The Price Mechanism Of International Trade - 2039 Words

Introduction Adam Smith outlined that the price mechanism in international trade is like an ‘invisible hand’ that coordinates the consumption and production decisions in a well-functioning market economy (Kerr and Gaisford 2007). However, there is need for the government to intervene in free market economies in order to implement trade regulations and avoid market failure that is associated with negative externalities. International trade is affected by government’s interventions that include direct participation in supply and purchase of essential goods and services, through regulation, taxation and other indirect participation influences. The free markets enhance market efficiency through ensuring that prices are determined by the†¦show more content†¦The trade flows (both exports and imports) decline thus leading to higher prices and reduction of customer marginal benefit. The profit-seeking firms choose to produce where the price is equivalent to the marginal cost of the last produced unit and when government measures affect their decision to produce. The interventions that lower the marginal costs of production such as subsidies will lead to increase in production (Kerr and Gaisford 2007). Governments intervene in international trade through use of tariffs that are levied on both imports and exports. The government may either impose fixed tariffs that are calculated per unit of the import commodity or the ad valorem tariff that is calculated as a fixed percentage of the monetary value of the imported commodity. The government imposes high import tariffs in order to control the rate of imports by making the imports more expensive in comparison to the domestically produced substitutes. The tariffs increase the prices of goods and services thus reducing the quantity demanded (Misra and Yadav 2009). The use of tariffs is detrimental to international trade since it lowers competition and results in high prices of commodities in th e markets. The tariffs discourage imports and domestic producers benefit from the higher prices and reduction in competition. The EU uses variable