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International Exchange


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 other nations.


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 consumers.


International competition 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).




E-mail Steve Margetts