1 19.International Trade 2 Chapter 19 : main menu 19.1 Illustrating how trade is beneficial to countries Concept Explorer 19.1 Progress Checkpoint 1

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19. International Trade

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Chapter 19 : main menu

19.1Illustrating how trade is beneficial to countries

Concept Explorer 19.1Progress Checkpoint 1Concept Explorer 19.2

19.2Other possible gains from trade

Theory in Life 19.1Progress Checkpoint 2

19.3 Trade barriersTheory in Life 19.2Progress Checkpoint 3

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Absolute and comparative advantages for a country in producing ALL goods

Can a country have absolute advantage in producing ALL good? Can a country have comparative advantage in producing ALL good?

Concept Explorer 19.1

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Absolute advantage means higher input-output ratio. Consider the following example:

Country X Country Y

Good A 2 5

or or

Good B 4 8

Table 19.2 Output per-unit of resources

Country Y may be a “developed” country (e.g. Japan, U.S.A., etc.) while Country X may be a “less-developed” country (e.g. the Philippines, Thailand, India, etc.). Country Y is able to produce more of both goods than Country X, because more advanced technology is available. Hence a country can have absolute advantage in producing all goods.

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Comparative advantage means lower opportunity cost (in terms of other goods forgone). For the data in table 19.2, the opportunity costs for each country to produce each good are:

Country X Country Y

Opportunity cost of producing 1A 4B

= 2B8B

= 1.6B2 5

Opportunity cost of producing 1B 2A

= 0.5A5A

= 0.625A4 8

Table 19.3 The opportunity costs of producing both goods

Since the cost for Country Y to produce 1A (in terms of Good B forgone) is lower, she has a comparative advantage in producing Good A. But as her cost to produce 1B (in terms of Good A forgone) is higher, she does NOT have a comparative advantage in producing Good B. This is due to the reciprocal nature (相互性質 ) of comparative advantage. Hence a country cannot have comparative advantage in producing all goods.

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Progress Checkpoint 1

Q19.1 The following table shows the output per-unit of resources of Japan and USA in producing sushi and beef :

Japan USA

Sushi 10 5

Or or

Beef 2 20

Is EACH of the following statement correct?(a) “Japan has an absolute advantage in producing sushi, because with 1 unit of resources,

she can produce 10 units of sushi but only 2 units of beef.”(b) “USA has a comparative advantage in producing beef, because her cost of producing

1 unit of sushi is 4 units of beef, but her cost of producing 1 unit of beef is only 0.25 units of sushi.”

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(a) The statement is wrong. Japan has an absolute advantage in producing sushi because, with 1 unit of resources, Japan can produce 10 units of sushi, but USA can produce 5 units of sushi only. With the same amount of resources, Japan can produce more sushi that USA.

(b) The statement is wrong. USA has a comparative advantage in producing beef because the cost for USA to produce 1 unit of beef is 0.25 units of sushi, but the cost for Japan is 5 units of sushi. The cost for USA to produce beef (in terms of sushi forgone) is lower than that for Japan.


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Q19.2 The following table shows the actual output of two countries in producing cars and toys. Country X uses 55% of resources to produce cars and 45% to produce toys. Country Y uses 75% of resources to produce cars and 25% to produce toys.

Country X Country Y

Car (units) 440 600

Toy (units) 450 200

(a) Find the opportunity cost of producing one unit of car for EACH country. Show your working.(b) Explain which country will import car if trade between them opens up.

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(a) Country X has used 55% of resources to produce car. If she uses 100% of the resources

to produce car, she can produce440

= 800 units of car.55%


Country X has used 45% of resources to produce toy. If she uses 100% of the resources

to produce toy, she can produce450

= 1,000 units of toy.45%

Hence Country X’s opportunity cost of producing 1 unit of car is1,000

= 1,000 units of toy.800

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Country Y has used 75% of resources to produce car. If she uses 100% of the resources

to produce car, she can produce600

= 800 units of car.75%

Country Y has used 25% of resources to produce toy. If she uses 100% of the resources

to produce toy, she can produce200

= 800 units of toy.25%

Hence Country Y’s opportunity cost of producing 1 unit of car is

800= 1 unit of toy.

800

(b) As Country X’s cost of producing 1 unit of car is higher, Country X will import cars from Country Y.

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Q19.3 The following table shows the output of computers and rice in Taiwan and Thailand per unit of resources:

Taiwan Thailand

Computers (units)

4 2

or Or

Rice (units) 50 80

Suppose Taiwan and Thailand trade at an exchange ratio of 2 units of computers to 30 units of rice. Calculate the gain per unit of import for Thailand.

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Taiwan’s cost of producing 1 unit of computer is50R

= 12.5 units of rice. 4

Thailand’s cost of producing 1 unit of computer is 80R

= 40 units of rice. 2

Hence Thailand will import computers.

The terms of trade is 1 unit of computers to 15 units of rice.Thailand’s per-unit gain from import of computers = (40 – 15) units of rice

= 25 units of rice

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Q19.4 The following table shows the output of two goods in two countries per unit of resources:

Good X (units)

Good Y (units)

Country A 300 OR 600

Country B 100 OR 400

(a) According to an economic principle, both countries would gain from specialization and trade. Name and state this principle.(b) Calculate the possible range of terms of trade for both countries to have mutually beneficial trade.

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(a) It is the principle of comparative advantage. It states that if countries specialize in producing goods which they have a lower opportunity cost, the total output will increase and be higher than under self-sufficiency.

(b) Country A’s cost of producing 1X is 2Y, while Country B’s cost is 4Y. The possible range of terms of trade is : 2Y < 1X < 4Y. OR Country A’s cost of producing 1Y is 0.5X, while Country B’s cost is 0.25X. The possible range of terms of trade is: 0.25X < 1Y < 0.5X.

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Finding absolute and comparative advantages by input requirement table

The following table shows the input requirement per-unit of output of two countries. Which country has an absolute advantage in producing the goods? Which country has a comparative advantage in producing the goods?

Country X Country Y

Good A 10 20

Good B 80 40

Table 19.8 Resources requirement per-unit of output

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To produce 1A, Country X needs 10 units while Country Y needs 20 units of resources. As Country X can produce 1A with less resources, she has an absolute advantage in producing Good A.

To produce 1B, Country X needs 80 units while Country Y needs 40 units of resources. As Country Y can produce 1B with less resources, she has an absolute advantage in producing Good B.

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Suppose Country X uses 10 units of resources to produce 1A. That 10 units of resources

can be used to produce 10

= 0.125B. Hence her cost of producing 1A is 0.125B. 80

Suppose Country Y uses 20 units of resources to produce 1A. That 20 units of resources


= 0.5B. Hence her cost of producing 1A is 0.5B. 40

As Country X produces Good A at a lower opportunity cost, she has a comparative advantage in producing Good A.

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Suppose Country X uses 80 units of resources to produce 1B. That 80 units of resources


= 8A. Hence her cost of producing 1B is 8A. 10

Suppose Country Y uses 40 units of resources to produce 1B. That 40 units of resources


= 2A. Hence her cost of producing 1B is 2A. 20

As Country Y produces Good B at a lower opportunity cost, she has a comparative advantage in producing Good B.

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Theory in Life 19.1

Why trade may not take place even though comparative advantage exists

Suppose the following shows the opportunity costs for Hong Kong and Britain in producing toys (T) in terms of computers (C): Opportunity cost for Hong Kong to produce 1T = 0.5COpportunity cost for Britain to produce 1T = 4C

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Theory in Life 19.1

Obviously Hong Kong will export toys to Britain. The possible range of terms of trade is 0.5C < 1T < 4C. Let the negotiated terms of trade be 1T = 2C. Hence the per-unit gain to Hong Kong from exporting 1T is (2C – 0.5C = ) 1.5C. The per-unit gain to Britain from importing 1T is (4C – 2C =) 2C. (a) What will be the possible range of terms of trade and how will the per-unit gain to each country be affected if :(i) Hong Kong has to pay a transportation cost of 1C per unit of T exported, and(ii) Britain has to pay a transportation cost of 1C per unit of T imported? (b) What is the minimum transportation cost per unit of T (expressed in terms of C) which will result in both countries NOT gaining from trade ?

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Theory in Life 19.1

(a) (i) If Hong Kong has to pay a transportation cost of 1C per unit of T exported, the minimum price she has to received to export 1T will be (0.5C + 1C =) 1.5C. The possible range of terms of trade will become 1.5C < 1T < 4C. Her per-unit gain from exporting 1T will be reduced to (2C – 0.5C – 1C) = 0.5C.

(ii) If Britain has to pay a transportation cost of 1C per unit of T imported, the maximum

price she offers to import 1T will be (4C – 1C =) 3C. The possible range of terms of trade will become 0.5C < 1T < 3C. Her per-unit gain from importing 1T will be reduced to (4C – 2C – 1C =) 1C.

Reminder :When the per-unit transportation cost has to be paid by the exporting (importing) country, then the lower (upper) limit of the possible range of terms of trade will be raised (reduced by the per-unit transaction cost.

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Theory in Life 19.1

(b) As the possible range of terms of trade limit is 0.5C < 1T < 4C, it implies that the sum of the per-unit gain from trading 1T to both countries is (4C – 0.5C =) 3.5C. If the transportation cost is 3.5C per unit of T, the gains from trade will be offset.Hence the minimum transportation cost per unit of T (in terms of C) which will result in both countries NOT gaining from trade is 3.5C.

Reminder :The minimum per-unit transportation cost to make countries NOT gaining from trade is equal to the difference between the upper and lower limit of a possible range of terms of trade.

Reminder :Other than transportation cost, unstable political situation and war may increase the insurance costs of trade. Countries may not trade when the insurance costs offset the gains from trade.

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Q19.5 The following table shows the resources requirement per unit of output of Country A and B:

Good X (units) Good Y (units)

Country A 2 4

Country B 6 4

Explain which country has (a) an absolute advantage(b) a comparative advantage in producing Good X and Good Y respectively

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(a) Country A needs 2 units of resources while Country B needs 6 units of resources to produce 1 unit of Good X. As Country A can produce the same amount of Good X with less resources, Country A has an absolute advantage in producing Good X.

Both Country A and B need 4 units of resources to produce 1 unit of Good Y. As no country can produce the same amount of Good Y with less resources, no country has an absolute advantage in producing Good Y.

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(b)

The cost for Country A to produce 1X is (

2

=) 0.5Y, while that for Country B 4

is (6

=) 1.5Y. As Country A’s cost is lower, Country A has a comparative4

advantage in producing Good X.

The cost for Country A to produce 1Y is (

4

=) 2X, while that for Country B 2

is (4

=) 0.67X. As Country B’s cost is lower, Country B has a comparative 6

advantage in producing Good Y.

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Progress Checkpoint 2Q19.6 The following table shows the output of two goods in two countries per unit of resources:

Lamb (units)Cheese (units)

Australia 800 OR 200

Canada 400 OR 200

(a) Calculate the opportunity cost of producing one unit of lamb for EACH country. Explain which economy would import lamb.

(b) State the possible range of terms of trade (for 1 unit of lamb) that is mutually beneficial to both countries.

(c) How will your answer in (b) be affected if (i) the exporting country (ii) the importing country

has to pay a transportation cost of 1 unit of cheese per unit of lamb traded?

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Progress Checkpoint 2(a)

Australia’s cost of producing 1 unit of lamb is (

200C

=) 0.5Y, while Canada’s80

cost is (200C

=) 0.5 units of cheese. As Australia’s cost is higher, she will400

import lamb from Canada.

(b) The possible range of terms of trade (for 1 unit of lamb) is:0.5 unit of cheese < 1 unit of lamb < 2.5 units of cheese.

(c) (i) If the exporting country (i.e. Canada) has to pay a transportation cost of 1 unit ofcheese per unit of lamb traded, she will required to receive (0.5 + 1 =) 1.5 units

of cheese to export 1 unit of lamb. The possible range of terms of trade (for 1 unit of lamb) will become 1.5 unit of cheese < 1 unit of lamb < 2.5 units of cheese.

(ii) If the importing country (i.e. Australia) has to pay a transportation cost of 1 unit of

cheese per unit of lamb traded, she will be willing to offer (2.5 - 1 =) 1.5 units ofcheese to import 1 unit of lamb. The possible range of terms of trade (for 1 unit

oflamb) will become 0.5 unit of cheese < 1 unit of lamb < 1.5 units of cheese.

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Theory in Life 19.2

Tariff Vs quota in reducing import volumeA government may impose tariffs or quota to reduce imports. Which one will give a more certain result in discouraging imports?

Tariffs make imports more expensive and reduces its quantity demanded. If local demand for imports is highly elastic, then imposing tariffs will lead to a relatively large reduction in the quantity demanded for imports; and vice versa. Hence whether it is successful depends on local demand elasticity for imports. A quota directly sets the maximum quantity of imports. The reduction in import volume does not depend on local demand elasticity for imports. Hence quota gives a more certain result in discouraging imports than tariffs.

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Q19.7 Suppose the demand for an imported good is perfectly elastic. With the aid of a diagram, explain how the market price, volume of imports and the total expenditure spent on the imported goods will change if an effective quota is imposed.

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If the demand for the imported good is perfectly elastic, the demand curve is horizontal.If a quota is set at Q2, the supply of the imported goods will decrease from S1 to S2, i.e. the kinked supply curve. The market price will remain constant at P1, and the volume of imports will decrease from Q1 to Q2. The total expenditure spent on the imported goods will decrease from P1 x Q1 to P2 x Q2, i.e. decreases by the shaded area.

Decrease in total expen

diture

Quantity0

P ($)

D

S1

S2quota

imposed

P1

Q1Q2

Quota


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End of Chapter 19

Documents

1 19.International Trade 2 Chapter 19 : main menu 19.1 Illustrating how trade is beneficial to countries Concept Explorer 19.1 Progress Checkpoint 1