Chapter 10 – International Trade

Factor Endowment

• An advantage in production comes from better skills, equipment, specialization, or other resources  

• Differences in trade patterns are the result of: 

  • Differences in climate, natural resources, human capital, policies 

Theory of Absolute Advantage

• Nations, like firms and individuals, should specialize in producing goods and services for which they have an advantage and trade for goods and services they do not have an advantage in  

• Specialization leads to increased total production. But if a country is going to specialize, it will need to trade in order to obtain those products it is not producing. Specialization implies trade. 

Theory of Comparative Advantage 

The advantage that comes from producing something at a lower opportunity cost than others are able to do  

Terms of Trade 

The average price of a country's exports compared with the price of its imports. Average exports/Average Imports

Advantages of Free Trade

• Lower prices as the result of lower costs of production 

• Higher incomes 

• Greater variety and quality of products 

• Increased competition  

Trade protection

• Import quotas – a limit imposed on the production or sale of a product  

• Protectionism – the economic policy of protecting domestic producers by restricting the importation of foreign products   

• Tariff – tax on imports 

• Currency exchange controls - government restrictions limited the amount of foreign currencies that can be obtained  

• Bureaucratic regulations – rules that make it challenging for foreign products enter the country's, or require them to be modified before entering  

• Voluntary export restriction (VER) - an agreement by an exporting country to restrict the amount of its exports to another country   

Import quotas

Raise the price, lower imports and increase domestic production

Tariffs

Raise the price, lower imports, increase domestic production and raise tax revenue

Arguments Against Free Trade  

• Strategic industry argument  

  • A country's strategic industries may be offered protection so the country does not become dependent on foreign manufacturers 

• Infant industry argument  

  • Certain 'infant' industries may be protected until they are sufficiently mature to take on foreign competition  

• Cultural identity argument  

  • Free trade brings mass protection and standardization, which may impact country's sense of identity  

• Environmental and labor standards 

  • May be eroded to compete with countries whose standards are lower and have a cost advantage as a result  

If domestic demand exceeds the domestic production, import or export?

Import