Britain needs to export
goods and services to finance imports of those products we cannot produce in
this country. Exports represent
an injection of demand into the circular flow of income.
There is an improvement in economic welfare if countries specialize in
the products in which they have an comparative advantage and then trade with
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
stimulates higher efficiency - particularly for domestic monopolies. For
example, Chorus faces very stiff competition from overseas steel producers.
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.
It is possible to demonstrate the gains from trade using
supply and demand analysis:
The 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).