global econ - intro to trade - lecture

8/9/2019 Global Econ - Intro to Trade - lecture

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International Trade: Basics

Dr. Katherine Sauer

Global Economic Issues

ECON 241


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I. Why do nations trade?

Why do nations export?- individuals/firms produce more than can be consumed

at home

- sellers could receive a higher price in a foreign market

Why do nations import?- some goods cant be produced at home (or not enough)

- some goods are produced at a lower cost or more

efficiently elsewhere

- consumers like variety


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II. Absolute and Comparative Advantage

Due to differences in supply conditions, a country may be ableto produce more of a good at a lower cost.

- superior technology

- large factor (resource) endowments

Absolute advantage is the ability to produce a good at the lowestcost.

It implies a potential trade pattern.

ex: tropical countries produce and export bananas

coastal countries produce and export seafood

It gives an incentive to specialize in a good and export it.


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Suppose Japan and Vietnam both produce rice.

- The demand for rice is roughly the same in each.

- Due to low production costs (abundant land suitable forgrowing rice), supply is higher in Vietnam.

Domestic Markets for Rice

P P

Q Q

Vietnam Japan

D D

S

S

Pv

Pj


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The domestic price of rice is lower in Vietnam.

Vietnam has an incentive to specialize in the production of riceand to export it.

Japanese consumers could get rice more cheaply if they

imported it from Vietnam.

So, suppose the two countries open up to trade.

- Once a country opens to trade, its domestic price no

longer matters.

- Only the world price will matter.


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The world price is determined by world supply and world

demand.

Vietnam

D

S

Pv

Pw

P

Q Q

P

S

D

World


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Vietnam Japan

D D

S

S

Pv

Pj

Pw Pw

P P

Q QQD QS QS QD

At the world price:

In Vietnam:

QS > QD

domestic surplus

export the surplus

In Japan:

QS < QD

domestic shortage

import to satisfy shortage


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How are consumers and producers affected by the countries

trading?


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Vietnam Japan

D D

S

S

Pv

Pj

Pw Pw

P P

Q QQD QS QS QD

Consumers used to pay Pv, now

they pay the higher Pw and buyless. (worse off, CS is less)

Producers used to sell at Pv, now

they sell at the higher Pw and sell

more. (better off, PS is greater)

Consumers used to pay Pj, now

they pay the lower Pw and buymore. (better off, CS is greater)

Producers used to sell at Pj, now

they sell at the lower Pw and sell

less. (worse off, PS is less)


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Vietnam Japan

D D

S

S

Pv

Pj

Pw Pw

P P

Q QQD QS QS QD

CS =

PS =

CS transferred to PS =

PS gained from trade =

TS =

CS =

PS =

PS transferred to CS =

CS gained from trade =

TS =


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Overall with trade:

The gain to producers is larger than the loss to consumers inVietnam.

Society as a whole in Vietnam is better off. (TS is larger)

The gain to consumers is larger than the loss to producers in

Japan.

Society as a whole in Japan is better off. (TS is larger)


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Summary:

1) Differences in supply conditions across countries lead to

complementary patterns of absolute advantage.

2) Complementary patterns of absolute advantage lead to

complementary patterns of trade.

superior technology

in a sector

large factor

endowments in a

sector

and/or

absoluteadvantage in

a sector

tendency toexport from

that sector

3) Trade can make countries as a whole better off, but there are

winners and losers among producers and consumers.


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Absolute advantage alone is not sufficient to fully explain

international trade.

- The opportunity cost of producing an item may

exceed the cost of trading for it.

An opportunity cost is the value of everything that must

be sacrificed in order to get something.

International trade is based on comparative advantage.

Comparative Advantage is the ability to produce at the lowest

opportunity cost.


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Even if a nation has absolute advantage in nothing, it can have a

comparative advantage.

When countries specialize in producing goods they have

comparative advantage in, and then trade those goods, they can

consume more goods and services than they could produce on

their own.

In a nutshell, this is why international trade is good and can be

good for all countries involved.


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III. Trade in Theory and in Practice

In reality, specialization and trade dont work exactly as thetheories of absolute and comparative advantage suggest:

- no country specializes exclusively in the production

and export of a single product

- countries produce at least some goods that could be

produced elsewhere more efficiently

- a lower income country may be able to produce morecheaply than a high income country but may not be able

to identify potential customers or to transport the item

cheaply or quick enough


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However, in general

Countries with a relative abundance of low-skilled labor tend to

specialize in and export items having low-skilled labor as a

major cost component.

Countries with a relative abundance of capital tend to specialize

in and export items having capital as a major cost component.


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IV. Trade Pattern

(what a country imports and exports and who its trading partners are)

Indiaexports: engineering goods, gems/jewelry, textiles, agricultural

goods, chemicals (US, China, UAE, UK)

imports: petroleum, capital goods, gold & silver, electronics,

gems (US, Belgium, China, Singapore)

Chile

exports: copper, fruit, paper products

(US, Japan, China, South Korea, Netherlands)

imports: intermediate goods, capital goods, consumer goods

(Argentina, US, Brazil, China, Germany)


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Bangladesh

exports: clothing, fish, jute goods, leather

(US, Germany, UK, France, Italy)

imports: capital goods, textiles & yarn, fuels, cereal & dairy goods

(India, China, Singapore, Kuwait, Japan)

Germanyexports: vehicles, machinery, chemicals, telecoms technology,

electricity devices

(France, US, UK, Italy, Netherlands, Belgium)

imports: chemicals, vehicles, fuels, machinery, computer

technology (France, Netherlands, US, Italy, UK, China)


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China

exports: office equipment, telecoms equipment, clothing,

electrical machinery(US, Hong Kong, Japan, South Korea, Germany)

imports: electrical machinery, petroleum products, professional

& scientific instruments, office equipment

(Japan, Taiwan, South Korea, United States, Germany)

Kenya

exports: horticultural products, tea, coffee, fish products

(Uganda, UK, US, Netherlands)

imports: industrial supplies, machinery & transport equipment,

consumer goods, food and drink

(UAE, Saudi Arabia, South Africa, US)


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V. The Relative Importance of Trade

Over time, trade has accounted for a larger and larger proportion

of world GDP.

year world exports world GDP exports as % GDP

1970 $317b $3,378b

1980 $2,408b $11,742b

1990 $4,256b $22,721b

2000 $7,819b $31,649b

2006 $14,464b $47,766b

9.4%20.5%18.7%

24.7%

30.3%

For an individual country, the total trade value as a share of GDP

is an indication of how important trade is in the countrys

economy.


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total trade value = exports value + imports value

trade value as a share of GDP = total trade value x 100GDP

Country GDP EX IM .

China $2,229b $762b $660b

Djibouti $0.702b $0.40b $0.32b

Thailand $178b $110b $118b

TTV IM

Trade value %GDP %GDP

$1,422b$0.72b

$228b

63.8%103%

128%

30%47%

66%

Another useful measure is the ratio of imports to GDP.


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VI. The Trade Balance

The trade balance is the difference between the value of acountrys exports and the value of its imports. It is also called net

exports.

TB = EX IM

If exports > imports, then there is a trade surplus.

If exports < imports, then there is a trade deficit.

When you hear that a countrys trade balance has worsened, it

means that there is less of a surplus or more of a deficit.

- imports are increasing

or

- exports are decreasing


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Factors that influence a countrys trade balance:

1) prices of goods manufactured at home

- if home goods are relatively expensive, then a country

will import cheaper goods

2) exchange rates

- if a countrys currency is strong against other currencies,then it is cheap to import while its exports are

expensive to other countries

3) trade agreements

- when a country signs a Free Trade Agreement, bothits exports and imports will likely increase


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4) trade barriers

- if a country imposes tariffs on imports, then imports

are reduced

- if a country subsidizes exports, then exports will rise

5) the business cycle at home or abroad

- in an expansion at home, consumer incomes are

increasing, in general this will increase imports

- in an expansion abroad, consumer incomes elsewhere

are increasing so the home country exports more

Most economists dont believe that trade deficits/surpluses are

inherently good or bad. The economic impact of a surplus or

deficit depends on the specific circumstances surrounding it.


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Arguments:

A Trade Deficit is Bad (a Trade Surplus is Good)

A trade deficit

- signifies economic weakness because it reflects anexcessive reliance on foreign products

- represents an expenditure of future growth because

whenever a nation purchases more than it produces,

funds that could have been used for investment (future

growth) are being used for consumption in the present

- large trade deficits create conditions favorable for a

financial crisis

Ex: In 8/06, New Zealand announced a wider than expected

trade deficit. The NZdollar lost value.


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A Trade Deficit may be Good

A trade deficit means

- consumers can enjoy a higher standard of living than if

they were limited to domestically produced goods

- could be a sign of economic strength because imports

are known to increase during times of economic growth

In industrial countries, trade deficits have not sparked economic

crisis.

Ex: In Mexico, the July 2006 trade deficit was $319m and in

August it was $783m. The increase in imports was due to an

increase in consumer wages. This import increase suggests that

domestic demand is strengthening.


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A Trade Surplus may not be Good

A trade surplus could mean a country is too reliant on foreigndemand for its goods.

The surplus could be the result of an undervalued currency.

Ex: In August 2006, China announced a trade surplus of$18.8billion. It has been accused of keeping its currency

undervalued in order to make its exports cheaper.

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