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comparative advantage


theory of CA: states that trade btn nations is beneficial to all if each specializes and trade according to its CA
a country has CA over another in the production of a good if it can produce the good at a lower opt cost
1. country only produces only 2 goods
2. they have same resource endowment and divide their resources equally btn the production of 2 goods
3. no transport/distribution costs
4. all resources are fully employed and perfectly mobile
5. no barriers to trade
6. there are constant returns to scale (PPC is a straight line)
- with specialisation and trade based on a favourable TOT, both countries can consumer at points beyond their PPCs, achieving higher levels of welfare for society


limitations of CA

  1. increasing opt cost as production increases
    - increasing specialisation means country need to use more resources that are less and less suited to its production and more suited to production of other goods
  2. factor immobility within country
    - higher COP to attract the necessary type/qty of factors to increase production
  3. transport costs
    - if transport and distribution costs are high, country with higher opt cost of producing good may find it cheaper to produce good in domestic country
  4. trade restrictions - protectionism

(dynamic CA) CA changes over time

a. change in qty/quality of resources or tech
- country discovers/invent FOP (e.g. investment in R&D, discovery of mineral deposits)
- depletion in factor endowment (ageing pop), lack of efforts to improve production technique, loss in CA in production




interconnectedness of national economies through trade, capital flows and labour flows.


benefits of freer trade



  1. higher material SOL
  2. higher econ growth, employment, more favourable BOT position, lower inflation
    - higher export volume with larger export mkt, increase in AD and increase RNY via the multiplier effect leading to actual growth and lower DD-deficient UN as derived demand for labour increases
    - trade allows developing country to obtain imports of higher quality FOP, hence increases its productive capacity, leading to PG
    - allows sourcing for FOP from low-cost economies, increases SRAS and lower cost-push inflation


  1. equity in income distribution
    - when economy can make structural adjustments to the loss in CA and make improvements to acquire new CA, workers are able to secure more higher value-added jobs
    - lower-skilled workers can move up the skills ladder while higher-skilled workers will move even higher.
    - although this indicates widening income gap, govt can earn higher tax revenue to help lower-skilled workers, lower inequity

costs of freer trade

  1. possible deterioration of BOT position, econ growth and employment
    - increase trade means greater accessibility to imported goods and services which were unavailable domestically. increases M, worsens BOT
    - if consumers switch away from dom-produced goods , AD falls, results in higher DD-deficient UN
  2. higher inflation
    - increase in DD for exports can lead to DD pull inflation if it is not met by an increase in productive capacity
    - higher costs of imported raw materials can be caused by inflation/depreciation of the exchange rate -> increase in COP, fall in SRAS, causing cost-push inflation
  3. increase vulnerability to external shocks
    - demand in export mkts fall due to global recession
  4. structural unemployment
    - structural changes occur in the economy when countries specialise in industries with CA.

benefits of higher capital flows



  1. higher econ growth and employment
    - inflow of FDI directly increase AG
    - inflow of skills and tech transfer, increase LRAS, potential growth
    - foreign firms train workers and develop their skills, increase quality of labour
    - tech transfer -> fall in unit COP

1. greater efficiency
face greater competition from foreign firms
- dynamic efficient: incentivises businesses to innovate
- productive efficient: engage in cost-reducing production techniques, reduce X-inefficiency
- allocative efficient: prices driven closer to MC


costs of higher capital flows



  1. vulnerability, over-reliance of FDI
    - many foreign firms are asset owners and mobile enough to shift production out of country once conditions in other countries more favourable [FDI shifts out of the country -> fall in AD]
    - greater mobility of hot money btn countries leads to fluctuations in exchange rates which affect export competitiveness and external PP for consumers and firms

1. greater inefficiency
- due to increased comp, domestic firms that are unable to compete with foreign firms faces fall in DD and profits
- foreign firms may push price so low (predatory pricing), such that domestic firms close down, increasing DD deficient UN
- fall in govt budget as govt spend on welfare subsidies on unemployed/production subsidies to reduce COP
- funds have to be diverted from other uses, incurring opt cost and leads to DWL
2. widening income inequity
firms relocate/ offshore factories and production process to take advantage of lower COP in developing countries where labour in abundant and cheaper.
- fall in DD for lower-skilled workers, results in higher wages for those with relevant skills while low/no income for those displaced -> widen income gap


benefits of increased labour flows



  1. higher PG
    - free mobility of labour enables more inflow of foreign talents which facilitate transfer of knowledge -> improves quality of human capital
  2. lower inflation
    - higher availability of cheaper foreign labour leads to fall in COP, increases SRAS, reduces cost-push inflation
    (e. g. HDB more affordable due to construction migrant workers)

1. worsened efficiency in the long run
- with availability of cheap foreign labour, firms are less motivated to innovate and discover more efficient methods of production, not productive efficient in long run, firm does not operating on LRAC
- heavy dependence on cheap labour -> loss in CA, not motivated to improve efficiency thru higher quality workforce
SG: reduce S-pass quotas for foreign workers for manufacturing sector


costs of increased labour flows

  1. unemployment of local workers

- cheaper foreign workers may displace more expensive local workers


impacts on consumers due to increased trade



  1. lower prices and higher CS
    - producers can obtain cheaper raw materials/reap IEOS -> lower COP -> fall in prices [MC curve shifts downwards}
    - increased comp. -> fall in prices (dd becomes more price elastic)
  2. greater variety of goods
    - owing to different factor endowment / diff in consumers taste and pref would cause product differentiation. brand names and other forms of PD with real/perceived differences in quality -> trade [able to enjoy goods that cannot be produced locally]


  1. fall in material SOL
    - local workers lose jobs due to firms outsourcing production to cheaper foreign countries
    - face structural UN
  2. higher prices, lower CS
    - foreign firms drive out domestic irms, in the long run can gain monopoly power and has ability to set higher prices, allowing them to exploit consumers

impacts on producers due to increased trade

  1. bigger mkts
    - increase in DD (DD curve shifts rightwards from AR1 to AR2), higher revenue and profits
  2. incentive to leverage internal EOS
    - increase in scale of production -> achieve IEOS
    SG: small domestic mkt: firms can reap IEOS to sufficiently lower costs and sell abroad at competitive prices. can pass down lower costs in terms of lower prices
    external EOS: as industry expands, indiv firms can enjoy reduction in their LRAC -> foster transfer of knowledge

impacts on producers due to capital inflows


domestic firms face fall in DD -> lower profits


benefits of economic cooperation and trade agreements

  1. improvement in BOT
    - access to mkts -> increase in X
  2. higher economic growth
    - inflow of FDI and higher next exports -> AG, PG
  3. lower DD-def UN
    - increase in DD, higher dd for derived dd
  4. increase in consumer welfare
    - high-cost domestic producers are replaced by low-cost imports from efficient partner countries
    - consumers can now buy cheaper imports from other countries without tariffs
  5. higher productive efficiency
    - increased mkt size allows country’s firm to exploit IEOS. benefit from EEOS from improvements in infrastructure
    - lowering of COP, increase in SRAS, alleviating cost-push inflation

costs of trade agreements

  1. inflation
    - economy operating near full-employment level, increase dd for exports could lead to dd-pull inflation
    - higher DD for FOP as a result of influx of FDI could lead to higher factor prices
    higher COP-> loss in price competitiveness of exports
  2. higher dd-deficient UN and structural UN
    - cheaper imports can cause consumers to switch away from dom-produced goods, results in fall in AD, fall in RNY and dd-def UN
    - domestic firms find it difficult to compete with foreign firms -> shut down [structural UN]
  3. trade diversion
    - shifting of trade away from low-cost producers to high-cost producers within the FTA -> higher prices, lower CS and lower consumer welfare

protectionist measures



taxes levied on imports, raises price that domestic consumers pay for imported goods


protectionist measures

non-tariffs measures

  1. import quotas
    - restrict volume/supply of imports by specifying max amt of foreign-produced good that is permitted into the country
    - demand for dom-produced import sub increases, increasing dom production of goods
  2. voluntary export restraints
    - urge foreign country to reduce SS of its exports
  3. subsidies
    - given to domestic producers to lower COP, hence increase domestic SS
    - leads to fall in domestic prices and increase in qty dd as domestic consumers switch to consume dom. goods (assume XED>0)
    - price of dom goods also become more price competitive in foreign mkt
  4. administrative regulatory conditions
    - administrative regulations include safety regulations, health regulations for hygienic preparation and packaging, labelling requirements
    - form of trade restriction -> make trade unnecessarily diff/ expensive for foreign producers to sell