<INTERNATIONAL TRADE>

-BENEFITS OF INTERNATIONAL TRADE--

--INCREASED COMPETITION--

When countries trade with each other, they import products from the other countries so that domestic firms become exposed to MORE COMPETITON IN THEIR DOMESTIC MARKETS. At the same time, they export products to other countries so their own products also face MORE COMPETITON IN THE OVERSEAS MARKET. This can be beneficial as it will FORCE INEFFICIENT FIRMS TO EXIT THE MARKET and should result in a BETTER ALLOCATION OF BOTH DOMESTIC AND GLOBAL RESOURCES.

--LOWER PRICES--

INCREASED COMPETITON from FOREIGN IMPORTED GOODS lead to GREATER PRICE COMPETITON and PRICE WARS, resulting in LOWER PRICES FOR CONSUMERS.
IMPORTED INTERMEDIATE GOODS that are produced more efficiently ain other countries, lead to LOWER COSTS OF PRODUCTION for domestic producers which they pass on to the consumer in the form of LOWER PRICES.

--GREATER CHOICE FOR CONSUMERS--

Through trade, countries can IMPORT A LARGER VARIETY of goods and services, possibly of HGHER QUALITY, INCREASING CHOICES FOR CONSUMERS.

--ACQUISITION OF RESOURCES--

Countries may NEED A NUMBER OF NATURAL RESOURCES OR CAPITAL GOODS that are NOT AVAILABLE DOMESTICALLY. Trade allows countries to import inputs they need for domestic production.

--MORE FOREX EARNINGS--

Whenever countries sell goods and services to other countries, they ACQUIRE FOREIGN EXCHANGE (FOREX), which allows them to make payments to other countries for the goods and services they import, or make other payments abroad.

--ACCESS TO LARGER MARKETS--

With trade, firms now have ACCESS TO A MUCH LARGER CUSTOMER BASE, which means they can POTENTIALLY MAE MUCH LARGER SALES AND PROFITS, especially if their domestic market is small or already saturated.

--ECONOMIES OF SCALE--

The possibility of trade and exports to other countries involves an EXPANSION N THE SIZE OF THE MARKET, allowing firms to produce more output, ACHIEVE ECONOMIES OF SCALE and enjoy the benefits of LOWER AVERAGE COSTS, which include LOWER PRICES and therefore GREATER EXPORT COMPETITIVENESS, or the ability to compete better in foreign markets.

--EFFICIENT RESOURCE ALLOCATION--

With the opportunity to trade, countries can now SPECIALSE in the production of the goods or services that it can produce relatively more efficiently than its trading partners. Without the need to devote resources to the goods it can now import, it can produce more of its specialised goods and EXPORT THEIR SURPLUS and IMPORT THE SURPLUSES of its other specialised trading partners. This should lead to BETTER RESOURCE ALLOCATION and MORE EFFICiENCY.

--MORE EFFICIENT DOM. PRODUCERS--

When countries trade with each other, DOMESTIC FIRMS BECOME EXPOSED TO COMPETITON from products produced by firms in other countries. They are therefore FORCED TO BECOME MORE EFFICIENT; in other words, they must try to PRODUCE AT THE LOWEST POSSIBLE COST.
If they do not become more efficient, they will have to sell their output at higher prices to cover their higher costs; consumers will prefer the lower-priced imported products, and HIGHER-COST FIRMS MAY GO OUT OF BUSINESS. Therefore, increased competition leads to greater efficiency.

--TASK--

Imagine you are the Foreign Minister of a country wishing to join the WTO (Goto: A list can be found HERE and pick one).
WRITE A LETTER explaining WHY INT'L TRADE IS SO BENEFICIAL to your country as well as the global community. In your letter include:
At least FOUR of the BENEFITS listed above.
Reference to your country's MAIN EXPORT(S).

--FREE-TRADE DIAGRAMS--

--BIG ASSUMPTION--

For the following trade models to make sense, we are assuming that all countries are 'PRICE TAKERS', (much like the assumption introduced in the perfect competition unit) and that the products are VERY CLOSE SUBSTITUTES, eg, wheat, oil, etc...
In other words, we are assuming that these countries are VERY SMALL IMPORTERS/EXPORTERS, and as such, any changes in the amount of exports they supply or imports they demand will have an INSIGNIFICANT IMPACT on GLOBAL SUPPLY or DEMAND and subsequently the WORLD PRICE.
Thus, when we are drawing the model for a 'SMALL OPEN ECONOMY' we include a PERFECTLY ELASTIC SUPPLY CURVE representing the world supply at world price (Wp) at which sufficient imports can be bought to satisfy any shortages, and exports can be sold at in order to clear any surplus.

--EXPORTER--

If the world price Pw is MORE THAN the domestic price Pd, then the domestic firms will base their output on the world price and produce a quantity of Qs,
At this price only Qd is demanded domestically, thus they will SATISFY DOMESTIC DEMAND and EXPORT THE SURPLUS.

--IMPORTER--

If the world price Pw is LESS THAN the domestic price Pd, then the domestic firms will base their output on the world price and produce a quantity of Qs.
At Pw, Qd is demanded, yet only Qs is produced thus they will SATISFY THS EXCESS DEMAND and IMPORT THE SHORTAGE.

--HL P3 TASK--

DOWNLOAD: QP MS

--ABSOLUTE & COMPARATIVE ADVANTAGE (HL)--

--THE THEORY OF 'ABSOLUTE ADVANTAGE'--

THE THEORY OF ABSOLUTE ADVANTAGE can be expressed in terms of...
- - - 1) UNITS OF RESOURCE PER UNIT OF OUTPUT: THE ABILITY OF ONE COUNTRY TO PRODUCE A UNIT OF A GOOD OR SERVICE USING FEWER AMOUNTS OF RESOURCES THAN ANOTHER COUNTRY. E.G, It takes 2 man-hours to make one Pizza in country X, but only 1 man-hour to make one Pizza in country Y.

- - - 2) OUTPUT PER UNIT OF RESOURCE: THE ABILITY OF ONE COUNTRY TO PRODUCE A GREATER AMOUNT OF A GOOD OR SERVICE USING THE SAME AMOUNT OF RESOURCES THAN ANOTHER COUNTRY. E.G, per man-hour country X, can make half a pizza, whereas per-man hour in country Y, they can make one pizza.
According to the theory of absolute advantage, IF COUNTRIES SPECIALISE IN AND EXPORT THE GOOD IN WHICH THEY HAVE AN ABSOLUTE ADVANTAGE (can produce with fewer resources), THE RESULT IS INCREASED PRODUCTION AND CONSUMPTION IN EACH COUNTRY.

--'ABSOLUTE ADVANTAGE' & THE PPC--

Let's look at an example, of 2 COUNTRIES and 2 PRODUCTS. The numbers given are in 1) UNITS OF OUTPUT PER UNIT OF RESOURCE, and for simplicity sake assume the resource is a unit of labour.

--THE THEORY OF 'COMPARATIVE ADVANTAGE'--

--DEFINITION--

Q. IF A COUNTRY HAS AN ABSOLUTE ADVANTAGE IN BOTH GOODS OVER ANOTHER COUNTRY, CAN IT STILL GAIN FROM TRADE?
The answer is 'YES', in accordance with the THEORY OF COMPARATVE ADVANTAGE which states that gains can still be made as long as both countries have DIFFERENT OPPORTUNITY COSTS for their goods, so that the production of one good is relatively cheaper in one country than in another, even if it is not absolutely cheaper.
Comparative advantage refers to the situation where one country has a lower opportunity cost (relative cost) in the production of a good than another country.

--'COMPARATIVE ADVANTAGE' & 'OPPORTUNITY COST'--

Referring to the table above we can see that 'COUNTRY X' HAS AN ABSOLUTE ADVANTAGE IN THE PRODUCTION OF BOTH GOODS and this implies 'COUNTRY Y' HAS AN ABSOLUTE ADVANTAGE IN THE PRODUCTION OF BOTH GOODS.
However when we look at THE RELATIVE COSTS PER UNIT, we can see that COUNTRY X ONLY HAS A COMPARATIVE ADVANTAGE IN COFFEE, with a cost of only 0.75 units of robots forgone, compared to Country Y's 1.33 units of robots (Column 'A'),
Whilst COUNTRY Y HAS A COMPARATIVE ADVANTAGE IN ROBOTS with a cost of only 0.75 units of Coffee, compared to Country X's 1.33 units of coffee (Column 'B'),

--PRACTICE TASKS--

--'COMPARATIVE ADVANTAGE' & 'GAINS FROM TRADE'--

To illustrate gains from trade in this situation, we again assume that under autarky, the countries will devote half of their resources to the production of both goods.

Now we use the COMPARATIVE ADVANTAGES previously established, SPECIALISATION OCCURS and in most cases THE COUNTRY WITH THE ABSOLUTE DISADVANTAGE IN BOTH GOODS, in this case 'COUNTRY Y', SPECIALISES ENTIRELY in the good it has a COMPARATIVE ADVANTAGE in, which is ROBOTS, producing 4R and no coffee.
Whilst 'COUNTRY X', SPECIALISES MAINLY in the good it has a comparative advantage in, namely COFFEE, but NOT ENTIRELY, producing 6C and 1.5R

Finally, they TRADE, using a 'TERMS OF TRADE (TOT)', which lies between the two opportunity costs. If we look at the table below we can choose a TOT of 1 COFFEE for 1 ROBOT. as this lies between 1C : 0.75R & IC : 1.33R

Now we decide HOW MANY UNITS TO TRADE AT THIS EXCHANGE RATE? and if we decide to trade 2C for 2R we can see that both sides GAIN FROM TRADE.

Finally, they TRADE, using a 'TERMS OF TRADE (TOT)', which lies between the two opportunity costs. If we look at the table below we can choose a TOT of 1 COFFEE for 1 ROBOT. as this lies between 1C : 0.75R & IC : 1.33R

Finally, they TRADE, using a 'TERMS OF TRADE (TOT)', which lies between the two opportunity costs. If we look at the table below we can choose a TOT of 1 COFFEE for 1 ROBOT. as this lies between 1C : 0.75R & IC : 1.33R

Now we decide HOW MANY UNITS TO TRADE AT THIS EXCHANGE RATE? and if we decide to trade 2C for 2R we can see that both sides GAIN FROM TRADE.

--PAST PAPER 3 PRACTICE--

--LIMITATIONS OF THE MODEL--

--UNREALISTIC ASSUMPTIONS--

FACTORS OF PRODUCTION ARE FIXED AND IMMOBILE: We assume that each country's FACTOR ENDOWMENTs (The quantity & quality of its FOPs) STAY FIXED and DO NOT INCREASE or DECREASE, whereas in the real world for example the supply of labour changes with NET MIGRATION.
TECHNOLOGY IS FIXED: The productivity levels of each unit of resources are assumed fixed, yet over time new tech inevitably changes these levels.
FULL EMPLOYMENT OF RESOURCES: As we can see on the models, full employment is assumed which as we know is never really the case.
FREE TRADE: In the real world supply and demand alone do not determine the prices of imports and exports, they are in fact heavily impacted by government PROTECTIONIST POLICES, such as IMPORT TAXES ('TARIFFS') and QUOTAS, etc...
NO TRANSPORTATION COSTS: In reality, a country may well have an absolute and/or comparative advantage in a good, but if its location means expensive transportation costs then this advantage will be eroded.

--LIMITS STRUCTURAL CHANGE--

As an economy develops, THE PRIMARY SECTOR usually SHRINKS, while the MANUFACTURING SECTOR GROWS.
As a result, its COMPARATIVE ADVANTAGE WILL CHANGE. For example, China has seen its CA change drastically from agriculture to textiles to high-tech products.
This has all been made possible due to specific INTERVENTIONS BY THE GOVERNMENT, such as a STRONG FOCUS ON EDUCATION and the improvement in human capital.
As such, if a developing country CONTINUES TO SPECIALISE IN ITS COMPARATIVE ADVANTAGE in PRIMARY OUTPUT, then it will BE UNABLE TO CHANGE STRUCTURALLY.

--OVER-SPECIALISATION--

OVER-SPECIALISATION in only a few products leaves the economy VULNERABLE TO ECONOMIC DOWNTURNS, in addition, if the products are AGRICULTURAL then they are also PRONE TO UNPREDICTABLE WEATHER & CLIMATE DISASTERS.

--WWW.EDULASTIC.COM--

--VIDEO RESOURCES--

--PAST PAPERS--

Q) The following diagram illustrates the production possibilities of two countries, Country A and Country B, in the production of cotton and bananas.

a) Using the diagram, calculate the opportunity cost of producing one tonne of bananas in Country A [1]

b) Using information provided in the diagram to support your answer, determine which country should specialise in the production of cotton. [2]

c) Distinguish between the terms absolute advantage and comparative advantage. [2]

d) Explain two reasons why specialisation in a narrow range of primary products according to the theory of comparative advantage might not benefit an economically less developed country. [4]

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