by mr. lau san-fatch7-international trade-sv1 hkcee macroeconomics w chapter 7:international trade

By Mr. LAU san-fat CH7-International Trade-SV 1

HKCEE Macroeconomics

Chapter 7:International Trade


Why do Countries Trade?

self-sufficiency cannot be achieved

cheaper products could be enjoyed

raising standard of living by enjoying a larger variety of products


The Model of Absolute Advantage Absolute Advantage (AA)

allows a country to produce more of a good with the same amount of resources

allows a country to produce the same amount of a good with less resource


The Model of Absolute Advantage An Illustration

Unit(s) of product being produced with 1 unit of resource

Good A Good B

Country X 3 or 1

Country Y 1 or 9

AA in producing good A: AA in producing good B:

Country X

Country Y


The Model of Absolute Advantage Task 1 ： Study the table below and

find out which country has the AA in producing goods A and B.


Good A Good B

Country X 6 or 1

Country Y 4 or 2


The Model of Absolute Advantage Task 2 ： Study the table below and

find out which country has the AA in producing goods A and B.

Unit(s) of resources required for producing 1 unit of…

Good A Good B

Country X 2 10

Country Y 3 1


The Model of Absolute Advantage The Principle of Absolute Advantage

Limitation: Trade would not occur if countries enjoy NO absolute advantage in production.

It states that countries should specialize in producing goods with absolute advantage.

They would then gain if they follow the principle to trade with other countries


The Model of Comparative Advantage Comparative Advantage (CA)

A country is said to have a comparative advantage in producing a good over others if it can produce the good at a lower opportunity cost than other countries.


The Model of Comparative Advantage An Illustration


Good A Good B

Country X 6 or 12

Country Y 5 or 3



Opportunity cost of producing

1 unit of …

Good A Good B

Country X 12B/6 = 2B or 6A/12 = 0.5A

Country Y 3B/5 = 0.6B or 5A/3 = 1.67A


The Model of Comparative Advantage Task 3 ： Study the table below and

find out which country has the CA in producing goods A and B.


Good A Good B

Country X 6 or 1

Country Y 4 or 2





Good A Good B

Country X 6 or 1

Country Y 4 or 21B/6 = 0.17B2B/4 = 0.5B

Opportunity cost of producing 1 unit of …

6A/1 = 6A4A/2 = 2A





Good A Good B

Country X 2 10

Country Y 3 9





Good A Good B

Country X 2 10

Country Y 3 9

Opportunity cost of producing 1 unit of …

2/10B = 0.2B3/9B = 0.3B

10/2A = 5A9/3A = 3A


The Model of Comparative Advantage The Law/Principle of Comparative Ad

vantage It states that countries should specialize

in producing goods with comparative advantage.

They then would gain if they follow the principle to trade with other countries

Total output will be increased by engaging specialization in production.



There are two countries only Each country has 2 man-hours Each country produces 2 goods only No country could live on one good only Without international trade, each country

is under self-sufficient


The Model of Comparative Advantage Given:


Good A Good B

Country X 6 or 12

Country Y 5 or 3


The Model of Comparative Advantage Under Self-sufficient

Assume each country devotes equal amount of resources (i.e. 1 man-hour) to produce both goods.

Units of product produced

Good A Good B

Country X 6 AND 12

Country Y 5 AND 3

Total Output 11 AND 15


The Model of Comparative Advantage After Specialization

Country X spends 0.5 man-hour in producing good A and 1.5 man-hours on good B.

Country Y spends all 2 man-hours in producing good A.


The Model of Comparative Advantage After Specialization

Units of product produced

Good A Good B

Country X 6(0.5) = 3 AND 12(1.5)=18

Country Y 5(2)=10 AND 3(0)=0

Total Output AND

Total Output under Self-sufficient AND

Net Increase AND

13 18

11 15

+2 +3


Terms of Trade and Gains from Trade Terms of Trade (TOT)

• TOT = ?X:1M

• TOT should be mutually beneficial to trading partners.

• TOT should be set in-between the opportunity costs of trading partners.

• TOT refers to the amount of goods that a nation must export for one unit of a good that she imports.


Find both countries’ O.C. in their productions from the table below.


Good A Good B

Country X 6 or 12

Country Y 5 or 3

Terms of Trade and Gains from Trade


Terms of Trade and Gains from Trade Finding the beneficial TOT:

Good A: 0.6B-2B• Mutually beneficial TOT:

or

or

Good BGood A

(5A/3=)1.67A(3B/5=)0.6BCountry Y

(6A/12=)0.5A(12B/6=)2BCountry X

Opportunity Cost of producing

1 unit of …

Good B: 0.5A-1.7A


Terms of Trade and Gains from Trade Gains from Trade to Importing Country

• Unit Gains from Trade = Domestic O. C. (saved) - TOT

• Total Gains from Trade = Unit Gains x Amount Imported


Terms of Trade and Gains from Trade Gains from Trade to Exporting Country

• Units Gains from Trade = TOT - Domestic O. C.

• Total Gains from Trade = Unit Gains x Amount Exported


Terms of Trade and Gains from Trade Task 5a: Find the opportunity cost of

both countries in producing goods A and B.

Given:• Output/1 man-hour: Country X: 6A or 12B• Output/1 man-hour: Country Y: 5A or 3B• Each country has 2 man-hours only• Complete specialization• Country X exports 5B


Terms of Trade and Gains from Trade The opportunity cost of both countries in p

roducing goods A & B are below:

or

or

Good BGood A

(5A/3=)1.67A(3B/5=)0.6BCountry Y

(6A/12=)0.5A(12B/6=)2BCountry X

Opportunity Cost of producing

1 unit of …


Terms of Trade and Gains from Trade Task 5b: Find the gains from trade for

both countries if the TOT is (a) 1A:1B (b) 1A:2B (c) 2A:1.2B


Terms of Trade and Gains from Trade (a) When TOT = 1A:1B

• Unit Gains from Trade to Importing country, Y

= Domestic O. C. (saved) - TOT = 1.67A - 1A = 0.67A (saved)

• Unit Gains from Trade to Exporting country, X

= TOT - Domestic O. C. = 1A - 0.5A = 0.5A


Terms of Trade and Gains from Trade (a) When TOT = 1A:1B

• Total Gains from Trade to Importing country, Y

= Unit Gains x Amount Imported = 0.67A(5) = 3.35A (saved)

• Total Gains from Trade to Exporting country, X

= Unit Gain x Amount Exported = 0.5A(5) = 2.5A


Terms of Trade and Gains from Trade (b) When TOT = 1A:2B ( 1B = 0.5A)


= Domestic O. C. (saved) - TOT = 1.67A - 0.5A = 1.17A (saved)


= TOT - Domestic O. C. = 0.5A - 0.5A = 0A


Terms of Trade and Gains from Trade (b) When TOT = 1A:2B( 1B = 0.5A)


= Unit Gains x Amount Imported = 1.17A(5) = 5.85A (saved)


= Unit Gain x Amount Exported = 0A(5) = 0A


Terms of Trade and Gains from Trade (c) When TOT = 2A:1.2B( 1B =1.67A)


= Domestic O. C. (saved) - TOT = 1.67A - 1.67A = 0A (saved)


= TOT - Domestic O. C. = 1.67A - 0.5A = 1.17A


Terms of Trade and Gains from Trade (c) When TOT = 2A:1.2B( 1B =1.67A)


= Unit Gains x Amount Imported = 0A(5) = 0A (saved)


= Unit Gain x Amount Exported = 1.17A(5) = 5.85A


Terms of Trade and Gains from Trade Task 6

Referring to your findings in Task 5:• How is the TOT set to allow the importing

country capture ALL the gains from trade?

• How is the TOT set to allow the exporting country capture ALL the gains from

trade?• Is it still beneficial for a country to trade if

its gains from trade is zero?


Terms of Trade and Gains from Trade The importing country will capture

ALL the gains from trade if the TOT is set equal to the exporting country’s domestic opportunity cost.

The exporting country will capture ALL the gains from trade if the TOT is set equal to the importing country’s domestic opportunity cost.


Terms of Trade and Gains from Trade Country with zero gains from trade

will still trade for other benefits:• To enjoy goods that it cannot produce.

• To enjoy higher standard of living.

• To maintain better international relationship.

• To improve skills and techniques of production by examining imports


Terms of Trade and Gains from Trade Task 7

Given:• each country has its own comparative

advantage in production• trading parties reach a mutually beneficial

terms of trade

Question: Must trade take place?

Answer: NO


Factors Affecting Trade Potential trade might be halted if:

• the transportation cost outweighs the potential gains from trade.

• the other costs of conducting trade (e.g. insurance cost) becomes prohibitively high when serious political problems occur, e.g. wars.


Free Trade Benefits of Free Trade:

• More output could be produced.

• Mass production allows firms to enjoy economies of scale.

• Exchange of technology is allowed.

• Standard of living is higher with a larger variety of cheaper imports.

• More employment opportunities

• Better international relationship


Promotion of Free Trade:• World Trade Organization, WTO: reducing

trade barriers• Generalized Schemes of Preference, GSP:

low/no tariffs to developing countries• Asia-Pacific Economic Cooperation,

APEC: promoting free trade & economic cooperation

• North America Free Trade Agreement, NAFTA: promoting tariff-free trade

Free Trade


Tariffs• Tariffs are taxes on imports.

Trade Restrictions(1)

• Tariffs can be per-unit tax or ad valorem tax (i.e. percentage tax).

Effects of Tariffs on Imports• Cost of production increases

• Supply of imports decreases

• Import price increases

• Quantity imported/transacted falls


Effects of Tariffs on Imports


P

D S1

0

P1

Q1Q

S2

tax

P2

Q2


Import Quota• Import quota fixes the maximum amount or value of imports during a given period.


Effects of Import Quotas on Imports• Supply of imports decreases

• Import price increases

• Quantity imported/transacted falls

• Kinked Supply curve resulted


Effects of Quota on Imports


P

D S1

0

P1

Q1Q

P2

Q2

S2Quota


Comparison Between Tariffs & Quota

Trade Restrictions

Tariffs Quota

Nature Import tax Output limit

↑P→ Q↓ ↓Q→ ↑ P

△ Q depending onEd of M

△ Q is certain

Effects

Tariffs revenue Quota revenueonly if byauction


Subsidies to Local Goods

Trade Restrictions (3)

• A sum of money provided by the government for local production

• Lower cost allows larger local supply

• Effects:

• Local product prices fall leading to more local products demanded

• Demand for imports falls and thus fewer products being imported


Embargo


• A ban on imports

• Total embargo versus partial embargo

• It is imposed for political reasons


Exchange Control


• A government control on the buying and selling of foreign currencies

• Imports will be reduced by limiting the amount of foreign currencies available


Voluntary Export Restriction


• The exporting countries themselves restrict their exports to some other countries

• Imports to Country A will then be reduced if Country B restricts her exports voluntarily.


To protect local industries

Reasons for Trade Restrictions

To enhance employment opportunity

To raise tariff revenue

To reduce balance of payments deficit

To undergo industrial diversification

For political reasons

by mr. lau san-fatch7-international trade-sv1 hkcee macroeconomics w chapter 7:international trade

Documents

countries trade

unit of 6a1

aunits of product

bopportunity cost

aunits of resources

lower opportunity cost

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larger variety of productsch7