Availability is a factor 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.
Another reason we import is price and quality. Domestic products may be available, but they are expensive. Or their quality is lower than foreign products. So, we buy from abroad to get cheaper or higher quality.
In addition to these two factors, other factors also affect imports, including:
- Domestic demand
- Domestic income
- Exchange rate
- Government policy
- Productivity level
Certain products may not be produced by the domestic economy. This is the main reason why imports exist. We need them, but we have to buy them from other countries.
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 other cases, a country imports because domestic production is insufficient. Thus, a shortage arises in the market because domestic supply is less than domestic demand. Consequently, the country had to import from abroad to cover the shortage.
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, we tend to increase imports when foreign goods are cheaper abroad. But, conversely, when domestic goods cost less than in international markets, we turn to them.
And in aggregate, the prices of goods and services are reflected in the inflation rate. Therefore, domestic goods are more expensive when the domestic inflation rate is higher than in the international market. This situation increases imports because foreign goods are cheaper. The opposite effect applies when the domestic inflation rate is lower.
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. Or, households buy luxury goods or antiques from abroad. Or 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.
We spend our income on imports, buying domestic products, and saving. Thus, an increase in imports is often attributed to a rise in income.
When income increases, we spend more on imported products. How much 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.
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. As a result, increased imports cause the domestic currency to depreciate, ceteris paribus.
Several government policies affect imports. 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. As a result, the policy reduces 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 affects the price. 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 it from abroad. Instead, we can export it and generate revenue because it is 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.
What to read next
- Import: Types, Influencing Factors, Impacts
- What Are the Factors Affecting Imports?
- Import Tariff: Purposes, Types, Advantages, and Disadvantages
- Import Quota: Types, Purposes, Methods, Pros and Cons
- How Do Imports Impact the Economy?