Economy 12 - International trade, capital, flows and exchange rates

Imports are

Goods and services purchased from other countries

Exports are

Goods and services sold to other countries

Globalisation is

the phenomenon of growing economic linkages among countries

International trade consist on

changing goods and services among different countries

There are … theories about winning on international trade:

3, the theories of mercantilism, absolute advantage and comparative advantage

Mercantilist theory

It was formulated in the 16th and 17th centuries and was the first to focus on the gains from international trade and who was to appropriate them.

Its advocates sought the constant enrichment of the country itself and, to this end, thought it best that the country should have a continuing surplus. To achieve this, they advocated an active policy of restricting free trade to protect domestic production from imports from third countries.

Theory of absolute advantage

This theory, argued by Adam Smith (1723 - 1790), defends free trade by stating that each country will specialise in producing only those goods that it produces using fewer working hours, which allows it to sell them more cheaply.

With the specialisation derived from this trade, all countries will be able to produce more with the same working hours, which will result in improved efficiency and economic growth for all countries.

Theory of comparative advantage

David Ricardo (1772 - 1823) showed that the main conclusion of the theory of absolute advantage was wrong, because the price that determines what a country specialises in is not the absolute price (determined by the hours of labour performed), but the relative price (i.e. the price of a good in relation to the price of other goods)

Protectionism:

economic thinking that considers that it is in the best interest of a country's industry to protect it from foreign competition, thus articulating measures to make it more difficult to import foreign products.

Free trade

the absence of barriers to trade in goods and services between countries

Comparative advantage:

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

he Ricardian model of international trade analyzes

international trade under the assumption that opportunity costs are constant

Autarky is

a situation in which a country cannot trade with other countries

The Ricardian mo del of intern ational trade shows that

trade between two countries makes both countries better off than they would be in autarky— that is, there are gains from trade.

Specialization has the effect of

increasing total world production of both goods and that each country can consume more of both goods than it did under autarky

The WTO is

an international organisation that seeks to progressively liberalise international trade barriers through agreements between its member states. It is made up of 192 full member countries and 24 observers. Its intentions are based on the belief that international trade is good for all those who participate in it.

Free trade can improve global economic growth and lower the prices of the goods and services we access

Gains from trade depend on

Comparative advantage (who can make it at a lower opportunity cost), not on absolute advantage (who can make more).

A country’s wage rate, in general, represents

Its labour productivity

In a country where labor is highly productive

employers pay higher wages

In countries where labor is less productivE

Wages are lower

There are … sources of comparative advantage:

3, differences in climate, factor endowments (Heckscher-Ohlin model, a country that has an abundant supply of a factor of production will have a comparative advantage in goods whose production is intensive in that factor. Factor intensity is a measure of which factor is used in relatively greater quantities than other factors in production) and differences in technology

Increasing returns to scale occur when

the productivity of labor and other resources used in production rises with the quantity of output.

Increasing returns to scale can give rise to

monopoly as well as international trade

If there are increasing returns to scale, then production will be

concentrated in only a few locations (But that also means that the good is produced in only a few countries)

The domestic demand curve shows

how the quantity of a good demanded by domestic consumers depends on the price of that good

The domestic supply curve shows

how the quantity of a good supplied by domestic producers depends on the price of that good

The world price of a good is

the price at which that good can be bought or sold abroad

If the world price is lower than the autarky price

trade leads to imports and a fall in the domestic price compared to the world price (There are overall gains from trade because consumer gains exceed the producer losses)

If the world price is higher than the autarky price

trade leads to exports and a rise in the domestic price compared to the world price. (There are overall gains from trade because producer gains exceed the consumer losses)

Exporting industries produce goods and services that are sold

Abroad

Import-competing industries produce goods and services that are also

Imported

International trade tends to increase the demand for factors that are abundant in our country compared with other countries, and to decrease the demand for factors that are scarce in our country compared with other countries. As a result

the prices of abundant factors tend to rise, and the prices of scarce factors tend to fall as international trade grows.

An economy has free trade when

the government does not attempt either to reduce or to increase the levels of exports and imports that occur naturally as a result of supply and demand. Policies that limit imports are known as trade protection or simply as protection. (Most economists advocate free trade, although many governments engage in trade protection of import-competing industries. The two most common protectionist policies are tariffs and import quotas. In rare instances, governments subsidise export industries)

A tariff is

a tax levied on import. It raises the domestic price above the world price, leading to a fall in trade and total consumption and a rise in domestic production. Domestic producers and the government gain, but consumer losses more than offset this gain, leading to deadweight loss in total surplus

An import quota is

a legal limit on the quantity of a good that can be imported. Its effect is like that of a tariff, except that revenues—the quota rents—accrue to the license- holder, not to the government

A country’s balance of payments accounts

summarize its transactions with other countries

The balance of payments on current account is

its balance of payments on goods and services plus net international transfer payments and factor income

The merchandise trade balance is

the difference between a country’s exports and imports of goods

The capital account balance

tracks a country's net financial transactions globally. A positive balance signals strong economic attractiveness, while a negative balance indicates a net capital outflow

A country’s financial account is

the difference between its sales of assets to foreigners and its purchases of assets from foreigners during a given period

Currencies are traded in the foreign exchange market. The prices at which currencies trade are known as

Exchange rates

When a currency becomes more valuable in terms of other currencies, it

Appreciates

When a currency becomes less valuable in terms of other currencies, it

Depreciates

The equilibrium exchange rate is

the exchange rate at which the quantity of a currency demanded in the foreign exchange market is equal to the quantity supplied.

Real exchange rates arE

exchange rates adjusted for international differences in aggregate price levels

Purchasing power parity between two countries’ currencies is

the nominal exchange rate at which a given basket of goods and services would cost the same amount in each country