Global Econ- International Trade

Sectors of the Circular flow of Income

In economics, the sectors of the circular flow of income include households, production, government, finance and the foreign sector.

Leakages and Injections into the circular flow of income.

Leakages: savings (finance), tax (gov) and imports (foreign)

Injections: investment (finance), government spending, and exports (foreign)

Leakage causes contraction and injection causes growth, when these are in balance economic equilibrium occurs.

International Economic Problem

How countries with limited resources decide what to produce and trade best satisfy unlimited wants. This necessitates specialization and international trade to supplement finite resources.

Reasons why nations engage in trade

Nations trade due to the unequal distribution of: 1. Natural resources (e.g., exporting oil or minerals). 2. Capital and technology (e.g., exporting microchips or medical machinery). 3. Labor and expertise (e.g., specialized manufacturing or technical services).

Improve quality of life (e.g. phones, imported food).

Profit motive (eg. some companies can earn more selling overseas, BHP selling iron in China)

Barriers to International Trade

Different currencies, cost structures (wages, production cost, regulations), social factors (language, values, consumer preferences), and technical differences (standards, regulations, safety requirements related to the good itself instead of cost).

Benefits of international trade

1. Consumers → more choice, better prices and quality

2. Domestic companies → can export, achieving economies of scale, more profit and sales

3. Economic growth → more demand for exports, foreign investment, innovation and productivity

4. Access to physical capital → industry development

5. Improved Quality of Life → better goods, more jobs

Drawbacks of international trade

1. Domestic companies can go out of business if uncompetitive

2. Job loss in uncompetitive industries

3. Regions with a high concentration of uncompetitive industries suffer: economic decline, less development, widespread unemployment

What is absolute advantage?

Trade theory by Adam Smith.

Countries should specialise in producing goods that it can make more efficiently than other nations using factors of endowments (labour, land, or resources) to it’s advantage.

Increases overall efficiency and global output.

Comparative Advantage

Trade theory by David Riccardo.

Countries should specialise in producing goods that have a lower opportunity cost, even if they don’t have absolute advantage.

By doing so, all countries allocate resources more efficiently, increased total output.

Oppurtunity Cost formula

Oppurtunity Cost of Good A = Quantity of Good B given up/ Quantity of Good A gained

Competitive Advantage

Michael Porter’s trade theory- countries become successful when conditions in their domestic economy encourage innovation and productivity, their success isn’t solely due to natural resources or low costs.

What conditions must be met for a country to achieve a competitive advantage in an industry?

Porter Diamond

Factor Conditions: Country must have skilled labour, infrastructure, and technology.

Demand Conditions: Sophisticated (knowledgeable) and demanding local market to push firms to innovate and improve quality.

Related and Supporting Industries: Efficient competitive supplier and partner industries help boost productivity and innovation.

Firm Strategy, Structure and Rivalry: Local firms must have strategic goals, strong management and healthy domestic competition, which drives efficiency and global competitiveness.