BUS 115 Module 9: International Trade and Globalisation

Overview of Globalisation and International Trade

• Definition of Globalisation: Globalisation is characterized by the interdependence of countries across several dimensions:

  • Trade of Products and Services: International exchange of goods and services.

  • Labour (Immigration): The movement of people across borders for work.

  • Capital (International Funds): The movement of financial resources and investment.

  • Technology and Innovation (IP): The sharing and protection of Intellectual Property and technological advancements.

• Drivers of Globalisation:

  • Technological Change: Advances in technology have significantly facilitated the process of globalisation.

  • Market Drivers: Driven by demand for products and various cost factors.

• Benefits of International Trade:

  • Consumption: Increases both the volume and variety of goods available for consumption.

  • Employment: Creates jobs to meet international demand.

  • Standard of Living: Leads to a higher standard of living, measured as GDP per person.

Absolute and Comparative Advantage

• Theoretical Foundation: David Ricardo (1772-1823) proposed that production decisions should be based on the opportunity cost of production.

• Production Possibilities Frontier (PPF):

  • Definition: The set of all points representing the maximum bundle of goods an economy can produce when using all resources efficiently.

  • Efficiency: Points on the PPF are efficient, points inside the curve are inefficient, and points outside are unattainable with current resources.

  • Tradeoffs: Moving along the PPF implies a tradeoff; to get more of one good, some of the other must be sacrificed.

• Opportunity Cost:

  • Defined as the value of the alternative given up to obtain a specific good. There is always an opportunity cost involved in production.

  • Marginal Cost: Relates to the cost of producing one additional unit.

• PPF Shapes and Implications:

  • Concave PPF: Implies an increasing opportunity cost of production. This occurs because resources are diverse; some are better suited for one industry than another. This shape also implies an upward-sloping supply curve.

  • Linear PPF: Implies a constant tradeoff (constant opportunity cost) between two goods.

• Example: Theo the Farmer:

  • Theo can choose between raising chickens ($C$) or printing books ($B$).

  • Linear PPF: $10\,C = 100\,B$.

  • Opportunity Cost for Theo: $1\,C = 10\,B$ (Every chicken costs 10 books) and $1\,B = \frac{1}{10}\,C$ (Every book costs 0.1 chickens).

• Comparative vs. Absolute Advantage:

  • Absolute Advantage: The ability to produce a larger total quantity of a good.

  • Comparative Advantage: The ability to produce a good at a lower opportunity cost than another producer.

• Case Study: Theo and Andrea:

  • Theo's Production: $10\,C = 100\,B$ (Cost of $C$ is $10\,B$; Cost of $B$ is $0.1\,C$).

  • Andrea's Production: $50\,C = 250\,B$ (Cost of $C$ is $5\,B$; Cost of $B$ is $0.2\,C$).

  • Analysis: Andrea has the absolute advantage in both goods. However, Andrea has a comparative advantage in chickens (5\,B < 10\,B), and Theo has a comparative advantage in books (0.1\,C < 0.2\,C).

• Gains from Specialization and Trade:

  • Autarchy (No Trade): Theo consumes 50 books and 5 chickens; Andrea consumes 50 books and 40 chickens.

  • Specialization: Andrea produces 50 chickens; Theo produces 100 books.

  • Trade Agreement: They trade at a rate of 7 books per chicken.

  • Theo sells 49 books for 7 chickens. Result: 51 books and 7 chickens (formerly 50B, 5C).

  • Andrea sells 7 chickens for 49 books. Result: 49 books and 43 chickens (formerly 50B, 40C).

  • Conclusion: Both consume outside their individual PPF by specializing where they have a comparative advantage.

International Trade and Economic Welfare

• Market Equilibrium without Trade (Autarchy):

  • Price adjusts to balance domestic supply and demand.

  • Consumer Surplus (CS): Difference between the price a consumer is willing to pay and the actual price paid. Example: If price is $5, Person A (willing to pay $8) has $CS = \$3$, Person B (willing to pay $7) has $CS = \$2$, and Person C (willing to pay $5) has $CS = \$0$.

  • Producer Surplus (PS): Difference between the cost for the nth unit and the actual price charged. Example: If price is $5, 2nd unit (cost $2) has $PS = \$3$, 4th unit (cost $3) has $PS = \$2$, and 20th unit (cost $5) has $PS = \$0$.

• Impact of Trade in an Importing Country:

  • Domestic price falls to equal the world price ($P_w$).

  • Domestic quantity demanded ($Q_d$) exceeds domestic quantity supplied ($Q_s.dom$).

  • Imports = $Q_d - Q_s.dom$.

  • Welfare Changes: Buyers are better off (CS rises from area A to A+B+D). Sellers are worse off (PS falls from B+C to C). Total surplus increases by area D.

• Impact of Trade in an Exporting Country:

  • Domestic price rises to equal the world price ($P_w$).

  • Domestic quantity supplied ($Q_s$) exceeds domestic quantity demanded ($Q_d.dom$).

  • Exports = $Q_s - Q_d.dom$.

  • Welfare Changes: Buyers are worse off (CS falls from A+B to A). Sellers are better off (PS rises from C to C+B+D). Total surplus increases by area D.

• Foundations of Global Efficiency:

  • Economies of Scale: Expanding markets allows for capitalising on large fixed costs.

  • Access to Resources: Lower-cost inputs.

  • Variety: Diversity in trading opportunities.

  • Competition: Leads to greater efficiency and consumer benefit.

The Market for Currency Exchange and Exchange Rates

• Foreign Exchange (FOREX) Markets:

  • Facilitate the purchase of the right to transact in a specific country.

  • Characteristics: Operates 24 hours a day, 5 days a week; ~$5 trillion traded daily; approaches perfect competition (many buyers/sellers, homogeneous product, good information).

  • Wholesalers: Act to equilibrate prices, reduce transaction costs, and manage risk.

• Currency Mechanics (The Edam and Frankfurt Example):

  • Edam (Cheese, E$) and Frankfurt (Frankfurters, F$).

  • To buy Frankfurters, Edamites must first sell E$ to get F$.

  • If Frankfurt wants pickles from Pickleville (P$) instead of cheese, they can sell E$ to Pickleville, who then uses E$ to buy cheese from Edam.

• Money Demand Components:

  • Transaction Demand: Purchasing goods and services from the foreign country.

  • Asset Demand: Investing in foreign capital, earning foreign interest, or storing value in stable currencies.

• Nominal Exchange Rate ($e$):

  • Defined as the number of units of foreign currency per dollar.

  • Example: On 3 April 2024, $NZD\$1 = £0.47$. Thus, $e = \frac{£0.47}{\$1} = 0.47\,£/\$$.

  • Appreciation: The dollar buys more foreign currency ($e \uparrow$).

  • Depreciation: The dollar buys less foreign currency ($e \downarrow$).

• Market Dynamics for NZD:

  • Demand Shifters: Shifts right ($D \rightarrow$) with increased demand for NZ goods/services, NZ capital (land/finance), higher NZ interest rates, or currency stability/expectations.

  • Supply Shifters: Shifts right ($S \rightarrow$) if NZ markets are undesirable, NZ sellers want other currencies (e.g., for Vietnamese shoes), or high anticipated inflation/instability.

• Scenarios:

  • Scenario 1 (Cricket World Cup): Hosting the finals in NZ (with India playing) increases transaction demand for NZD by Indian fans traveling to NZ. Demand shifts right, exchange rate increases, and NZD appreciates.

  • Scenario 2 (RBNZ Policy): If the Reserve Bank of New Zealand (RBNZ) sells large blocks of NZD, the supply of NZD increases. Supply shifts right, the exchange rate decreases, and NZD depreciates.

The Balance of Payments and Exchange Rate Dynamics

• The Balance of Payments (BoP) Formula: $CA + CFA = 0$ or $CA = -CFA$. It must always balance.

• Current Account (CA):

  • Net Exports: Exports minus imports.

  • Net Factor Payments: Income from foreign assets owned minus payments to foreign owners of domestic assets.

  • Net Transfers: Remittances in minus remittances out.

• Capital and Financial Account (CFA):

  • Net Change in Ownership of Capital: Foreign purchases of domestic assets minus domestic purchases of foreign assets.

  • Net Change in Ownership of Debt: Borrowing minus lending.

• Bilateral Trade Imbalance Example:

  • Edam buys $10 of sausages from Frankfurt but Frankfurt only buys $5 of cheese from Edam ($CA = -\$5$).

  • Frankfurt uses the remaining $5 to buy Edam assets (bank deposits/bonds). This is lending to Edam ($CFA = +\$5$).

  • Edam pays for imports via a mix of exports and financial assets/debt.

• Exchange Rate Impacts on Trade and Capital:

  • Appreciating Dollar: Helps importers (buy more for less) but harms exporters (domestic goods become expensive for foreigners). It makes it harder for foreigners to buy domestic capital but easier for locals to buy capital overseas.

  • Depreciating Dollar: Helps exporters and harms importers. It makes it easier for foreigners to buy domestic capital but harder for locals to buy capital overseas.

• Summary of Interdependence:

  • Changes in the CA (driven by trade) will impact the CFA, and vice versa.

  • For example, if lots of money flows in for capital (CFA surplus), it makes the currency more expensive, potentially causing a trade deficit (CA deficit).