university of maiduguri centre for distance learning 1-5/eco 313.pdf · university of maiduguri...

UNIVERSITY OF MAIDUGURICENTRE FOR DISTANCE LEARNING

ECO 313: International Trade (2 Units)

Course Facilitator: Dr. Jibrin M. Talba

Econ 313 : International Trade

CDL, University of Maiduguri, Maiduguri-Nigeria of 27 Page 2

STUDY GUIDE

Course Code/ Title: ECO 313: International Trade

Credit Units: 2

Timing: 26hrsTotal hours of Study per each course material should be twenty Six

hours (26hrs) at two hours per week within a given semester.

You should plan your time table for study on the basis of two hours per

course throughout the week. This will apply to all course materials you

have. This implies that each course material will be studied for two

hours in a week.

Similarly, each study session should be timed at one hour including all

the activities under it. Do not rush on your time, utilize them adequately.

All activities should be timed from five minutes (5minutes) to ten

minutes (10minutes). Observe the time you spent for each activity,

whether you may need to add or subtract more minutes for the activity.

You should also take note of your speed of completing an activity for the

purpose of adjustment.

Meanwhile, you should observe the one hour allocated to a study

session. Find out whether this time is adequate or not. You may need to

add or subtract some minutes depending on your speed.

You may also need to allocate separate time for your self-assessment

questions out of the remaining minutes from the one hour or the one

hour which was not used out of the two hours that can be utilized for



your SAQ. You must be careful in utilizing your time. Your success

depends on good utilization of the time given; because time is money, do

not waste it.

Reading:

When you start reading the study session, you must not read it like a

novel. You should start by having a pen and paper for writing the main

points in the study session. You must also have dictionary for checking

terms and concepts that are not properly explained in the glossary.

Before writing the main points you must use pencil to underline those

main points in the text. Make the underlining neat and clear so that the

book is not spoiled for further usage.

Similarly, you should underline any term that you do not understand its

meaning and check for their meaning in the glossary. If those meanings

in the glossary are not enough for you, you can use your dictionary for

further explanations.

When you reach the box for activity, read the question(s) twice so that

you are sure of what the question ask you to do then you go back to the

in-text to locate the answers to the question. You must be brief in

answering those activities except when the question requires you to be

detailed.

In the same way you read the in-text question and in-text answer

carefully, making sure you understand them and locate them in the main

text. Furthermore before you attempt answering the (SAQ) be sure of



what the question wants you to do, then locate the answers in your in-

text carefully before you provide the answer.

Generally, the reading required you to be very careful, paying attention

to what you are reading, noting the major points and terms and concepts.

But when you are tired, worried and weak do not go into reading, wait

until you are relaxed and strong enough before you engage in reading

activities.

Bold Terms:

These are terms that are very important towards

comprehending/understanding the in-text read by you. The terms are

bolded or made darker in the sentence for you to identify them. When

you come across such terms check for the meaning at the back of your

book; under the heading glossary. If the meaning is not clear to you, you

can use your dictionary to get more clarifications about the

term/concept. Do not neglect any of the bold term in your reading

because they are essential tools for your understanding of the in-text.

Practice Exercises

a. Activity: Activity is provided in all the study sessions. Each

activity is to remind you of the immediate facts, points and major

informations you read in the in-text. In every study session there is

one or more activities provided for you to answer them. You must

be very careful in answering these activities because they provide

you with major facts of the text. You can have a separate note book



for the activities which can serve as summary of the texts. Do not

forget to timed yourself for each activity you answered.

b. In-text Questions and Answers: In-text questions and answers

are provided for you to remind you of major points or facts. To

every question, there is answer. So please note all the questions

and their answers, they will help you towards remembering the

major points in your reading.

c. Self Assessment Question: This part is one of the most essential

components of your study. It is meant to test your understanding of

what you studied so you must give adequate attention in answering

them. The remaining time from the two hours allocated for this

study session can be used in answering the self- assessment

question.

Before you start writing answers to any questions under SAQ, you

are expected to write down the major points related to the

particular question to be answered. Check those points you have

written in the in-text to ascertain that they are correct, after that

you can start explaining each point as your answer to the question.

When you have completed the explanation of each question, you

can now check at the back of your book, compare your answer to

the solutions provided by your course writer. Then try to grade

your effort sincerely and honestly to see your level of performance.



This procedure should be applied to all SAQ activities. Make sure

you are not in a hurry to finish but careful to do the right thing.

e-Tutors: The eTutors are dedicated online teachers that provide

services to students in all their programme of studies. They are expected

to be twenty- four hours online to receive and attend to students

Academic and Administrative questions which are vital to student’s

processes of their studies. For each programme, there will be two or

more e-tutors for effective attention to student’s enquiries.

Therefore, you are expected as a student to always contact your e-tutors

through their email addresses or phone numbers which are there in your

student hand book. Do not hesitate or waste time in contacting your e-

tutors when in doubt about your learning.

You must learn how to operate email, because e-mailing will give you

opportunity for getting better explanation at no cost.

In addition to your e-tutors, you can also contact your course facilitators

through their phone numbers and e-mails which are also in your

handbook for use. Your course facilitators can also resolve your

academic problems. Please utilize them effectively for your studies.

Continuous assessment

The continuous assessment exercise is limited to 30% of the total marks.

The medium of conducting continuous assessment may be through

online testing, Tutor Marked test or assignment. You may be required to

submit your test or assignment through your email. The continuous



assessment may be conducted more than once. You must make sure you

participate in all C.A processes for without doing your C.A you may not

pass your examination, so take note and be up to date.

Examination

All examinations shall be conducted at the University of Maiduguri

Centre for Distance Learning. Therefore all students must come to the

Centre for a period of one week for their examinations. Your preparation

for examination may require you to look for course mates so that you

form a group studies. The grouping or Networking studies will facilitate

your better understanding of what you studied.

Group studies can be formed in villages and township as long as you

have partners offering the same programme. Grouping and Social

Networking are better approaches to effective studies. Please find your

group.

You must prepare very well before the examination week. You must

engage in comprehensive studies. Revising your previous studies,

making brief summaries of all materials you read or from your first

summary on activities, in-text questions and answers, as well as on self

assessment questions that you provided solutions at first stage of studies.

When the examination week commences you can also go through your

brief summarizes each day for various the courses to remind you of main

points. When coming to examination hall, there are certain materials that

are prohibited for you to carry (i.e Bags, Cell phone, and any paper etc).



You will be checked before you are allowed to enter the hall. You must

also be well behaved throughout your examination period.



DEPARTMENT OF ECONOMICS, UNIVERSITY OF MAIDUGURI

ECO 313

Dr Jibrin Musa Talba



GENERAL INTRODUCTION

This course, Eco 313 International trade is a two credit unit, one semester core

course designed for third year economics students in the department of Economics

at the Centre for Distance Learning. The course will help you gain some insight of

into the understanding international trade theory. Therefore the course is structured

to expose you to the skills required to understand the theories of international

trade, and the law of comparative advantage, reasons and expansion of

international trade as well as benefits and costs of international trade.

This course guide tells you what international trade entails at this level, what

course materials will you be using and how you can work your way through these

materials. It also guides you on in-text questions and answers and some self

assessment questions.



OBJECTIVES OF THE STUDY

At the end of the course module, the students are expected to:

Define international trade

Know the absolute advantage theory of trade

Know the comparative advantage theory

Understand the rationale behind trade

Discuss the advantages of trade

Comprehend the cost of trade

Explain the reasons for trade expansion



TABLE OF CONTENTS

PAGES

GENERAL INTRODUCTION

OBJECTIVES OF THE STUDY

STUDY SESSION 1: RATIONAL BEHIND THE STUDY OF INTERNATIONAL TRADE

2: THEORY OF COMPARATIVE ADVANTAGE

3: MERCANTILISM



STUDY SESSION 1

INTERNATIONAL TRADE AND MERCANTILISM

PAGE

INTRODUCTION

1.1. LEARNING OUTCOMES

1.2 IN-TEXT

1.3. MERCANTILIST VIEW OF TRADE

1.4 . REASONS FOR EXPANSION OF INTERNATIONAL TRADE

1.4. FUNDAMENTALREASONS FOR INTERNATIONAL TRADE

1.5. BENEFITS AND COSTS OF INTERNATIONAL TRADE

1.5.1. BENEFITS OF INTERNATIONAL TRADE

1.5.2. COSTS OF INTERNATIONAL TRADE

IN-TEXT QUESTIONS

IN-TEXT ANSWERS

1.6. ACTIVITY

1.7. .SUMMARY

1.8 SELF ASSESSSMENT QUESTIONS

1.9 REFERENCES

1.10. FURTHER READINGS



STUDY SESSION 1: INTERNATIONAL TRADE AND MERCANTILISM

Introduction

The theory of trade has a central place in economic analysis, and underpins the doctrine of free

trade. Free trade doctrines have a long and fascinating history in Europe. In 1846 Britain

repealed the Corn Laws, an historic event which marked the start of the era of free international

trade, and lasted until the great depression of the 1870s. The Corn Laws were the duties on

imports of grain, which had been in force in England since the middle of the fifteenth century.

Other European countries had similar taxes: France, Sweden, Bavaria, Belgium and Holland.

The reasoning behind the Corn Laws was as follows. Grain, chiefly wheat, is a staple foodstuff,

especially important in the diets of labouring people. But its price varies greatly from year to

year, depending on the size and quality of harvests. Duties on imports were levied on a sliding

scale in order to stabilise the price of wheat. When the domestic price was high because of a poor

harvest, duties were lowered to permit imports. When the domestic price was low because of a

bumper harvest, import duties were raised.

In the decades leading up to the repeal of the Corn Laws in Britain, the system had fallen into

disrepute. In fact the sliding scale of duties was tending to increase rather than reduce

fluctuations in the price of wheat. When the domestic price was high, traders tended to withhold

supply to raise the price even further. They anticipated that import duties would soon be lowered,

which was in fact what tended to happen. Then, when duties fell, traders began to import large

quantities of grain. As supply rapidly increased, and prices fell dramatically, import duties were

quickly increased. The net effect was to amplify market fluctuations through speculation, making

a vulnerable market even more unstable, much to the detriment of consumers.

The Corn Laws had another important effect; they, benefited agricultural interests at the expense

of the emerging manufacturing sector. High prices of grain, maintained through restricting

foreign supply, increased the value of land. Landowners, understandably, came to constitute an

important pressure group for the maintenance of the Corn Laws. Against these landed interests

were ranged the burgeoning manufacturing classes. In Britain, opposition to the Corn Laws

centered around Manchester, the home of the textile industry. The ‘free traders’ as they were

called, believed that lower grain prices were needed so that the labouring classes in industrial

areas would have access to cheap foodstuffs. Led by Cobden, formerly a manufacturer, the free



traders argued for the opening-up of British markets to cheap grain imports from overseas.

Manufacturers were also anxious that free trade principles should be reciprocated in other

countries, so that foreign markets would be opened up to exports of cheap manufactured goods

from Britain.

In Britain free trade principles eventually triumphed. In the twentieth century, with the important

exception of the period 1918 to 1939, free trade principles also came to dominate the world

economy. In this chapter we explore the economic principles which underpinned the doctrine of

free trade, a doctrine which is arguably one of the most robust of any in present-day economics.

Chapter 2 starts with the mercantilist thinking which pre-dates the free trade era, and passes on to

the writings of Adam Smith and David Ricardo, which formed the basis of the case for free

trade. These principles were reinterpreted in terms of modern economics by the economist

Haberler in the 1930s.

Finally, a word of warning – the theory of comparative cost, on which everything in this chapter

rests, is deceptively simple! In 1996, the world-famous US economist Paul Krugman came to

Manchester, UK, to give a paper to mark the 150 years which had elapsed since the repeal of the

Corn Laws. He entitled his address ‘Ricardo’s Difficult Idea: Why Intellectuals Don’t

Understand Comparative Advantage’. In it he made clear that intelligent people who read, and

even those who write about world trade, often fail to grasp the idea of comparative advantage.

The aim of this chapter is to ensure that you fully understand the basis of the theory of trade.

1.1 Learning Outcomes

At the end of the lecture, you should be able to ;

i) show how Adam Smith’s theory of absolute advantage, in the book Wealth of Nations,broke with the mercantilist tradition;

ii) reasons for fast expansion of international trade

iii) Fundamental reasons for international trade

iv) Understand the benefits and costs of international trade

1.2. Bold Terms

International trade, merchantilism, Gravity model, absolute advantage, comparative

advantage

i) The Mercantilists’ Views on Trade



a. Economic philosophy in 17th and 18th centuries, in England, Spain, France,

Portugal and the Netherlands.

b. Belief that nation could become rich and powerful only by exporting more than it

imported.

c. Export surpluses brought inflow of gold and silver.

d. Trade policy was to encourage exports and restrict imports.

e. One nation gained only at the expense of another.

ii) Mercantilists measured wealth of a nation by stock of precious metals it possessed.

iii) Today, we measure wealth of a nation by its stock of human, man-made and natural

resources available for producing goods and services.

a. The greater the stock of resources, the greater the flow of goods and services to

satisfy human wants, and the higher the standard of living.

ii) Reasons for Fast Expansion of International Trade

The following are the reasons why international trade expand and grow faster:

Liberalization of Trade

GATT/WTO

Economic Integration

Development of Transport

Sea Transport

Air Transport

Development of Telecommunication

Telephone

Internet

iii) Fundamental reasons for international trade

The sub section below summaries the reasons for international trade:

Comparative advantage

Difference in technology - David Ricardo

Difference in factor endowments – Heckscher-Ohlin

Inter-industry trade

Economies of scale and product differentiation



Economies of scale

Product differentiation

Intra-industry trade

iv) Benefits and cost of international trade

In this sub section we will highlight the benefits and costs of international trade as follows: First

at individual, firms and then the national levels.

■ Benefits of International Trade

Individuals

Consumption of better quality products with lower prices(As consumers,

individuals become better off, but as workers, individuals may become

worse off.

Consumption of diverse products

Firms

Greater business opportunities(Greater business opportunity but may lose

competitive edge)

Greater profit (Overall national welfare becomes greater, but the nation

may face the problems of income disparity, environmental degradation,

etc).

Nation

Fast economic growth

Job creation

Costs of International Trade

o Individuals

Loss of jobs in the less competitive industries

o Firms

Face stronger competition and may lose competitive edge

o Nation



Greater income disparity

Possibility of environmental degradation in developing countries

Greater vulnerability to foreign shocks

o Gravity Model

o Other things equal, the bilateral trade between two countries is proportional, or at

least positively related, to the product of the two countries’ GDPs, and the greater

the distance between the two countries, the smaller is their bilateral trade.

o That is, the larger (and more equal in size) and the closer two countries are, the

larger the volume of trade between them is expected to be

IN-TEXT QUESTIONS AND ANSWERS (ITQs and ITAs)

ITQs

what is the main thrust of absolute advantage theory?

What is the reason for fast expansion of international trade?

What are the fundamental reasons for international trade?

What are the benefits and costs of international trade?

ITAS

The main thrusts of absolute advantage theory are:

A nation has absolute advantage over another nation if it can produce a commoditymore efficiently.

When one nation has absolute advantage in production of a commodity, but an absolutedisadvantage with respect to the other nation in a second commodity, both nations cangain by specializing in their absolute advantage good and exchanging part of the outputfor the commodity of its absolute disadvantage.

Specialization and trade advantage both countries.

Adam Smith and other classical economists advocated policy of laissez-faire, or minimalgovernment interference with economic activity.

Free trade would cause world resources to be utilized most efficiently, maximizing worldwelfare.

The main reasons for expansion of international trade are:

Liberalization of Trade

Development of Transport

Development of Telecommunication



The fundamental reasons for international trade includes among others:

Comparative advantage

Economies of scale and product differentiation

Benefits of international trade

It varies depending on the agent be it individual, firm or national.

Cost of international trade include among other things loss of jobs, increase competition,

vulnerability to shocks

REFERENCES Main textbook

Dominick Salvatore, International Economics, 10th edition, John Wiley &Sons, 2010.

Auxiliary textbooks Recent research articles Economic daily news papers.

Homepage: http://cc.kangwon.ac.kr/~hhlee/

FURTHER READING

The discussion related to this overlooks many important and controversial issues. SeeMilanovic (2002) for a discussion, or google it.

Milanovic, B. (2002). "Worlds Apart: Inter-National and World Inequality 1950-2000". World Bank,http://www.worldbank.org/research/inequality/world%20income%20distribution/world%20apart.pdf

ACTIVITIES

Activity 1: what is the The Mercantilists’ Views on Trade ?

Activity 2: Explain Trade Based on Absolute Advantage: Adam Smith

Activity 3: Discuss Trade Based on Comparative Advantage: David Ricardo

Activity 4: Highlight the Basis for and the Gains from Trade under Constant Costs



STUDY SESSION 1: The Law of Comparative Advantage

Introduction

Born in 1772, David Ricardo was of Dutch parentage. His family was Jewish and settled inEngland where his father followed the profession of a stockbroker. The younger Ricardo alsomade his fortune in stockbroking, and then retired from business to embark upon his intellectualjourney. His most important work, The Principles of Political Economy and Taxation, was firstpublished in 1817 and contained, in addition to his theory of international trade, work on thetheory of value, wages, profit and rent, a theory of accumulation, and a theory of economicdevelopment. It is a complete account of the workings of an economic system, much morerigorous and less philosophic than Wealth of Nations. The contribution of David Ricardo was todemonstrate that even though a country may be absolutely more efficient than another in theproduction of all tradeable goods, nevertheless trade will be mutually advantageous.

Absolute advantage explains a certain proportion of trade taking place in the world economy inthe eighteenth and early nineteenth centuries. Britain probably had an absolute advantage inmanufactured goods in the early stages of industrialisation and an absolute disadvantage in theproduction of commodities like sugar and tobacco, which required specific climatic conditions.Sugar, tobacco, raw cotton and tea were significant commodities in Britain’s import bill.

But suppose a country has an absolute advantage over its trading partner in respect of allcommodities. Is there any basis for mutually advantageous trade? Adam Smith thought not. If thetrading partner had no absolute advantage, then there would be no opportunity to trade.

Consider Table 2.2. The US has an absolute advantage in the production of both wheat and cloth.By 1860, this was a distinct probability. The US was an agricultural economy capable ofproducing large quantities of low-cost wheat, as the margin of cultivation was extendedwestwards. But due to high rates of investment, productivity levels were also rising in certaintypes of manufactured cotton goods. Productivity levels could well have outstripped those in theUK.

Based on Smith’s principle of absolute advantage, Table 2.2 suggests that there is no basis fortrade between the UK and the US. The US is absolutely more efficient in the production both ofwheat and cloth. But, looking again at Table 2.2, it is clear that the US is relatively more efficientin the production of wheat (four times more efficient than the UK) than it is in the production ofcloth, where it is three times more efficient than the UK. The US has a comparative advantage inwheat production. The UK, comparatively speaking, is more efficient in cloth production thanwheat.

Ricardo was the first of the classical economists to recognise that it is relative rather thanabsolute values which are fundamental to the operation of a market economy. This insight wascritical to the further development of the theory of trade.

2.1 Learning Outcomes

At the end of this session, you should be able to;



i) Understand Trade Based on Comparative Advantage: David Ricardo

ii) Comprehend Comparative Advantage and Opportunity Costs

iii) Appreciate the Basis for and the Gains from Trade under Constant Costs

iv) See empirical tests of the Ricardian Model

2.2 Bold Terms

Law of comparative advantage, opportunity costs, Ricardian model

i) Law of Comparative Advantage states that:

Even if one nation is less efficient than (has absolute disadvantage with respect

to) the other nation in production of both commodities, there is still a basis for

mutually beneficial trade.

U.S. U.K.

Wheat (bushels/labor hour) 6 1

Cloth (yards/labor hour) 4 2

U.S. U.K.

Wheat UK has higher opportunity cost than US in Wheatproduction

Cloth US has higher opportunity cost than UK in Clothproduction

U.K. has absolute disadvantage in both goods.

Since U.K. labor is half as productive in cloth but six times less productive in

wheat compared to U.S., the U.K. has a comparative advantage in cloth.

U.S. has comparative advantage in wheat.

ii) Comparative Advantage and

Opportunity Costs

The original idea of comparative advantage was based on the labor theory of value:



The value or price of a commodity depends exclusively on the amount of labor

used to produce it.

Can use the opportunity cost theory to explain comparative advantage:

The cost of a commodity is the amount of a second commodity that must be given

up to release just enough resources to produce one additional unit of the first

commodity.

Production Possibilities Frontier

A curve that shows alternative combinations of the two commodities a nation can

produce by fully using all resources with best available technology.

Constant opportunity costs arise when:

1. Resources are either perfect substitutes for each other or used in fixed proportion in

production of both commodities, and

2. All units of the same factor are homogeneous.

FIGURE 2-1 The Production Possibility Frontiers of the United States and the United

Kingdom.

iii ) The Basis for and the Gains from Trade under Constant Costs

In the absence of trade, a nation’s production frontier also represents its consumption

frontier.



Increased output resulting from specialization and trade represents nations’ gains from trade,

allowing nations to consume outside production possibilities frontier.

Under constant cost conditions, nations will completely specialize in their comparative

advantage .

With complete specialization in both nations, the equilibrium-relative commodity price of

each commodity lies between the pretrade relative commodity price in each nation.



FIGURE 2-3 Equilibrium-Relative Commodity Prices with Demand and Supply.

iv) Empirical Tests of the Ricardian Model

McDougall (1951 and 1952)

Argued that costs of production would be lower in the U.S. in industries where

U.S. labor was more than twice as productive as U.K. labor.

Found positive relationship between labor productivity and exports; industries

with relatively productive labor in U.S. have higher ratios of U.S. to U.K. exports,

supporting Ricardian theory of comparative advantage.

Results supported by Balassa, Stern and Golub in later studies.

FIGURE 2-4 Relative Labor Productivities and Comparative Advantage–United States and

United Kingdom.



Chem ical

Food

O ffice M achineryTextilesFuel

Basic Iron

W oodElectric M achinery

Paper

M etal

Transport M achinery

Non-m etal

General M achinery

Precision M achinery.

y = 0.2129x + 1.3368

R2 = 0.4598

1.0

1.2

1.4

1.6

1.8

2.0

2.2

2.4

2.6

2.8

0.0 1.0 2.0 3.0 4.0 5.0 6.0

JPN Exports/KO R Exports

Output per JPN Worker/

Output per KOR Worker

FIGURE 2-4-K Relative Labor Productivities and Comparative Advantage–Korea and

Japan.



FIGURE 2-5 Relative Exports and Relative Unit Costs– United States and Japan.

In-text In-text questions and answers(ITQs and ITAs)

ITQs

Explain trade based on Comparative Advantage: David Ricardo Compare and contrast Comparative Advantage and Opportunity Costs

ITAs The main thrust of comparative advantage is that even if one nation is less

efficient than (has absolute disadvantage with respect to) the other nation in

production of both commodities, there is still a basis for mutually beneficial trade.

ii) Compare and contrast Comparative Advantage and Opportunity Costs



The original idea of comparative advantage was based on the labor theory of value:

The value or price of a commodity depends exclusively on the amount of labor

used to produce it.

Can use the opportunity cost theory to explain comparative advantage:

The cost of a commodity is the amount of a second commodity that must be given

up to release just enough resources to produce one additional unit of the first

commodity.

Production Possibilities FrontierConstant opportunity costs arise when:

1. Resources are either perfect substitutes for each other or used in fixed proportion in

production of both commodities, and

2. All units of the same factor are homogeneous.

REFERENCE Dominick Salvatore, International Economics, 10th edition, John Wiley &

Sons, 2010. Homepage: http://cc.kangwon.ac.kr/~hhlee/

FURTHER READING

Milanovic, B. (2002). "Worlds Apart: Inter-National and World Inequality 1950-2000". World Bank,http://www.worldbank.org/research/inequality/world%20income%20distribution/world%20apart.pdf

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