Teaching and Learning Notes for the role of the financial market in GCE A-Level Economics

1. Free Trade
GCE A-LEVEL & IB ECONOMICS

2. Lesson Structure
Patterns of Trade
oChanges in Relative Exchange Rates
Restrictions on Free trade
oTypes of Trade Barriers
o Tariffs
o Quotas
o Subsidies for Domestic Producers
o Non-Tariff Barriers
o Embargoes
oReasons For Trade Protectionism
oReasons Against Trade Protectionism

3. Patterns of Trade
THEME 4.1.3: A GLOBAL PERSPECTIVE
4.1 INTERNATIONAL ECONOMICS: 4.1.3

4. Changes in Exchange Rate
An exchange rate is the price of a currency compared to another.
When the exchange rate decreases, our exports will become cheaper, and
imports will be more expensive. Hence, will we export larger quantities and
import lower quantities.
This will affect the trade patterns of imports/exports.

5. Changes in Exchange Rate
As imports/exports are generally considered price elastic, when export prices fall,
there is a bigger % increase in quantity sold. Hence, this will increase total
volume of exports sold.
Hence, some countries tend to depreciate their exchange rate to increase their
international competitiveness, and improve their current account.
Note that this is not true for some developing countries that mainly exports
inelastic goods (e.g. commodities like agricultural goods / iron / steel).

6. Exchange Rate Example
Assume the UK government uses GBP £1m to exchange into USD to buy US
assets.
This will increase supply of GBP in the global currency market as more GBP is
available to be traded in the market. This will decrease the price of GBP in USD,
as it is more abundant in the US economy and people can pay less to obtain it.
Hence, the exchange rate of GBP to USD will decrease, and make UK exports
more competitive.
On the other hand, it will create a higher demand for USD in the global currency
market as availability of USD becomes more scarce. Hence, the cost of buying
USD will go up. This will increase the price of USD in GBP. Hence, the exchange
rate of USD to GBP will increase, making US exports more uncompetitive.

7. (Depreciation)

8. Quartz – Currency Manipulators
Government purchases of foreign assets/capital by foreign currency as a % of that economy’s GDP

9. Quartz – Current Account Surpluses

10. What Shifts Patterns of Trade?
- Protectionist measures (E.g. Tariffs, quotas)
- Trade agreements (International Relations)
- Regulation (E.g. Quality standards)
- Changing technology patterns
- Changes in factors of production & comparative advantage
- Cost to transport
- Shifts in exchange rate

11. Shifting Trade Agreements
International relationships can be fragile...
https://www.youtube.com/watch?v=uFMOF8IVi5I
4:03 – 8:15 min

12. In the Hot-seat
Will each one of you be able to name any factor or example that affects the
pattern of trade between countries?
Start from your left. You can call a friend to help if needed.

13. Restrictions on Free Trade
THEME 4: A GLOBAL PERSPECTIVE
4.1 INTERNATIONAL ECONOMICS: 4.1.6

14. A Life Without Imports
What is your favourite imported product? Why?
What will life be like without it?

15. A Life Without Imports
Why may the UK government stop or prevent
importing these products?
What measures can they take to do so?

16. Tariffs
Tariffs are taxes placed on
imported goods into the
country.
- E.g. US tariffs on Chinese
aluminum, steel

17. Tariff Diagram
Price
Quantity
Domestic
Supply
Domestic
Demand
To illustrate a tariff, we first draw the
domestic demand & supply curves in the
importing country.

18. Tariff Diagram
Price
QuantityQ1
Domestic
Supply
Q4
P
Domestic
Demand
After that, we draw a horizontal line for
World Price. The World Price of the good
needs to be below the domestic market
equilibrium price. Otherwise there is no
point in importing the good.
Q1 is the amount which the good is
supplied domestically. Q1Q4 is the
amount of the good imported to satisfy
high domestic demand.
Imported
Quantity
Domestic
Production
World Price

19. Tariff Diagram
Price
Quantity
World Price
Domestic
Supply
Q4
P
Domestic
Demand
Finally, draw a higher horizontal World
Price as the tariff will make importing
the good more expensive.
Because of the higher World Price P1,
domestic production increases to Q2;
and quantity of the imported good
decreases from Q1Q4 to Q2Q3.
Imported
Quantity
Domestic
Production
P1
World Price
+ Tariff
Q2 Q3Q1

20. Tariff Diagram
Price
Quantity
World Price
Domestic
Supply
Q4
P
Domestic
Demand
Due to the tariff, domestic producer
surplus increases by area A, and area
C is the amount of government
revenue from the tariff (Imported
Quantity Q2Q3 x Tariff per Unit).
As area B and area D used to be
consumer surplus, but is now not
gained by anyone as a result of the
tariff, indicating welfare loss.
Note that all areas used to be
consumer surplus.
Imported
Quantity
Domestic
Production
P1
World Price
+ Tariff
Q2 Q3Q1
A B C D
Tariff

21. Tariff Diagram
Price
Quantity
Draw the tariff diagram and explain
it to your neighbor!
... try not to peek.

22. Quotas
Quotas is a limit on the amount of imports for certain
goods into the country.
- E.g. Thailand’s import quota of corn from China
A quota can be seen as a more stringent regulatory
measure than a tariff given there is an absolute amount
of the goods being imported, despite prices and cost.
It does not generate tax revenue for the government,
but can be effective and efficient in reducing imports.

23. Subsidies for Domestic Producers
Subsidies for Domestic Producers are government payments to
local firms to reduce production costs and make them more
competitive.
- E.g. EU farm subsidies
Subsidies tend to increase quantity of production of domestic
producers and reduce the prices of goods provided by them.
This comes at an opportunity cost of how the funds can be
used. However, subsidies are useful in encourage the
development of infant industries before they expand large
enough to reach the minimum efficient scale.

24. Non-Tariff Barriers
Non-Tariff Barriers are other measures that
countries can undertake/implement as an
obstacle for imports. This can range from health
and safety regulations, mandatory inspection of
goods to product specification requirements etc.
“Chinese customs officials have begun to strictly
inspect US lobster, requiring “all kinds” of new
documents... US lobsters used to clear Chinese customs
quickly, as an express product, which helped make sure
they were still alive when they got to their final
destination” Quartz Daily Brief

25. Flamin’ Hot Cheetos Banned in UK!

26. Types of Trade Barriers
Split into 4 groups, each responsible for one trade barrier. Take 10 minutes to
research a good that the UK currently imposes a
Tariff
Quota
Domestic Producer Subsidy
Non-Tariff barrier
... on. Next, discuss the reason why a trade barrier is implemented on the good.

27. Main UK Imports
What do you think will happen if the UK gov happen to impose protectionist
barriers on the top 4 products that we import?

28. Why Protectionism?
1. Protect Infant Industries
◦ Developing industries are unlikely to be able to compete with MNCs due to their low cost
production from large economies of scale. Hence, a country may strategically grow a
particular industry and protect them from international competition.
2. Prevent Dumping
◦ Overproduction of particular goods from developing countries can disrupt supply of goods.
Overseas producers may undercut domestic ones and force them out of the market.
3. Domestic Employment
◦ Trade barriers increase domestic production and local employment as labour is a type of
derived demand for goods/services to be produced. However, one may question whether it is
worthwhile to protect industries in structural decline (sunset industries).

29. Why Protectionism?
4. Negative Externalities
◦ Goods imported may cause significant negative externalities for the country e.g.
drugs, weapons and should be limited from domestic markets
5. Balance of Payments
◦ Protectionism should reduce the amount of imports and hence improve the current
account
6. Political Reasons
◦ Politicians and MPs may be inclined to protect particular industries that may have
funded their campaigns, or there may be long term strategic interests involved for a
country to protect certain industries

30. Problems with Protectionism
1. Economic inefficiency
◦ Trade barriers are fundamentally inefficient in theory as they restrict operation of the
free market, causing allocative inefficiency. This can clearly be seen in the welfare
loss from the tariff diagram.
2. Cost-push inflation
◦ Tariffs and other trade barriers tend to restrict supply of cheap imported raw
materials in a developed economy. This will increase the cost to produce, leading to
cost-push inflation. There may also be an increase in price for consumer products.

31. Problems with Protectionism
3. Retaliation from other countries
◦ Other countries may impose the same trade barriers, leading to a vicious cycle and a
tit-for-tat trade war (e.g. US and China)
4. Government reliance
◦ Domestic firms may become overly reliant on government protectionist measures
and lack the incentive to develop international competitiveness through higher
efficiencies.
5. Government failure
◦ The government is unlikely to be able to estimate tariffs correctly to ensure the
desired impact is achieved, given the lack of information.

32. Role Play
Assume you are an advisor of Trump.
Each of you have to come up with an
advantage or disadvantage on the tariff I am
about to impose on Chinese steel to keep
your jobs.
Start from the right!