FREE TRADE
refers to the exchange of goods and services between countries without governmental restrictions such as tariffs and quotas.
Theory of Comparative Advantage
Trade can benefit the countries involved:
- if they specialize in producing and trading those goods in which they have comparative advantage in and
- provided the terms of trade (TOT) lies between the domestic opportunity cost ratios of the 2 countries.
→ MUTUALLY BENEFICIAL TO TRADE
Sources
Comparative Advantage
Producing a good at a relatively lower opportunity cost compared to another country.
Demographics
Rates of Capital Investment
Quantity and quality of natural resources
Dynamic CA
Dependent on climate/geography
New natural resources may be discovered
Determines the quantity and type of labour available
Investment in capital goods (including public infrastructure) can reduce costs
CA can change over time due to changes in factor endowments
Advantages
LIMITS to gains
Increasing cost (due to possible diseconomies of scale)
Factor immobility
Transport costs
Trade barriers
Other explanations for trade
Differences in demand conditions in different countries
Intra-industry trade
Disadvantages
ECONOMIC FLUCTUATIONS
Economic gains
Other gains
Advantages of large scale production (due to larger international market
Greater efficiency and innovation (can produce more with the same amount of resources
Welfare gain (lower price, larger quantity, more choices
Economic growth (national output increases)
Social & Cultural (social cohesion, safer to live, higher education level, better health)
Political (creating strong institutions and an effective government)
Structural unemployment
EV: small, open → rapid, significant structural changes persist
Greater income inequality → adversely affect a country's inclusive growth
Increase the susceptibility to high inflation in other economies
EV: ↑vulnerability: small. open > large, relatively closed economy
Environmental costs → adverse effect on productive capacity & sustainable growth in long run
EV: more acute in developing countries
Increase susceptibility to recession in other economies
EV: ↑volatility: small, open > large, relatively closed economy
Unfair practices