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

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MERCANTILISMPrevailed in 1500 - 1800Zero-sum vs positive-sum game view of tradeExport more to strangers than we import to build up treasure, expand kingdomGovernment intervenes to achieve a surplus in exportsKing, exporters, domestic producers: hppySubjects: unhappy because domestic goods stay expensive and of limited variety

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MERCANTILISMA nations wealth depends on accumulated treasureGold and silver are the currency of tradeTheory says you should have a trade surplus. Maximize export through subsidies.Minimize imports through tariffs and quotas

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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

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ABSOLUTE ADVANTAGEAdam 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 productsHas absolute advantage when it has the ability to produce a good USING FEWER INPUTS than another country

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ABSOLUTE ADVANTAGEAdam 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 efficientTrade between countries is, therefore, beneficial Assumes there is an absolute balance among nations*

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*

ABSOLUTE ADVANTAGE*G: GanaK: South Korea

ABSOLUTE ADVANTAGE*

COMPARATIVE ADVANTAGEDavid Ricardo: Principles of Political Economy, 1817Country 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

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COMPARATIVE ADVANTAGE David Ricardo: Principles of Political Economy (1817)Extends free trade argumentEfficiency of resource utilization leads to more productivityShould 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 resourcesTrade is a positive-sum game

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COMPARATIVE ADVANTAGE*

COMPARATIVE ADVANTAGE*

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

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FACTOR PROPORTIONS THEORYHeckscher (1919) - Olin (1933) TheoryExport goods that intensively use factor endowments which are locally abundantCorollary: 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 productivityRemember, focus on relative advantage, not absolute advantage

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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 sizeSo what should it export and import?

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4-*Factor endowmentsFactor endowments:- A nations position in factors of production such as skilled labor or infrastructure necessary to compete in a given industryBasic factor endowmentsAdvanced factor endowments

4-*Basic factor endowmentsBasic factors: Factors present in a countryNatural resourcesClimateGeographic locationDemographics While basic factors can provide an initial advantage they must be supported by advanced factors to maintain success

4-*Advanced factor endowmentsAdvanced 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

4-* Advanced factor endowments

communicationsskilled laborresearchTechnologyeducation

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 supplyExample:Philippines: large population relative to its sizeSo what should it export and import?

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Factor Proportions Trade TheoryConsiders Two Factors of Production

Labor

Capital

4-*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)

The Determinants of TradeThe equilibrium without tradeDomestic buyers and sellersEquilibrium price and quantityDetermined on the domestic marketTotal benefitsConsumer surplusProducer surplus*

Figure

The equilibrium without international trade1*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.

The Determinants of TradeAllow 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?*

The Determinants of TradeThe world price and comparative advantageWorld pricePrice of a good that prevails in the world market for that goodDomestic priceOpportunity cost of the good*

The Determinants of TradeThe world price and comparative advantageCompare domestic price with world priceDetermine who has comparative advantageIf domestic price < world priceExport the goodCountry has comparative advantageIf domestic price > world priceImport the goodWorld comparative advantage *

The Winners and Losers From TradeThe gains and losses of an exporting countryIf domestic equilibrium price before tradeBelow world priceOnce trade is allowedDomestic price rises to = world priceDomestic quantity supplied > domestic quantity demandedThe difference = exports*

Figure

International trade in an exporting country2*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.

Before tradeAfter tradeChangeConsumer SurplusProducer SurplusTotal SurplusA+BCA+B+CAB+C+DA+B+C+D-B+(B+D)+D

The Winners and Losers From TradeThe gains and losses of an exporting countryBefore tradeConsumer surplusProducer surplusAfter tradeSmaller consumer surplusHigher producer surplusHigher total surplus*

The Winners and Losers From TradeThe gains and losses of an exporting countryWhen a country allows trade and becomes an exporter of a goodDomestic producers of the good are better offDomestic consumers - are worse offTrade raises the economic well-being of a nationGains of the winners exceed the losses of the losers*

The Winners and Losers From TradeThe gains and losses of an importing countryIf domestic equilibrium price before tradeAbove world priceOnce trade is allowedDomestic price drops to = world priceDomestic quantity supplied < domestic quantity demandedThe difference = imports*

Figure

International trade in an importing country3*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 well-being of the country as a whole

Before tradeAfter tradeChangeConsumer SurplusProducer SurplusTotal SurplusAB+CA+B+CA+B+DCA+B+C+D+(B+D)-B+D

The Winners and Losers From TradeThe gains and losses of an importing countryBefore tradeConsumer surplusProducer surplusAfter tradeHigher consumer surplusSmaller producer surplusHigher total surplus*

The Winners and Losers From TradeThe gains and losses of an importing countryWhen a country allows trade and becomes an importer of a goodDomestic producers of the good are worse offDomestic consumers - are better offTrade raises the economic well-being of a nationGains of the winners exceed the losses of the losersTrade can make everyone better off*

The Winners and Losers From TradeThe effects of a tariffTariffTax on goods produced abroad and sold domesticallyFree tradeDomestic price = world priceTariff on importsRaises domestic price above world priceBy the amount of the tariff*

Figure

The effects of a tariff4*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.

Before tariffAfter tariffChangeConsumer SurplusProducer SurplusGovernment RevenueTotal SurplusA+B+C+D+E+FGNoneA+B+C+D+E+F+GA+BC+GEA+B+C+E+G-(C+D+E+F)+C+E-(D+F)

The Winners and Losers From TradeThe effects of a tariffPrice rises by the amount of the tariffDomestic quantity demanded decreaseDomestic quantity supplied increase Reduces the quantity of importsMoves the domestic market closer to its equilibrium without tradeDomestic sellers better offDomestic buyers worse off*

The Winners and Losers From TradeThe effects of a tariffBefore the tariffConsumer surplusProducer surplusGovernment tax revenue = 0With a tariffConsumer surplus - smallerProducer surplus - biggerGovernment tax revenueTotal surplus - smaller*

Other Benefits of International Trade Arguments for Trade Restrictions Trade Agreements Philippine Trade Policies *

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