International trade and lower prices

International Trade leads to lower prices:

Another common argument put forward to support international trade is that it lowers the price of goods and services.

There are a number of reasons why international trade may lower prices:

1-      International trade allows firms to take advantage of larger markets which means they can take advantage of greater economies of scale. These economies of scale allow firms to lower their costs which they can pass onto the consumer in the form of lower prices.

2-      International trade also means firms face greater competition. This forces firms to improve their game; being more efficient, lowering costs, improving products and lowering prices. Prices should therefore be competed down.

3-      The theory of comparative advantage and absolute advantage state that countries will increasingly specialize in those products that are most suitable to their resources endowments. What this basically means is that each country does what it is most suited to and this again leads to more efficiency and potentially lower prices.

If you combine all of the above you have some pretty strong forces working to bring prices down. So is there any reason why prices might stay high or even go up.

Counter arguments:

The above really depends on firms passing on the cost savings resulting from more specialization and economies of scale. Consumers will only experience the lower prices if these cost savings are past on and firms are only likely to pass these savings on if there is competition forcing them to do so.

If there are barriers to entry, monopoly power, collusion, or government intervention to restrict competition then firms will have little incentive to lower prices.

Free market economists tend to argue that competition will exist, or at least the threat of it will (contestable markets), and therefore firms will pass on their saving in lower prices.

Others will argue that the most likely outcome is that certain firms will start to gain monopoly power and just absorb the cost savings in the form of higher profits and consumer will see little or no benefit. Indeed if the monopoly power is significant then prices might go up.

I think the truth is somewhere in between these two views. Certain products certainly seem to get cheaper – electronics and clothes being two obvious examples. But at the same time they are not as cheap as they could be. Take this example of smart phones:

If you think about what you get for your money smartphones and the like are very cheap. But the evolution of the industry neatly exemplifies the upward and downward pressures on prices as a result of trade.

Firstly, international trade allows Apple to make the Ipad cheaply:

http://www.economist.com/node/21525685

But the industry has quickly moved toward monopoly power which allows firms to keep price high:

http://www.guardian.co.uk/technology/2012/may/02/samsung-apple-smartphone-dominance

And, while smartphones are incredibly cheap when you compare them to what you would have got for the same money 10 yrs ago, prices could certainly be lower: http://www.guardian.co.uk/technology/2012/apr/23/bad-apple-employ-more-us-workers

And

http://online.wsj.com/article/SB10001424052702304459804577285781308878646.html

While obviously this is only one industry it is a good example.

 

Easter Revision Courses in Economics found here: http://www.athenatutorials.co.uk/

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One thought on “International trade and lower prices

  1. I think this is a great of example of theory vs. reality.

    Theory is correct that through comparative and absolute advantage nations will specialize in what they are good at and therefore global prices fall. Real life backs this up; Apple designs in California, making use of the immense skill base in silicone valley, and china build the product making use of the cheap labor.

    However, I would argue ‘third’ party factors come to play stopping the theory playing out as it should.

    You make the point of government intervention, but there is also consumer, company and union intervention stopping comparative advantage fully applying itself. Take Renaults recent decision to close production outside Swindon, UK, to focus on the French manufacturing base. This, despite the fact the Swindon factory was more efficient.

    The company being French saw that it was prudent to support the French base – politics. Consumers,love to buy nationalistically, even if the product is inferior. And, Trade Unions in France are very strong and could have caused serious issues if Renault closed French production over English.

    Beyond this a cost which is never accounted for in the theory is that of fluctuation in transport costs. In our industry, fire-safety, where many components are made in developing nations (Thai computer components for example) are bought to the EU for final assembly and then re-exported. But transport prices are rocketing. Oil prices are driving up freight costs which are very sticky coming down again. These varying transport prices call into question the benefits of specializing and undermine the basis for comparative advantage as an applicable model.

    Finally I think the biggest factor in comparative advantage not working is domestic demand! For example; French resistance to foreign wine; American Steel having to be ‘American’; Australians drinking VB!; and in India ‘Thumb’s Up’ (a horrible cola drink) preferred to the internationally loved Coke Cola!

    However, you could counter this last point. Do consumer really ignore the superior quality and lower prices of foreign products and therefore undermine compartative advantage or do domestic produces just know their market better.
    Either way your arguments of potential worldwide monopoly, Economies of Scale etc can be shot down when a international super power such as Coca-Cola can’t get a strong foot hold in market of a billion Indians!

    Ultimately another question to be asked is do we want comparative advantage to succeed?

    This is a social-political-economic argument. Closer trade brings nations together; the EU has fostered the longest period of peace between European nations in history. But then do nations want/need to be interdependent? Would we lose our skill base if we imported in all our textiles for example?

    Also in the west particular we are discerning consumers. We dont want the coffee from the cheapest national producer; we want Columbian Fair-Trade, medium roast, course ground coffee and so forth.

    Finally; are we also moving to a state where the word comparative advantage should no longer be applied to states but rather businesses? I could give you a huge list of where companies buy off competitors because they do this better and cheaper. The car industry is infamous for it; rover buying honda engines; the one series chassis was bought from Hyundai; VW sell their engines to BMW, Audi, Alfa, Fiat and many more. The one producer who insisted doing it alone went bust; Saab!

    Are global ‘super brands’ the new basis for the comparative advantage model?

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