Unit 6.1 - Reasons for international trade

• International trade


  Exists because different countries have different factor endowments. It is easier to move goods and services internationally than factors of production
• Absolute advantage


  A situation where, for a given set of resources, one country can produce more than another country with the same set of resource
• Comparative advantage


  A situation where a country can produce at a lower opportunity cost than another country
• Opportunity cost ratio


  The quantity of one product compared to another that has to be sacrificed
• Trade advantage


  1. Determine which country has the absolute advantage of producing each product

  2. Calculate the opportunity cost for producing one of each product

  3. Identify which country has the comparative advantage of producing each product

  4. Identify the terms of trade that benefit both countries
• The opportunity cost of producing 1 tonne of rice in Indonesia is a 0.4 tonne of coffee, for Brazil it is 2.5 tonnes of coffee

  
• Laptops and Phones


  • Japan: 4 Laptops, 12 Phones

  Brazil: 1 Laptop, 5 Phones
• Planes and Cruise ships

  • US: 20 Planes, 2 Cruise ships

  France: 12 Planes, 2 Cruise ships
• TVs and Salsa


  • Cuba: 4 hrs TVs, 12 hrs Salsa

  Mexico: 1 hr TV, 5 hrs Salsa
• Rate of trade = 4
• Rate of trade = 8
• Benefits of specialisation and free trade

  • Free to trade in quantities desired

  No tax, limits, subsidies or red tape

  Efficient allocation of resources - increased output and living standards

  Increased competition could decrease prices and increase quality

  Economies of scale and wider variety
• Trading possibility curve


  Shows the benefits of specialising and trading on an economy
• Exports


  Goods and services sold to other countries
• Imports


  Goods and services purchased from other countries
• Terms of trade index

  A numerical measure of the relationship between export and import prices

  
• Terms of trade index = (index of export prices / index of import prices) x 100
• Favourable movement: if the trade index increases. (When there is a rise in export prices relative to import prices - impact is not always beneficial)
• Changes in terms of trade are caused by changes in supply and demand of exports and imports, the price level and the exchange rate (or deliberate deterioration)
• Prebisch-Singer hypothesis: Terms of trade tends to move against countries that produce primary products
• Limitations to the theory of absolute and comparative advantage

  • It does not provide a full explanation of the pattern of international trade

  Some governments may want to avoid over-specialisation

  Higher transportation costs may offset the comparative advantage

  The exchange rate may not lie between the opportunity cost ratios

  Other governments may impose trade restrictions

  It also assumes that resources are as mobile and as productive, if output is increased

  Difficult to determine where comparative advantage actually lies, with so many countries and so many products