Background to the EU.

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Background to the EU

1. Background to the EU

Supply and Demand

One of the main functions of markets is to make trade easier Markets also have a lot to do with the price of a product or service, economics, call this the market price. Markets have a least two players, a buyer and a seller. So the price depends on how the buyer is prepared to pay and how much the sellers are willing to sell for. The acceptable price is called the equilibrium price. The equilibrium price is important because in theory there should be no unsold stock and no customers waiting for more deliveries. A market with either unsold stock or unsatisfied customers is in disequilibrium. The equilibrium price is where the demand and supply line cross.  


The supply is the amount of goods or services that businesses are willing to produce over a defined period of time. The quantity businesses want to supply is related to the price that can be charged. The higher the price, the greater potential profit and the larger quantity supplied. This relationship can be presented in the form of a graph or supply curve.

If the price falls, businesses will reduce output and look around for other products which are more profitable.

These are some influences on supply:

  • Price
  • Costs of production
  • New technologies
  • Taxation
  • Subsidies


This is the amount of goods or services that people wish to buy over a defined period time. When businesses identify a profitable opportunity they are observing the existence of potential demand for the product. Whether they can create this opportunity for themselves depends very much on the price at which they are prosing to sell the product. This relationship can be presented in the form of a graph or demand curve.

These are some of the influences on demand:

  • Price
  • Income
  • Age distribution
  • Tastes/fashion
  • Marketing activity
  • Price of related products
  • Price of credit

Absolute and Comparative Advantage

Absolute Advantage

A classical economist Adam Smith wrote a famous book in 1776 in which he established a basis for trade between countries as an extension of the principle of specialisation and division of labour between individuals and households. He also said that the wealth of a country is decided by the level of goods and services enjoyed by its people i.e. GDP (Gross Domestic Product).

Different countries can produce some goods more effectively using fewer resources than others because of factors including natural resources, technology, labour supply and skills. Each country should therefore develop those areas where it holds an absolute advantage.

However, this can only work if certain rules apply:

  • One country must be able to produce a good more cheaply than another
  • That the other country must be able to produce a different “product” to that of the first country
  • When these conditions are satisfied then each nation has something to exchange and therefore develops a specialisation
  • Each nation will now specialise in the production of a product at its cheapest rate
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This economic principle is known as Absolute Advantage.

Absolute advantage has benefits to each nation:

  • Exporting goods for its own sake is pointless, therefore:
  • Exporting of products to another nation allows the first country to import a product it cannot produce for a variety of reasons
  • It may seem desirable for a country too be self sufficient, but this would possibly reduce: specialisation, division of labour and wealth of nations

There are criticisms of Adam Smiths principles:

  • Its all too simple and applies only when both countries have an absolute advantage in ...

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