5) International Trade

Why countries trade

Countries benefit from specialisation and exchange

Australia exports a lot of raw resources, buying them back refined. Not because of capability, bit rather opportunity cost

Countries specialise on prioritising what they can produce with the lost opportunity cost because it is what benefits them the most, trading for other goods

Basic Analysis

We can simplify the analysis into a two-country model

We compare the two goods produced by each country, measuring the input costs to allocate productive efficiency and identify advantages

Absolute and Comparative Advantage

Absolute Advantage

• Being able to produce at a cheaper input cost than the other country

Comparative Advantage

• Producing at a cheaper opportunity cost compared to the other country

Absolute advantage doesn’t imply comparative advantage

Country Production Possibility Frontier (PPF curve)

Shows the relationship between the production of each good (opportunity cost)

• The Y intercept is the max amount of Good A you can produce

• The X intercept is the max amount of Good B you can produce

• The slope shows the opportunity cost between the two (ie -2 if it costs 2 Ga for a Gb)

International PPF Curve

The country with the lowest OC goes first until hitting their limit, the second continues with their slope until hitting their limit (X intercept for World Production)

Trading Rates

The trading rate would fall between both countries opportunity costs

• OC_A of LNG < 1 shipment of fuel < OC_B of LNG

Trade determines consumption

Countries balance what supply they keep and what supply they trade

Countries may need to trade for resources to be able to consume that resource, meaning the level of trade between countries dictates their consumption

Benefits of international trade

International trade always increases economic surplus

Specialisation makes trading most effective

Countries can consume past their individual PPF as they import

How we analyse domestic welfare, and importers/exporters

To analyse international trade we compare the domestic autarky market against the international price for importing

If the international price is higher than the domestic, the country exports the product and vice versa

Comparative Advantage Market (Exporter)

When the international price is higher than domestic, producers can raise their price above equilibrium

The loss from reduced domestic demand is offset by international exports

Welfare in an exporting market

With the raise in price, producers take the lost consumer surplus, plus the size of exports

The total economic surplus is raised.

Domestic consumers are negatively affected, and producers benefit

Comparative Disadvantage (Importer)

When the domestic price is lower than the international price consumers will often buy from international producers

Comparative Disadvantage Welfare

Consumers gain the domestic producers’ loss in surplus, plus the size of imports

Total welfare in increased

Consumers benefit, domestic producers don’t

Tariffs

Tariffs are government taxes on imported goods to “raise the world price“ for domestic use

Tariff Welfare

Restricting potential trade will always reduce Total Welfare and cause DWL

Why are tariffs implimented

Protect local jobs

National security (level of independence)

Unfair competition