Chapter 5: International Economics Notes

International trade

The exchange of goods and services across borders.

Benefits of International Trade

Improves welfare for both producers and consumers (e.g., Chinese smartphone producers & American consumers)

Hyperglobalization

A phenomenon characterized by extremely high levels of international trade.

Comparative advantage

A country has a comparative advantage in producing a good or service if the opportunity cost of production is lower for that country than for others.

Ricardian Model

Trade follows this model, assuming constant opportunity costs.

Key Assumptions in Comparative Advantage and Trade

• Countries specialize in goods they can produce more cheaply.

• Trade allows consumption beyond production capabilities.

Autarky

A situation where a country does not trade; consumption is limited by production.

Comparative Vs. Absolute Advantage

• Just because the U.S. can produce more of both goods doesn’t mean it’s better off without trade.

• Opportunity costs determine trade benefits.

Specialization

When countries focus on producing certain goods they can make more efficiently, leading to increased total world production.

• U.S. focuses on trucks; China focuses on phones → Total world production increases.

Economies of scale

As firms grow, their average total cost (ATC) drops, allowing access to larger markets.

Ex: Some firms, like Toyota, expand globally to access larger markets.

Diseconomies of scale

When costs increase beyond a certain point as firms grow.

Sources of Comparative Advantage

1. Differences in Climate

2. Factor Abundance

3. Factor Intensity

4. Technology Differences

5. Changing Comparative Advantages

Differences in Climate

Bananas grow better in certain regions than others

Factor Abundance

• Supply of production factors (land, labor, capital, entrepreneurship).

• Example: A country rich in forests vs. one rich in machinery.

Factor Intensity

• The quantity of a factor used compared to others (e.g., labor vs. natural resources).

Technology Differences

• Some countries develop advanced technologies (e.g., Swiss watches, AI).

• U.S. once had an advantage in manufacturing but shifted focus.

Changing Comparative Advantages

• Example: Hong Kong lost its advantage in garments as it specialized in higher-value industries.

Domestic Demand Curve

Shows how the quantity demanded of a good depends on the price.

Domestic Supply Curve

Shows how the quantity supplied of a good depends on the price.

World Price

The global market price for a good.

With Vs. Without Trade

Without: Equilibrium price & quantity depend only on domestic supply and demand.

With:

If world price (Pw) < domestic price (Pa) → Imports increase, domestic price drops.

• If world price (Pw) > domestic price (Pa) → Exports increase, domestic price rises.

Effects of Trade on Surplus

• Imports lower domestic prices, benefiting consumers.

• Exports raise domestic prices, benefiting producers.

Tariffs

Taxes on imports that increase domestic production but reduce domestic consumption.

• Increase domestic production but reduce domestic consumption.

• Raise prices → Decrease consumer surplus, increase producer surplus.

• Government earns revenue, but deadweight loss occurs.

Import Quotas

Limits on imports that restrict supply and raise domestic prices.

• Same effects as tariffs but with revenue going to quota holders instead of the government.

Smoot-Hawley Tariff

A tariff from the 1930s that increased tariffs and worsened the Great Depression.

Bretton Woods Agreement (Post-WWII):

• Established international economic cooperation (IMF & World Bank).

National Security Argument for Protection

Essential industries like oil and defense must be protected for national security.

NAFTA (Now USMCA)

Trade agreement between the U.S., Canada, and Mexico.

Arguments for Trade Protection

1. national security

2. Domestic employment

3. infant industry argument

4. using tariffs as a bargaining tool

Domestic Employment:

• Globalization may cause job losses in some industries.

Infant Industry Argument

The rationale that new industries need protection from foreign competition until they become established and competitive.

Using Tariffs as a Bargaining Tool

• Tariffs can be used to negotiate better trade deals.

Critiques of Protectionism

• Hard for governments to predict which industries will succeed.

• Protection discourages competitiveness.

• Political influence often determines which industries receive protection.

Wage Effects of Trade

Trade can widen the wage gap between highly educated and less educated workers.

Consumer Price Index (CPI)

Measures inflation and is released monthly.

Deflation

The condition of falling price levels.

WTO (World Trade Organization)

• Oversees trade agreements and disputes.

EU (European Union)

• Customs union among 28 European nations.

Inflation

The condition of rising price levels, leading to a decrease in the purchasing power of money.

Disinflation

A reduction in the rate of inflation, indicating a slowdown in the increase of price levels.

Inflation quick

• Inflation: Rising price levels.

• Deflation: Falling price levels.

• Disinflation: Slowing inflation rate.

Controlling Inflation

• Governments raise interest rates to slow the economy.

• Politicians often avoid drastic economic slowdowns due to electoral risks.