International Trade

Introduction

Each country are different in the following ways: Location on the globe – four seasons, different

temperature etc Land size – is it big like US, China or Singapore Geographical landscape- land covered by tropical

rainforest/ mountains Coastline – beautiful beaches or Natural resources Human resources Because of such difference, each country would

tend to specialize in producing certain goods or services

Absolute Advantage

Occurs when one country can produce more of one product compare than another country when both are using the same quantity and combination of resources

Law of Comparative Advantage

States that two countries can benefit from specialization and trade if each country specializes in the production of the good in which it has lower opportunity costs compared to the other country.

Example 1 (Absolute Advantage)

The production of Carland and Tableland1. Carland can produce 10 million cars and 5 million

wooden table if it were to utilize half its resources to produce each of the output

2. Tableland can produce 8 million cars and 12 million wooden tables when it utilize the same resources as Carland

3. Summary:  

** Total production before specialization & before trade

  Car (mil) Tables (mil)

Carland 10 5

Tableland 8 12

  18 17

Discussion Example 1

Carland has absolute advantage over Tableland in the production of cars (10>8), while Tableland has absolute advantage in production of wooden tables (12>5).

Total production: 18 mil of car & 17 mil of wooden tables

No specialization and no international trade between Carland and Tableland, even though each country have absolute advantage over the other in the production of one product (cars/ wooden tables)

Example 2: Law of Comparative Advantage (LCA)

Assume both countries have decided to specialize and exchange for their benefits.

Based on LCA, Carland would specialize in cars production & Tableland would specialize in wooden tables production.

Assumption:

** total production after specialization but before trade If both countries decided not to exchange and trade,

the situation would worse than before specialization. Conclusion: specialization without international trade

will therefore not benefit the countries involved.

  Car (mil) Tables (mil)

Carland 20 0

Tableland 0 24

  20 24

Example 2 (Continue)

Assume both countries decided to exchange by trading with each other.

Carland & Tableland must decide the Term of Trade. E.g. 1 car to exchange for 2 tables (fair?).

** question of fairness by both countries

Example 2 (continue)

Assume: Carland is willing to trade the extra cars that it can produce and Tableland is willing to exchange the extra wooden table that it can produce.

This mean 10 mil car will be exchange for 12 mil wooden tables.

thus, agreed term would 5 cars for 6 wooden tables (ratio 1: 1.2).

Summary:

** total production after specialization and after trade

  Car (mil) Tables (mil)Carland 10 12Tableland 10 12  20 24

Total production after specialization and after trade

Carland can consume the same quantity of cars (10 mil) plus more wooden tables (12 mil instead 5 mil) before trading.

Tableland can consume the same quantity of wooden table (12 mil) and more cars (10 mil instead of 8 mil) before trading.

What is the term of trade is different? ** Initially, we assume both countries decided to exchange

their extra unit.

Car (mil) Tables (mil)

  Before After Before After

Carland 10 10 5 12

Tableland 8 10 12 12

Total 18 20 17 24

Importance and benefits of International Trade

Total world production will increase Change in consumption patterns Improved product quality and production efficiency Producer’s market size will increase Producer’s will enjoy increased economies of scale Reduction in unemployed resources Increased variety of goods and services Greater mobility of resources Political alliances and allegiance

Disadvantage of International Trade

Undesirable goods and services Production for local or export

markets Mergers and acquisitions

Balance of Trade

Export refer to out-flow of goods and services from one country to the rest of the world

Imports refer to the in-flow of goods and services from the rest of world into one country

Surplus Balance of Trade : net-in-flow of money into country

Deficits Balance of Trade : net-out-flow of money from the country to all other foreign country

Balance of Payment (BOP)

Is a statistical accounting record of a country’s international trade and capital transactions measured during a certain period of time (usually one year).

Typically, three types of BOP Current account Capital account Financial account

Current Account

Trade transaction: Trade in goods Trade in services Income flows Transfers

Capital Account

This account in the BOP measures the flow of funds into (credit) and out (debits) of the country.

It only record new capital transactions for the intended period and not a record of external assets and liabilities accumulated over time.

Capital account records: acquisition and disposal of fixed assets (e.g. land) in the country, transfer of funds by migrant & payment of grants by a government for capital projects abroad.

Financial Account

Changes in the external assets and liabilities are recorded in the Financial Account

Changes country’s external assets: Foreign currency Shares & investment Loans to anyone overseas

Country’s external liabilities Investment into country Borrowing from abroad

Sections such as: Long-term capital account Short-term capital account Reserves in-flow & out-flow

Importance of Exports

Exports are important due to: Controlling balance of payment

Trading of goods & services are more easier to control compare to capital flows

Adjusting it help manage its Balance of Payment which will influence its Exchange Rates

Economic growth Higher export to more countries will allow

countries to experience faster economic growth.