Economics

Unit 7: International Trade

OBJECTIVES

  • At the end of the document, the learner should be able to:

    • Define key terms and concepts associated with international trade.

    • Explain the rationale for international trade.

    • Describe the primary factors that influence the level of international trade.

    • Explain the concept of gains from trade.

Key Terms

  • Trade: The exchange of goods and services.

  • International Trade: Refers to exchanges of goods and services between countries and the citizens of these countries.

    • Specialization: Involves the use of resources by a nation to produce the goods and services for which those resources are best suited.

    • Specialization allows each country to produce commodities at the cheapest opportunity cost.

Rationale for International Trade

  • Necessity for Goods: Citizens of one country may desire goods produced in another country because local options are too expensive or unavailable.

    • Example: Caribbean countries need to trade for machinery, equipment, cars, computer software, etc.

  • Uneven Resource Distribution: Economic resources such as natural, human, and capital goods are unevenly distributed among nations, leading nations to specialize in producing specific goods and services.

Factors Influencing International Trade

  • Level of Exports is influenced by:

    • International prices

    • Population growth rates

    • Domestic prices & exchange rates

    • Changes in international incomes

    • Domestic production

    • International economic activities

    • Shifts in international demand

  • Level of Imports is influenced by:

    • Domestic income

    • Domestic prices and inflation

    • Exchange rates

    • Changes in local tastes and preferences

    • Existence of domestic substitutes

    • Government restrictions such as tariffs & custom duties

GAINS FROM TRADE

  • Definition: Gains from trade refer to the amount by which a country benefits from trade, resulting from specialization and increasing returns to scale.

    • Importance: Gains from trade are crucial in determining the trading policies of nations; when gains are low, a country may lean towards protectionist measures.

  • Protectionist Methods include tariffs, subsidies, quotas, and embargos.

Absolute Advantage

  • Definition: A theory of examining gains from specialization developed by economist Adam Smith.

    • According to this theory, trade between two countries is beneficial if one country has an absolute advantage over the other in producing a good.

    • This means one country can produce a particular product more efficiently and cheaper than others, or at a lower per unit resource cost.

Absolute Advantage: Assumptions

  • Assumptions of the theory:

    • There are only 2 countries and 2 goods being produced.

    • No transportation costs exist.

    • Both countries have the same amount of resources.

    • The countries cannot produce the same products in the same proportions.

Example: Production per Labour Hour of Resources

  • Countries: Guyana and Jamaica

  • Production Data:

    • Sugar Production (million tons):

    • Guyana: 100

    • Jamaica: 50

    • Bauxite Production (million tons):

    • Guyana: 50

    • Jamaica: 100

  • Total Production (World):

    • Sugar: 150 million tons

    • Bauxite: 150 million tons

Outcome of Specialization

  • If both countries specialize in producing the goods they are most efficient at:

    • Guyana:

    • Sugar Production: 200 million tons

    • Bauxite Production: 0 million tons

    • Jamaica:

    • Sugar Production: 0 million tons

    • Bauxite Production: 200 million tons

  • Total Production (World) after specialization:

    • Sugar: 200 million tons

    • Bauxite: 200 million tons

Comparative Advantage

  • Definition: The second theory of examining gains from specialization, developed based on David Ricardo’s argument.

    • A country can benefit from international trade if it can produce a good with the lowest relative opportunity cost.

Comparative Advantage: Assumptions

  • Assumptions of the theory include:

    • Factors of production are mobile within countries but immobile between countries.

    • Countries have homogenous tastes in products like cars, music, fast food, etc.

    • There is a constant return to scale.

    • No learning or experience curve exists (goods do not become easier to produce over time).

Example: Oil and Natural Gas Production

  • Countries: Trinidad and Barbados

  • Production Data:

    • Trinidad:

    • Oil Production: 100 million tons

    • Natural Gas Production: 50 million tons

    • Barbados:

    • Oil Production: 5 million tons

    • Natural Gas Production: 10 million tons

  • Trinidad has an absolute advantage in both goods but should specialize in producing oil.

  • Barbados has a comparative advantage in natural gas because:

    • Trinidad produces oil 20 times faster than Barbados but only 5 times faster in natural gas.

  • Total Production (World) before specialization:

    • Oil: 105 million tons

    • Natural Gas: 60 million tons

Continued Example of Specialization

  • Trinidad will allocate some resources to oil production while still producing some natural gas:

    • Resource Allocation:

    • Trinidad: 110 million tons of oil and 45 million tons of natural gas.

    • Barbados: 0 million tons of oil and 20 million tons of natural gas.

  • Total Production (World) after specialization:

    • Oil: 110 million tons

    • Natural Gas: 65 million tons

  • This demonstrates a “nothing lost, everything to gain” situation or a “win-win” scenario for both countries.

ASSIGNMENT

  • Define the following key terms relevant to understanding International Trade:

    1. Balance of trade

    2. Balance of payments

    3. Tariff

    4. Common External Tariff (CET)

    5. Quota

    6. Exchange rate

    7. Exchange rate regime

    8. World Trade Organization (WTO)