II. International Trade
A. Foundations of Modern Trade Theory
1. Historical development
a. Mercantilists (1500 - 1800)
- Sought favorable trade balance (exports >
imports)
- Gold and silver flows into country
- Money stimulates economy
- Advocated trade barriers (tariffs, quotas,
regulations)
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- Price-specie-flow doctrine (David Hume)
- Money (specie) flows into
country => inflation => consumers turn to other countries
(imports increase)
- Mercantilists' view is static
- View world's wealth as
fixed
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b. Absolute advantage
- Adam Smith - specialization and division of
labor increases overall wealth
- Nations should specialize in the production
of goods that could be produced cheaply
- Production costs differ among nations due to
different productivities of factor inputs
- Natural advantages - climate, soil, mineral
wealth
- Acquired advantages - special skills and
techniques
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- Emphasizes supply side of market
- Cost of production is the chief consideration
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c. Comparative advantage
- David Ricardo - nations can gain from
specialization, even if they lack absolute advantage
Ex. -
Country |
Product |
|
Country |
Product |
Canada |
Lumber |
|
China |
Textiles |
Israel |
Citrus fruit |
|
Japan |
Automobiles |
Italy |
Wine |
|
South Korea |
Steel, ships |
Jamaica |
Aluminum ore |
|
Switzerland |
Watches |
Mexico |
Tomatoes |
|
United Kingdom |
Financial services |
Saudi Arabia |
Oil |
|
United States |
Airplanes |
- Look at relative cost differences and
opportunity costs
(1) World consists of two nations and two goods
(2) Labor, fully employed and homogeneous, is the only
input (Labor Theory of Value)
(3) Labor can move freely only within its nation
(4) Technology level is fixed for both nations; all
firms within a nation use common production methods
(5) Costs are proportional to the amount of labor used,
do not vary with level of production
(6) Perfect competition in all markets, including
identical products produced
(7) Free trade between nations
(8) Transportation costs are zero => customer doesn't
care who produces products
(9) Profit maximization and utility maximization are the
goals of firms and consumers
(10) Trade is balanced => exports must pay for imports
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- Less efficient nation should specialize in
and export good which is relatively less inefficient
- More efficient nation should specialize in
and export good which is relatively more efficient
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2. Production possibilities schedules
- Shows alternative combinations of two goods that
could be produced by all factors in a country
- Maximum output possibilities of a nation given
resource constraints, level of technology
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- Marginal rate of transformation (MRT) -
amount of one product that must be given up to get the other product
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- Equals slope of the production possibilities
schedule
- Measures opportunity cost
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3. Trading under constant cost conditions
- Opportunity cost the same at all levels of
production
- Factors of production are perfect substitutes
- All units of a factor are of equal quality
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a. Basis and direction of trade
- Autarky - absence of trade
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b. Production gains from specialization
- Complete specialization leads to higher
productivity
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c. Consumption gains from trade
- Trading possibilities line - shows
alternative combinations that can be obtained by trade
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- Trade triangle - shows exports,
imports, and terms of trade
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d. Distributing gains from trade
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e. Equilibrium terms of trade
- Theory of reciprocal demand (John Stuart
Mill) - actual terms of trade determined by relative strength of
each country's demand for the other country's product
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- Most relevant when both countries are equal
in economic power
- Importance of being unimportant - one country
dwarfs another in economic power
- Domestic exchange ratio of big country
prevails because small country has little impact
- Most of gains from trade go to smaller
country
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- Small country may not produce enough to meet
big country's needs => big country produces both
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- Commodity terms of trade - measures
relationship between import and export prices
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- Improvement in terms of trade => export
prices rise relative to import prices
- Deterioration in terms of trade => export
prices fall relative to import prices
Ex. - 2013 (2005 = 100)
Country |
Export Price Index |
Import Price Index |
Terms of Trade |
Australia |
194 |
143 |
136 |
Argentina |
166 |
153 |
108 |
Canada |
132 |
125 |
106 |
Switzerland |
148 |
142 |
104 |
United States |
124 |
127 |
98 |
China |
127 |
130 |
98 |
Brazil |
156 |
184 |
85 |
Japan |
108 |
145 |
74 |
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4. Dynamic gains from trade
- More efficient use of resources
- More saving and investment
- Higher rate of economic growth
- Economies of large scale production, even in
smaller countries
- Increased competition encourages innovation and cost
efficiencies
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5. Changing comparative advantage
- Differences in productivity growth may change
comparative advantage
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6. Trading under increasing-cost conditions
- Increasing opportunity costs - increasingly more
of one product must be given up to produce more of the other product
- Inputs are imperfect substitutes for one another
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- Costs rise as more is produced => advantage is
eventually eliminated
- Partial specialization - both countries likely
to produce both goods
- Exit costs (antiquated plants, labor and input contracts,
environmental cleanup requirements) may slow adjustment process
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7. Multiple products and countries
a. Multiple products
- Rank goods by comparative advantage
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- Dividing line depends on strength of demand
for products
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b. Multiple countries
- Multilateral trading relationships
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- Bilateral balance of trade not significant
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8. Outsourcing
- Global supply chains use outsourcing - subcontracting
work to another firm or purchasing components
a. Advantages
- Reduced costs and increased competitiveness
- New exports - inputs and consumer products
- Repatriated earnings from overseas
- Job losses tend to be temporary
- Creation of new industries and jobs
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b. Burdens
- Overall level of jobs should be unchanged or
increase, mix of jobs will change
- Downward pressure on wages
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c. Reshoring
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Wage gap narrowing
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Cost of shipping goods by ocean freight increasing sharply
- goods in transit for weeks
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Distance makes it difficult to customize goods to local
markets
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Natural disasters, geopolitical shocks disrupt supply
chains
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Many firms now returning to the U.S.
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