Unit Four International Trade Theory

International Trade Theory The Trading Game Each person will select an unknown product. Without revealing the product to the rest of the class, record the degree of satisfaction with the product. (1-Low, 5-High) Each person will have the opportunity to make a trade within their group. Trading is optional and only the group members may know the products. After the trade, record the degree of satisfaction. The class will have the opportunity to make a trade. Trading is optional however, the products are fully revealed. After all trading is complete, record the degree of satisfaction.

International Trade Theory The Trading Game How did the satisfaction change as the market of trading opportunities increased?

Unit 4 Vocabulary Absolute Advantage Comparative Advantage Factor Endowment Theory Mercantilism Opportunity Cost

Unit 4 Essential Question What are the various international trade theories and how do they interrelate?

Who is Adam Smith? How is mercantilism applied in modern economics? Essential Question 1 International Trade Theory What is the theory of mercantilism? Amplifying Questions Who is Adam Smith? How is mercantilism applied in modern economics? Mercantilism Handout

Adam Smith Known as “Father of Modern Economic Theory.” Wrote, Inquiry into the Nature and Causes of the Wealth of Nations (1776). Attacked the Theory of Mercantilism.

Mercantilism Economic philosophy based on the belief that a nation’s wealth depends on accumulated treasure, specifically precious metals. Government policies promoted exports and stifled imports. Trade surpluses were settled in precious metals.

Modern Mercantilism Modern mercantilism is known as “economic nationalism”. Trend by some countries to restrict foreign ownership of local businesses and establish strict protectionist laws against imports.

What is absolute advantage? How is absolute advantage calculated? Essential Question 2 International Trade Theory What is the theory of absolute advantage? Amplifying Questions What is absolute advantage? How is absolute advantage calculated? Absolute Advantage Handout

Theory of Absolute Advantage Developed by Adam Smith Under free and unregulated trade, a nation should specialize in producing those goods it could produce most efficiently (had an absolute advantage, either natural or acquired). The capability of a nation to produce more of a good with the same amount of input than another country.

Theory of Absolute Advantage Example: Output per Unit of Input United Commodity States Japan Tons of Rice 3 1 Automobiles 2 4

Theory of Absolute Advantage Example: Output in Days Rice Autos Commodity (1 ton) (1 ton) United States 3 6 Japan 4 5

What is opportunity cost? How is comparative advantage calculated? Essential Question 3 International Trade Theory What is the theory of comparative advantage? Amplifying Questions What is opportunity cost? How is comparative advantage calculated? Comparative Advantage Handout

Theory of Comparative Advantage Developed by David Ricardo. If a nation holds an absolute advantage in the production of two goods trade could still take place with advantages to both countries provided the less efficient country is not equally less efficient in the production of both goods.

Theory of Comparative Advantage A nation having absolute disadvantages in the production of two goods with respect to another nation has a comparative or relative advantage in the production of the good in which its absolute disadvantage is less.

Theory of Comparative Advantage Example: Output per Unit of Input United Commodity States Japan Tons of Rice 6 3 Automobiles 5 4

Theory of Comparative Advantage Example: Output in Days Rice Autos Commodity (1 ton) (1 ton) United States 3 4 Japan 6 5

Essential Question 4 International Trade Theory What is the factor endowment theory? Amplifying Questions What are the factors of production? How should trade be conducted using factor endowment theory? What assumptions are made when using factor endowment theory? Factor Endowment Theory Handout

Factor Endowment Theory Developed by Eli Heckscher and Bertil Ohlin. International and interregional differences in production costs occur because of differences in the supply of production factors.

Factor Endowment Theory Those goods that require a large amount of an abundant – thus less costly – factor will have lower production costs, enabling them to be sold for less on the international market.

Factor Endowment Theory China, well endowed with labor compared to The Netherlands, ought to concentrate on producing labor intensive goods; The Netherlands, with more capital than labor, should specialize in capital intensive goods.

Factor Endowment Theory Assumptions: A given technology is universally available. All consumers have the same or similar tastes. Currency exchange rates remain constant.