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Availability is one of the fundamental factors affecting imports. We import goods from abroad because they are unavailable in the domestic market. For example, the domestic economy does not produce them because the geographical location does not support them.
While availability is a crucial factor, price and quality are equally important factors affecting imports. Even if domestically produced goods are available, import decisions are often influenced by these aspects:
- Price: Domestic products may be more expensive than their foreign counterparts due to various reasons. This could be a lack of economies of scale, inefficient production methods, or higher input costs. In such cases, importing cheaper goods becomes more attractive.
- Quality: Sometimes, domestic products may not meet the desired quality standards. Consumers might prefer foreign goods with better quality, even if they come at a higher price.
As you can see, price and quality significantly influence import decisions. However, several other factors affecting imports deserve consideration:
- Domestic demand
- Domestic income
- Exchange rate
- Government policy
- Productivity level
Availability
Certain products may not be produced by the domestic economy. This is a critical factor affecting imports, highlighting the need to source these goods from other countries. We rely on imports to fill these gaps in domestic production and meet our consumption needs.
The demand for wheat by countries in Southeast Asia, such as Indonesia, is a good example. Their geographical area is not suitable for growing wheat. So, they must buy from other countries such as China, Russia, and India to meet domestic demand.
In some cases, insufficient domestic production emerges as a key factor affecting imports. This occurs when domestic supply falls short of domestic demand, creating a market shortage. To bridge this gap and meet consumer needs, the country resorts to importing goods from abroad.
Price or inflation rate
Domestic production may meet demand, but it is expensive. The reason may be insufficient resources or unsupported technology. As a result, the domestic economy produces them at a higher cost than other countries. In other words, the domestic economy does not have a comparative advantage in producing these goods.
Comparative disadvantage makes production less efficient than in other countries. As a result, domestic products are more expensive because they cost more. So, we have to import from other countries to get cheaper ones. This option makes more sense than using resources to produce uncompetitive goods.
Long story short, one of the key factors affecting imports is price. We tend to increase imports when foreign goods are cheaper abroad. Conversely, when domestic goods cost less than in international markets, we prioritize domestic products.
And in aggregate, the prices of goods and services are reflected in the inflation rate. Inflation is another factor affecting import decisions. When the domestic inflation rate is higher than the inflation rate in the international market, domestic goods become relatively more expensive. This price difference can incentivize consumers and businesses to import goods, as foreign products become comparatively cheaper.
Domestic demand
Demand changes in household consumption, business investment, and government spending affect imports. And domestic production may not be able to meet all of these demands. Thus, when domestic production is not enough, we must import to meet domestic demand.
For example, a business must purchase some high-tech capital goods from a developed country. Households buy luxury goods or antiques from abroad. The government uses services provided by foreign consultants for domestic infrastructure projects.
Changes in imports related to consumption, investment, and government spending are influenced by several factors. Income and profits are examples. Meanwhile, the government may increase imports to support launched infrastructure projects. In addition, changes in consumer tastes and preferences can also change their demand for foreign products.
Domestic income
Domestic income is another key factor affecting imports. We spend our income on a combination of imports, domestic products, and savings. As income rises, individuals tend to increase their spending on a variety of goods and services, including those imported from abroad.
When income increases, we spend more on imported products. The amount of extra product we import relative to our extra income is called the marginal propensity to import (MPM). The higher the MPM, the more we spend on imports.
Economists usually use the gross domestic product (GDP) or gross national income (GNI) to represent income in the aggregate. And because aggregate income will equal aggregate output, changes in income are positively correlated with changes in aggregate output.
Thus, when it produces more output (expansion), the economy creates more income. As a result, demand for imports increases because not all goods needed and desired are provided by local producers.
For this reason, increased imports do not always have a negative connotation. Instead, it could indicate a growing economy.
Exchange rate
Exchange rate fluctuations are another important factor affecting imports. Depreciation makes imported goods more expensive when they enter the domestic market, reducing their demand, ceteris paribus. On the other hand, appreciation makes foreign goods cheaper, increasing import demand.
For example, a product costs $1 and does not change. However, the euro exchange rate depreciates from EUR1 to EUR1.2 per US dollar. Although the price did not change, the depreciation made the product more expensive for Europeans because they had to spend EUR1.2 to get it, more than before the euro depreciated (EUR1).
Conversely, the item becomes cheaper if the euro appreciates to EUR0.98 per US dollar. As a result, Europeans spend fewer euros (from EUR1 to EUR0.98) to buy the product.
When we adjust the nominal exchange rate for the inflation rate, we get the real exchange rate. So, for example, when it depreciates, domestic goods are cheaper than foreign goods. As a result, exports tend to increase, and imports tend to decrease.
However, the relationship between imports and exchange rates is more complex. For example, depreciation may not result in an increase in imports if the costs associated with shipping goods to the domestic market are expensive, higher than the difference between domestic and international prices.
In other cases, changes in imports can also affect exchange rates. That’s because our imports involve two different exchange rates. When imports increase, we exchange the domestic currency for the currency of the partner country to pay. As a result, the demand for the partner country’s currency rises relative to the domestic currency. Increased imports cause the domestic currency to depreciate, ceteris paribus.
Government policy
Government policies play a significant role in influencing import decisions. These policies can either encourage or discourage international trade activity. For example, liberalization stimulates trade between countries, including imports. On the other hand, trade protections such as import quotas and tariffs reduce trade.
For example, when the government imposes higher import tariffs, foreign products become more expensive when sold in the domestic market. Consequently, they are less attractive to domestic consumers. Higher prices make imported products less competitive than domestic products, reducing the demand for imported products.
In addition to the examples above, the government’s macroeconomic policies can also affect imports through their effects on domestic economic activity and income. For example, an increase in interest rates encourages capital inflows and causes the exchange rate to appreciate. As a result, imported goods become cheaper, increasing their demand.
Then the government may also form regional cooperation by forming an economic union, as the European Union countries do. The policy encourages increased trade among member countries, and goods and services flow freely between them as trade barriers are removed.
Productivity level
Productivity level is a crucial factor affecting import and export decisions. We have a comparative advantage when we are more productive in making a product. So, we can produce these products cheaper than other countries. Therefore, we do not need to import them from abroad. Instead, we can export them and generate revenue because they are more competitive in foreign markets.
Then, we may not have a comparative advantage over other products. Indeed, we can produce them, but at a higher cost because they are less productive. As a result, we sell them at a higher price. In this case, we are better off buying the product from abroad than producing it, assuming price as our primary consideration – ignoring the contribution to income and job creation in the economy.
