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Gains from Trade

economists, the real benefits of trade are more important in importing rather than in exporting, although politicians frequently persuade consumers to favour domestically-made goods and describe a widening trade deficit as a bad thing. Economists know that the only reason for exporting is to earn the necessary means to import.

The benefit which results from exchanging one commodity for another arises from the commodity received, not the commodity given. This benefit arises even if one country can make everything more cheaply than all others. The basic theory that accounts for this and the principle of comparative advantage were developed by David Ricardo and his contemporaries.

To see how this theory works, think about why two countries - call them South and North - might gain from trading with one another. Suppose that each has 1,000 workers, and each makes two goods: cameras and radios.

North's economy is far more productive than South's economy. In order to make a radio, North needs the labour of two workers; South needs four. To make a camera, North uses ten workers while South uses 100. Suppose that there is no trade, and that in each country half the workers are in each industry. North produces 250 radios and 50 cameras. South makes 125 radios and five cameras.

Now suppose that the two countries specialize. Although North makes both radios and cameras more efficiently than South, it has a bigger advantage in camera-making. Now it devotes most of its resources to that industry, employing 700 workers to make cameras and only 300 to make radios. This raises camera output to 70 and cuts radio production to 150. East switches entirely to radios, turning out 250. World output of both goods has risen. Both countries can consume more of both if they trade.

At what price? Neither will want to import what it could have made more cheaply at home. So North will want at least five radios per camera; and South will not give up more than 25 radios per camera. Suppose the terms of trade are fixed at 12 radios per camera and that 120 radios are exchanged for ten cameras. Then North ends up with 270 radios and 60 cameras, and South with 130 radios and ten cameras. Both are better off than they could be without trade.

  Output and consumption before trade Output after specialization Consumption after trade
  Radios Cameras Radios Cameras Radios Cameras
South            
North            

This is true even though North has an "absolute advantage" in making both cameras and radios. The reason is that each country has a different "comparative advantage". North's advantage is greater in cameras than in radios. Being less productive in both industries, South is a relatively cheaper maker of radios. So long as each country specializes in products in which it has a comparative advantage, both will gain from trade.

 

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What other examples illustrating the principle of comparative advantage can you think of?

TEXT B

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European Common Market

In 1952 a definite step towards economic integration was taken with the formation of the European Coal and Steel Community, whose purpose was to unite coal and steel resources of six nations (France, Belgium, Luxembourg, the Netherlands, Italy, West Germany) and to eliminate trade barriers on these resources. The success of this Community led to the formation in 1958 of the European Economic Community (EEC), usually called the Common Market. This association including the same nations was formally established by one of the Treaties of Rome and the main goals were the following: 1) to remove barriers to trade among the member nations, 2) to establish a single commercial policy toward non-member countries, 3) to coordinate members' transportation systems, agricultural and general economic policies, 4) to remove private and public measures restricting free competition, 5) to ensure the mobility of labour and capital among the members. Different countries joined this coalition later: the United Kingdom, Denmark and Ireland in 1973 Greece in 1981, Poland and Spain in 1986. The former East Germany was admitted as part of reunified Germany in 1990. Austria, Finland and Sweden joined in 1995. The four primary structural organs of the EEC were the Commission, the Council of Ministers, the Court of Justice and the European Parliament. From the beginning one of the EEC's main goals was to eliminate the tariffs and quotas imposed by its members on each other's exports. The first tariff reduction, 10 percent on industrial goods, was made in 1959 and this proved to be so successful in stimulating trade between member states that by 1968 all internal tariffs had been removed. However, the movement toward the common external tariff advanced at a slower pace. Trade among the members of the EEC quadrupled in value in the period from 1958 to 1968. A common agricultural policy was established in 1962 and consisted of a system of common guaranteed prices that would offer protection against agricultural imports from lower-cost markets outside the EEC. Progress has been made toward common internal policies regarding monopoly control, transportation and social security systems. Furthermore, labour-force training and mobility have received increased coordination. So, the Common Market has contributed greatly toward economic growth and prosperity in Western Europe. Later the European Economic Community was renamed the European Community (EC) and after some reorganizations in 1967 and 1980 the EC became the principal organization within the European Union (EU) formed in 1993. The Commission of the EC is headed by 20 members including a president and several vice presidents with at least one commissioner from each nation in the Union. This Commission is responsible for the formal and practical implementation of the various treaties of the Union and rules issued by the Council of Ministers, prepares different acts, implements the EU's agricultural policies and regional development programmes, etc. The Council of Ministers, the European Council, the European Parliament, the Court of Auditors, the European Investment Bank, the Economic and Social Committee are the main branches of the European Union.

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1. How can the European Union, the former EEC, ensure the mobility of labour?

2. What advantages do the citizens of the member countries of the European Union have?

3. What are the tasks of different branches of the European Union?

 

TEXT C

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