Appendix IV – International Trade – An Introduction
1. Globalisation - economic interdependence of
nations.
2. Imported products = imported employment = internal unemployment
3. Ricardo's theory of Comparative Advantage
4. Absolute advantage - fewer resources to produce the same products Comparative Advantage - it take less to produce the
same in terms of other goods
5. Two country / two goods model - mutual absolute advantages
Phase A: Mutual absolute advantage
MacedoniaUSA
Wine 6
2
Tobacco 2
6
Phase B: Land allocation for equal unit production MacedoniaUSATotals
Wine 25 x 6 = 150 75 x 2 = 150
300
Tobacco 75 x 2 = 150 25 x 6 = 150 300
Phase C: International trading MacedoniaUSATotals
Wine 100 x 6 = 600
0 600
(Mac. sells 300 to USA)
Tobacco
0 100 x 6 = 600 600
(USA sells 300 to Mac.)
6. Trade enables countries to move beyond previous resource and
productivity constraints.
7. Two country / two goods model - unilateral absolute advantages
Phase A: MacedoniaUSATotals
Wine 50 x 6 = 300 75 x 1 = 75
375
Tobacco 50 x 6 = 300 25 x 3 = 75
375
Phase B: Land allocation for equal unit production MacedoniaUSATotals
Wine 75 x 6 = 450
0
450
(Mac. sells 100 to USA)
Tobacco 25 x 6 = 150 100 x 3 = 300 450
(USA sells 200 to Mac.)
8. Explanation: The opportunity cost of 3 bales of tobacco in
Macedonia is 3 litres of wine - in USA, only 1 litre.
The opportunity cost of 1 litre of wine in Macedonia is 1 bale of tobacco
- and in the USA it is 3 bales.
9. When countries specialize in production of goods in which they have a
comparative advantage - they maximize their combined output and
allocate their resources more efficiently.
10. Terms of trade: The ratio at which a country can trade
domestic products for imported ones.
In the above example: 1 litre wine = 2 bales tobacco
Macedonia benefits because its opportunity cost is 1 = 1
(it would get 1 bale domestically by giving up 1 litre)
USA benefits because its opportunity cost is 1 = 3
(it would have to give up 3 bales domestically to get 1 litre)
11. Exchange rates determine the terms of trade.
For any pair of countries, there is a range of exchange rates which can lead to
both countries realizing gains from specialization and comparative advantage.
Within that range, the exchange rate will determine which country gains the most
from trade.
13. Comparative advantage can be expressed in terms of exchange rates:
Instead of comparing goods directly - money is used.
In Macedonia - the production of 1 bale of tobacco costs 4/3 litres of wine.
14. Exchanges rates in the right ranges drive countries to shift
resources into sectors in which they enjoy comparative advantages.
15. Factor endowments - the quantity of labour, land and natural
resources of a country
16. Heckscher - Ohlin theorem and the Learner corollary
A country has a comparative advantage in the production of a product if that
country is relatively well endowed with inputs (natural resources, knowledge
capital, physical capital, land, skilled and unskilled labour) used intensively
in the production of that product.
17. Why do countries import and export the same product?
Differentiation of products in response to diverse preferences / brand loyalty.
1. Protection - shielding a sector of the economy from
(foreign) competition
2. Tariff - tax on imports Export subsidy - payment to encourage exports Dumping - sale of products at prices below the
costs of production Quota - limit on quantity of imports
(mandatory and legislated or voluntary and negotiated)
3. GATT, the Uruguay round, the WTO, latest multilateral
WTO agreements
5. Trade barriers Prevent a country from benefiting from specialization Push it do adopt inefficient production techniques Force consumers to pay higher prices for protected products
6. Protection
Counter - Argument
(A) Saves Jobs
· Reallocation - not disappearance
· Retraining and relocation
(B) Unfair trade practices
Underinvestment in environment
(C) Cheap foreign labour
· Reflects lower productivity
(unfair competition)
· This IS comparative advantage
(D) Protect national security · Every industry
uses it
(E) Discouraging dependency
(F) Safeguarding infant industries · No infant industry asked for help (allows
them to acquire comparative advantage)
(H) Protection against
· What is proper rate?
Temporary currency overvaluation
International Trade and Exchange Rates
1. International trade is determined by exchange rates.
2. History: The gold standard, Bretton Woods (1944-1971), the snake
(EMS), the Louvre accord (1985).
3. Influences on foreign exchange: central banks interventions,
macroeconomic policy, statements by policymakers.
4. Balance of payments: the record of a country's transactions in goods,
services & assets - current account and capital account.
5. (Merchandise exports - merchandise imports) = balance of trade
(deficit or surplus) + (exports of services - imports of services) = net export
/ import of services + (income from investments) - (payments to investors) = net
investment income + net transfer and other payments = current account
6. Increase (-) or decrease (+) in private (and in Government) assets abroad
+ increase (+) or decrease (-) in foreign private (and in Government) assets in
the country = balance of capital account
7. + statistical discrepancy = balance of payments
8. Debtor and creditor nations
9. The effect of a sustained increase in Government spending (or investment) on
income (= the multiplier) - is smaller in an open economy, some of the extra
consumption goes to imports. Multiplier = 1 / 1-(MPC-MPM) (in open economy)
10. Anything that affects consumption - affect imports (income, aftertax
real wages, aftertax nonlabour income, interest rates, relative prices and the
state of the economy).
11. The trade feedback effect - export increases consumption which
increases imports. Imports in one country is exports in another which increases
consumption and so on.
An increase in one country's economic activity leads to worldwide increase in
economic activity which feeds back to that country. Its imports stimulate other
countries' exports which stimulate those countries' imports and so on.
12. Prices of exports / imports are influenced by inflation.
Export prices of other countries affect a country's import prices.
Inflation is exported through export. It affects a country's import prices.
13. An increase in the price of imports affects local prices:
(A) Through stagflation: rising prices and falling output
(B) Expensive imports lead to increased demand for domestic products
14. The price feedback effect
Inflation in one country is exported to another and then re-exported to the
first
15. The demand and supply for currencies
Firms, households and Government that import / export
Tourists in / out the country
Buyers of stocks, bonds or other financial instruments in / out the country
Investors in / out the country
Speculators who bet with / against a currency
16. What affects appreciation and depreciation of currencies?
The law of one price (for the same good everywhere)
For the same basket of goods - The exchange rate would be determined
by the relative price levels in the 2 countries
This is the purchasing power parity theory (PPP)
17. PPP does not account for transportation costs substitute products are not identical baskets of goods are different
18. Relative interest rates - higher rates lead to appreciation
19. Imports, like taxes and savings are a leakage from the income -
consumption cycle. Exports are like investments and Government
purchases (stimulate output).
20. A depreciation stimulates exports and domestic consumption = the GDP
21. The J curve: balance of trade gets worse before its gets better
following a currency depreciation.
Exports increase, imports decrease, currency price of exports doesn't change
very much (until domestic prices adjust), currency price of imports increases.
The value of imports increases, even as volume decreases, initially.
22. Expansion of money supply ® decrease in interest rates ® investment and
consumption ® lower inventories ® rising income (output).
Lower demand for debt securities ® lower demand for currency ® more foreign
securities bough ® currency sold and depreciates ® stimulates the economy.
