Country A has absolute advantage in production of both goods since the PPC lies fully above
country B curve
sacrifice of one good
Opportunity cost (to find comparative advantage)=
gain of theother good
- The law of comparative advantage states that if a country specialises and trades according to
their comparative advantage, global production and consumption will increase because of an
improvement in the global allocation of resource, making all countries involved better off.
Due to this improvement in resource allocation, both countries produce at a point on their
PPCs and through specialisation and trade they can consume outside their PPC!!
, - IF PPCs ARE PARALLEL…. Then the two countries face identical opportunity costs for the two
goods. This means there is no country in which the good is relatively cheaper, therefore
there are no possibilities for countries to gain from specialisation and trade- so there is no
point in trading
ASSUMPTIONS OF THEORY OF COMPARATIVE ADVANTAGE
1. Factors of production are fixed and are perfectly mobile within a country
2. Full employment of scarce resources, such that all countries produce at a point of their PPC
3. International trade is free
4. Goods traded are globally homogenous
5. Transportation costs and negative externalities are ignored
CONS OF INTERNATIONAL TRADE AND SPECIALISATION
1. Greater dependence on export markers to drive growth
2. Overly dependent on certain imports: loss of self-sufficiency
3. Specialisation in primary sectors may inhibit economic growth
4. Complex supply chains are vulnerable to disruption
5. Uneven gains from trade, drives rising global income and wealth inequalities
PROTECTIONSIM
Tariffs
- Tariffs are taxes on imported goods
- Tariff increases domestic price above world price
- They serve two purposes 1. To protect domestic industry from foreign competition, and 2. to
raise revenue for the government
WINNERS:
- Domestic producers now receive a higher price and sell a larger quantity, Q3 instead of Q1
- Domestic employment in protected industry increases
, - Government gains tariff revenue, represented by area 3
LOSERS:
- Domestic consumers are worse off as they now pay more and can only buy Q4 instead of Q2
- Domestic income distribution worsens, it acts like a regressive tax which burdens people of
lower incomes proportionately more than individuals in higher incomes
- Foreign producers are worse off because whereas they receive the price Pw, the levels of
imports decrease (previously was Q2-Q1) so they lose export revenue
- There is a loss of world efficiency and a global misallocation of resources due to the shift of
production from more efficient foreign producers towards more inefficient domestic
producers- evidenced by dead weight loss (AREA 2)
RWE: Trump tariffs, 25% tariff on all steel imports, this led to higher steel prices which heavily
impact auto industries in the US. Instead of boosting overall steel employment, this tariff created
higher costs for major steel consumers such as Detroit-based automakers general motors and
Ford (led to huge loss of jobs: trade war has caused a net loss of 175,000 U.S. manufacturing
jobs by mid 2019)
Import Quotas
- An import quota places a legal limit on the quantity of imports of a good that can come into
a country, over a given period of time (typically a year)
- When setting a quota, the gov typically issues a limited number of import licences
corresponding to the total permitted quantity of imported units.
WINNERS:
- Domestic producers are better off, as they now receive a higher price (Pq) and sell a larger
quantity of goods: Q2
- Foreign consumers still get same price ONLY
- Domestic employment increases, since producers increase quantity of output they produce
LOSERS:
- Domestic consumers are worse off as they pay higher price for smaller quantity (Q3 instead
of Q4)
- Is regressive due to higher prices consumers face
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