International Trade

• International trade


  Exchange of goods and services between two countries through import and export activities
• Domestic trade


  Exchange of goods and services within the boundaries of a country
• Absolute advantage


  The ability to produce a good more efficiently using fewer inputs than another producer
• Assumptions for absolute advantage

  • There are only two countries in the world
  • Only two goods are produced
  • Free trade exists between these two countries
  • No transportation costs are involved
  • Production is under the law of constants costs
  • Identical production functions between trading countries

  
• Absolute advantage example


  • Malaysia can produce 20 tons of cotton and 60 tons of rice

  China can produce 40 tons of cotton and 20 tons of rice

  Malaysia has absolute advantage in producing rice, China has absolute advantage in producing cotton
• Specialization with absolute advantage

  Malaysia uses 100% of resources to produce rice

  China uses 100% of resources to produce cotton

  Total world output increased with specialization
• Comparative advantage


  Ability of one country to produce goods at a lower opportunity cost than another country
• Opportunity cost


  The cost of the desired goods that have to be forgone to obtain another good
• Comparative advantage example


  • Malaysia has lower opportunity cost (0.17 tons of rice) in producing cotton

  China has lower opportunity cost (2 tons of cotton) in producing rice
• Malaysia has comparative advantage in cotton, China has comparative advantage in rice
• Terms of trade


  The rate at which goods are exchanged, measured as the ratio of export prices to import prices
• Terms of trade example

  • Relative price for rice and cotton in Malaysia is 1 rice = 6 cotton

  Relative price for rice and cotton in China is 1 rice = 2 cotton

  Average relative price is 1 rice = 4 cotton
• International trade between Malaysia and China

  Increases world output and gains
• Why the US imports T-shirts

  • US demand and supply without trade: price $8, quantity 40 million

  With trade, world price $5, US produces 2 million, consumes 60 million, imports 40 million
• Why the US exports airplanes

  • US demand and supply without trade: price $100 million, quantity 400

  With trade, world price $150 million, US has comparative advantage in airplanes
• The world price is less than $8


  The rest of the world has a comparative advantage in producing T-shirts
• How Global Markets Work

  1. With international trade, the price of a T-shirt in the United States falls to $5

  2. At $5 a T-shirt, U.S. garment makers produce 2 million T-shirts a year

  3. At $5 a T-shirt, U.S. consumers buy 60 million T-shirts a year

  4. The United States imports 40 million T-shirts a year
• Why the United States Exports Airplanes

  1. Figure 7.2(a) shows U.S. demand and U.S. supply with no international trade. The price of an airplane is $100 million

  2. Boeing produces 400 airplanes a year and U.S. airlines buy 400 a year

  3. Figure 7.2(b) shows the market in the United States with international trade. World demand and world supply of airplanes determine the world price of a airplane at $150 million

  4. The world price exceeds $100 million, so the United States has a comparative advantage in producing airplanes

  5. With international trade, the price of an airplane in the United States rises to $150 million

  6. At $150 million, U.S. airlines buy 200 jets a year

  7. At $150 million, Boeing produces 700 airplanes a year

  8. The United States exports 500 airplanes a year

  
• Tariff


  A tax on a good that is imposed by the importing country when an imported good crosses its international boundary
• Tariff example


  • The government of India imposes a 100 percent tariff on wine imported from the United States
  • When an Indian wine merchant imports a $10 bottle of Ontario wine, he pays the Indian government $10 import duty
• The Effects of a Tariff

  1. With free international trade, the world price of a T-shirt is $5 and the United States imports 40 million T-shirts a year

  2. The United States imposes a tariff of $2 on each T-shirt imported

  3. The price of a T-shirt in the United States rises by $2

  4. Figure 7.5 shows the effect of the tariff on the market for T-shirts in the United States
• Import quota


  A restriction that limits the maximum quantity of a good that may be imported in a given period

  
• Import quota examples


  • The United States imposes import quotas on food products such as sugar and bananas and manufactured goods such as textiles and paper
• Effect of an import quota

  1. Figure 7.7(b) shows the market with an import quota of 10 million T-shirts

  2. With the quota, the supply of T-shirts in the United States becomes S + quota

  3. The price rises to $7

  4. The quantity produced in the United States increases and the quantity bought decreases

  5. Imports decrease

  
• Other import barriers


  • Thousands of detailed health, safety, and other regulations restrict international trade
  • Voluntary export restrain (VER)
  • Export Subsidy - A payment made by the government to a domestic producer of an exported good
• Export subsidies bring gains to domestic producers, but they result in overproduction in the domestic economy and underproduction in the rest of the world and so create a deadweight loss
• Balance of Payments (BOP)


  • Records of all economic transactions between one country and the rest of the world in a given period of time
  • Debit - outflow of money (-)
  • Credit - inflow of money (+)
  • Records its international trading, borrowing , and lending
• Components of BOP


  • Current account
  • Capital account
  • Official Settlement Account
• Current account


  Includes merchandise trade balance, service balance, net income, and current transfers
• Merchandise trade balance


  Difference between export and import of physical goods
• Service balance


  Difference between receipts and payments from services
• Net income


  Difference between investment income flows into and out of a country
• Current transfers


  Includes gifts, military aid and financial aid by the government, private individuals and organizations to foreign countries and also the inflows from other countries into the country
• Capital account


  Records the payment flows on purchases of foreign assets by residents or resident assets by foreigners
• Errors and omissions


  Used to balance the BOP account when there is missing information
• Official settlement account


  Records the change in official reserves