The importance of international trade Chapter 62

Why trade? 1. Sell off unwanted surpluses.

Why trade? Obtain goods which are impossible to find at home. This applies not just to individuals buying goods, but firms buying raw materials.

Why trade? Obtain reserves of foreign currency.

Why trade? Trade allows a country to specialise.

Absolute advantage Exists when a country is able to produce a good more cheaply in absolute terms than another country.

Absolute advantage Dolls Teddy bears Spain 25 10 France 12 30

Absolute advantage So it is mutually beneficial for Spain to specialise in the production of dolls and France to specialise in the production of teddy bears and they trade with each other. Trade has helped increase their total combined output of dolls and teddybears from …. to ……

There are a couple of assumptions we need to make 1. There are no transport costs. 2. a doll is as valuable as a teddybear. 3. there are constant returns to scale. 4. factors of production can switch easily between doll and teddybear production. 5. products are homogeneous – so a French doll is the same as a Spanish doll.

Absolute advantage Even though those assumptions are a bit unrealistic – the theory of absolute advantage is still valid.

USA and France

It makes enormous sense for Belgium to specialise in beer and for Italy to specialise in wine, for example.

Comparative advantage Dolls Teddybears Spain 15 30 France 12 10

In the second example, it is clear that Spain has absolute advantage in both dolls and teddy bears. So, is there any point in Spain trading with France?

The opportunity cost for Spain of producing 1 doll is… The opportunity cost for Spain of producing 1 doll is….. The opportunity cost for France of producing 1 doll is……

As opportunity costs differ, it is still mutually beneficial for both countries to trade. Spain has comparative advantage at producing teddybears and France has comparative advantage of producing dolls.

Comparative Advantage The ability to produce a good relatively more efficiently – or at a lower opportunity cost.

Comparative advantage Dolls Teddybears Spain 15 30 France 12 10

Comparative advantage Dolls Teddybears Spain 60 France 24

Before specialisation France and Spain’s combined output was 67 units of dolls and teddy bears.

After Specialisation. France and Spain’s combined output is 84 units of dolls and teddy bears.

Consider two goods – agriculture and technology Consider two goods – agriculture and technology. The EU (better capital, education, infrastructure and governance) has absolute advantage in both TVs Boxes of fruit EU 100 Africa 1 40

But, Comparative advantage considers the …………………… But, Comparative advantage considers the ……………………. …………… of producing one extra unit of a good or service. So, for every box of fruit the EU produces, it gives up …………………………………… However, for every box of fruit Africa produces, they only give up ………………………………………………..

Therefore, if both countries trade they end up producing

Apart from Africa/EU with fruit and TVs, can you think of other, practical examples.

However…..

Any relevant example?

Any relevant example? The USA has absolute advantage over Senegal in the production of both movies and sugar. But by allowing Senegal to specialise in sugar and the USA in movies, both countries can end up better off. (This assumes that watching a movie from America satisfies your utility, some American movies can make you physically sick)

Terms of Trade The ratio of export prices to import prices.

Price of exports x100 = TOT Price of imports

Country A exports tea and imports apples Country A exports tea and imports apples. Tea per unit is $12 and apples per unit is $15. Their terms of trade is …….. Apples then fall in price to $9, their terms of trade are….

When terms of trade improve: a country has to export less to be able to buy a given quantity of imports. When terms of trade worsen: a country has to export more to be able to buy a given quantity of imports.