Chapter

Chapter

International
Trade
Neil D. Ammen
Nov. 29, 2014

 What is international trade?

Exchange of raw materials and
manufactured goods (and services)
across national borders
Trade Theories:
explain national economy conditions--country
advantages--that enable such exchange to happen
explain links among natural country advantages,
government action, and industry characteristics
that enable such exchange to happen

MERCANTILISM
Prevailed in 1500 - 1800
Zero-sum vs positive-sum game view of
trade
Export more to strangers than we import
to build up treasure, expand kingdom

Government intervenes to achieve a

surplus in exports
King, exporters, domestic producers: hppy
Subjects: unhappy because domestic goods
stay expensive and of limited variety

MERCANTILISM
A nations wealth depends on
accumulated treasure
Gold and silver are the currency
of
trade
Theory says you should have a
trade surplus.
Maximize export through
subsidies.
Minimize imports through tariffs
and quotas
5

MERCANTILISM

trade theory holding that nations

should accumulate financial wealth,
usually in the form of gold (forget
things like living standards or human
development)
by
encouraging
exports and discouraging imports

ABSOLUTE ADVANTAGE
Adam Smith: The Wealth of Nations,
1776
Mercantilism weakens country in long
run; enriches only a few
A country
Should specialize in production of and
export products for which it has absolute
advantage; import other products
Has absolute advantage when it has the
ability to produce a good USING FEWER
INPUTS than another country
7

ABSOLUTE ADVANTAGE
Adam Smith: Wealth of Nations (1776)
argued:

Capability of one country to produce

more of a product with the same
amount of input than another country
A country should produce only goods
where it is most efficient, and trade
for those goods where it is not
efficient
Trade between countries is, therefore,
beneficial
Assumes there is an absolute balance among
nations
8

ABSOLUTE ADVANTAGE
destroys the mercantilist idea
since there are gains to be had by
both countries party to an
exchange
questions the objective of
national governments to acquire
wealth through restrictive trade
policies
measures a nations wealth by
the living standards of its people
9

ABSOLUTE ADVANTAGE
G: Gana
K: South Korea

10

ABSOLUTE ADVANTAGE

11

COMPARATIVE ADVANTAGE
David Ricardo: Principles of Political
Economy, 1817
Country should specialize in the
production of those goods in which it is
relatively more productive... even if it
has absolute advantage in all goods it
produces
- has comparative advantage when it
has the ability to produce a good at a
LOWER OPPORTUNITY COST than
another country
12

COMPARATIVE ADVANTAGE
David Ricardo: Principles of Political
Economy (1817)
Extends free trade argument
Efficiency of resource utilization leads to more
productivity
Should import even if country is more efficient
in the products production than country from
which it is buying.
Look to see how much more efficient. If only
comparatively efficient, than import.
Makes better use of resources
Trade is a positive-sum game

13

COMPARATIVE ADVANTAGE

14

COMPARATIVE ADVANTAGE

15

ASSUMPTIONS & LIMITATIONS

Driven only by maximization of
production and consumption
Only 2 countries engaged in production
and consumption of just 2 goods?
What about the transportation costs?
Only resource labor (that too, nontransferable)
No consideration for learning theory

16

FACTOR PROPORTIONS
THEORY
Heckscher (1919)
- Olin (1933) Theory

Export goods that intensively use factor

endowments which are locally abundant
Corollary: import goods made from locally
scarce factors

Note: Factor endowments can be impacted

by government policy - minimum wage

Patterns of trade are determined by

differences in factor endowments - not
productivity
Remember, focus on relative advantage, not
absolute advantage

17

FACTOR PROPORTIONS
THEORY
trade theory
holding that countries
produce and export those goods that
require resources (factors) that are
abundant (and thus cheapest) and
import those goods that require
resources that are in short supply

Example:
Philippines: large population relative to its
size
So what should it export and import?
18

Factor endowments
Factor endowments:- A nations
position in factors of production
such as skilled labor or
infrastructure necessary to
compete in a given industry
Basic factor endowments
Advanced factor endowments
4-

Basic factor endowments

Basic factors: Factors present in a
country
Natural resources
Climate
Geographic location
Demographics

While basic factors can provide an

initial advantage they must be
supported by advanced factors to
maintain success
4-

421

Advanced factor
endowments
Advanced factors: Are the result
of investment by people,
companies, government and are
more likely to lead to competitive
advantage

If a country has no basic factors,

it must invest in advanced factors

Advanced factor
endowments
communications
skilled labor
research
Technology
education

4-

FACTOR PROPORTIONS
THEORY
trade theory
holding that countries

produce and export those goods that

require resources (factors) that are
abundant (and thus cheapest) and
import those goods that require
resources that are in short supply
Example:
Philippines: large population relative
to its size
So what should it export and import?
23

Factor Proportions Trade

Theory
Considers Two Factors of
Production

Labor

Capital

Factor Proportions Trade

Theory
A country that is relatively
labor abundant (capital
abundant) should specialize
in the production and export
of that product which is
relatively labor intensive
(capital intensive)
4-

The Determinants of Trade

The equilibrium without trade
Domestic buyers and sellers
Equilibrium price and quantity
Determined on the domestic market

Total benefits
Consumer surplus
Producer surplus

26

Figure 1
The equilibrium without international trade
Price of
textiles

Domestic
Supply
Consumer
surplus

Equilibrium
price Producer
surplus
Domestic
Demand

Equilibrium
quantity

Quantity of textiles

When an economy cannot trade in world markets, the price adjusts to balance domestic
supply and demand. This figure shows consumer and producer surplus in an equilibrium
without international trade for the textile market in the imaginary country of Isoland.

27

The Determinants of Trade

Allow for international trade?
Price and quantity sold domestic
market?
Who will gain from free trade; who
will lose, and will the gains exceed
the losses?
Should a tariff be part of the new
trade policy?

28

The Determinants of Trade

The world price and comparative
advantage
World price
Price of a good that prevails in the
world market for that good

Domestic price
Opportunity cost of the good

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The Determinants of Trade

The world price and comparative
advantage
Compare domestic price with world price
Determine who has comparative
advantage
If domestic price < world price
Export the good
Country has comparative advantage

If domestic price > world price

Import the good
World comparative advantage
30

The Winners and Losers From

Trade
The gains and losses of an exporting
country
If domestic equilibrium price before
trade
Below world price
Once trade is allowed
Domestic price rises to = world price
Domestic quantity supplied > domestic
quantity demanded
The difference = exports
31

Figure 2
International trade in an exporting country

Price of
textiles

Domestic
Supply

Exports
A

Price
after
trade

Price
before
trade

World
Price

C
Domestic
Demand

Exports

Domestic
Quantity
Demanded

Consumer
Surplus
Producer

Domestic
Quantity
Supplied

Once trade is allowed, the domestic price rises

to equal the world price. The supply curve shows
the quantity of textiles produced domestically,
and the demand curve shows the quantity
consumed domestically. Exports from Isoland
equal the difference between the domestic
quantity supplied and the domestic quantity
demanded at the world price. Sellers are better
off (producer surplus rises from C to B + C + D),
and buyers are worse off (consumer surplus falls
from A + B to A). Total surplus rises by an
amount equal to area D, indicating that trade
raises the economic well-being of the country as
a whole.

Quantity of textiles

Before
trade

After
trade

Change

A+B
C
A+B+C

A
B+C+D
A+B+C+

-B
+(B+D)
+D

The area D shows

the increase in total
surplus and
represents the
gains from trade

32

The Winners and Losers From

Trade
The gains and losses of an exporting
country
Before trade
Consumer surplus
Producer surplus

After trade
Smaller consumer surplus
Higher producer surplus
Higher total surplus
33

The Winners and Losers From

Trade
The gains and losses of an exporting

country
When a country allows trade and
becomes an exporter of a good
Domestic producers of the good are
better off
Domestic consumers - are worse off
Trade raises the economic well-being of a
nation
Gains of the winners exceed the losses of the
losers
34

The Winners and Losers From

Trade
The gains and losses of an importing
country
If domestic equilibrium price before
trade
Above world price
Once trade is allowed
Domestic price drops to = world price
Domestic quantity supplied < domestic
quantity demanded
The difference = imports
35

Figure 3
International trade in an importing country

Price of
textiles

Domestic
Supply
A

Price
before
trade

Price
after
trade

World
Price

Domestic
Demand

Imports

Domestic
Quantity
Supplied

Consumer
Surplus
Producer

Once trade is allowed, the domestic price falls to

equal the world price. The supply curve shows
the amount produced domestically, and the
demand curve shows the amount consumed
domestically. Imports equal the difference
between the domestic quantity demanded and
the domestic quantity supplied at the world price.
Buyers are better off (consumer surplus rises
from A to A + B + D), and sellers are worse off
(producer surplus falls from B + C to C). Total
surplus rises by an amount equal to area D,
indicating that trade raises the economic wellbeing of the country as a whole

Domestic Quantity of textiles

Quantity
Demanded

Before
trade

After
trade

Change

A
B+C
A+B+C

A+B+D
C
A+B+C+

+(B+D)
-B
+D

The area D shows

the increase in total
surplus and
represents the
gains from trade

36

The Winners and Losers From

Trade
The gains and losses of an importing
country
Before trade
Consumer surplus
Producer surplus

After trade
Higher consumer surplus
Smaller producer surplus
Higher total surplus
37

The Winners and Losers From

Trade
The gains and losses
of an importing country

When a country allows trade and becomes

an importer of a good

Domestic producers of the good are worse off

Domestic consumers - are better off
Trade raises the economic well-being of a
nation
Gains of the winners exceed the losses of the
losers

Trade can make everyone better off

38

The Winners and Losers From

Trade
The effects of a tariff

Tariff

Tax on goods produced abroad and sold

domestically

Free trade
Domestic price = world price

Tariff on imports
Raises domestic price above world price
By the amount of the tariff
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Figure 4
The effects of a tariff
Price of textiles

Domestic
Supply

Tariff
B

Price with tariff

C

Price without
tariff

World Price

Imports
with tariff
Q1S

Q2S

A tariff reduces the quantity of

imports and moves a market
closer to the equilibrium that would
exist without trade. Total surplus
falls by an amount equal to area D
+ F. These two triangles represent
the deadweight loss from the tariff.

Domestic
Demand

Q2 D Q1 D

Quantity of textiles

Imports without tariff

Consumer
Surplus
Producer Surplus
Government

Before tariff

After
tariff

Change

A+B+C+D+E
+F
G
None

A+B
C+G
E
A+B+C+

-(C+D+E+F)
+C
+E
-(D+F)

The area D + F
shows the fall in
total surplus and
represents the
deadweight loss of
the tariff

40

The Winners and Losers From

Trade
The effects of a tariff
Price rises by the amount of the tariff
Domestic quantity demanded
decrease
Domestic quantity supplied increase
Reduces the quantity of imports
Moves the domestic market closer to
its equilibrium without trade
Domestic sellers better off
Domestic buyers worse off
41

The Winners and Losers From

Trade
The effects of a tariff
Before the tariff
Consumer surplus
Producer surplus
Government tax revenue = 0

With a tariff
Consumer surplus - smaller
Producer surplus - bigger
Government tax revenue
Total surplus - smaller
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 Other Benefits of
International Trade
Arguments for Trade
Restrictions
Trade Agreements
Philippine Trade Policies
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LOADING

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