By Mr. LAU san-fatCH7-International Trade-SV1 HKCEE Macroeconomics w Chapter 7:International Trade

By Mr. LAU san-fatCH7-International Trade-SV2 Why do Countries Trade? wself-sufficiency cannot be achieved wcheaper products could be enjoyed wraising standard of living by enjoying a larger variety of products

By Mr. LAU san-fatCH7-International Trade-SV3 The Model of Absolute Advantage w Absolute Advantage (AA)  allows a country to produce more of a good with the same amount of resources  allows a country to produce the same amount of a good with less resource

By Mr. LAU san-fatCH7-International Trade-SV4 The Model of Absolute Advantage w An Illustration Unit(s) of product being produced with 1 unit of resource Good AGood B Country X3or1 Country Y1or9 w AA in producing good A: w AA in producing good B: Country X Country Y

By Mr. LAU san-fatCH7-International Trade-SV5 The Model of Absolute Advantage  Task 1 ： Study the table below and find out which country has the AA in producing goods A and B. Unit(s) of product being produced with 1 unit of resource Good AGood B Country X6or1 Country Y4or2

By Mr. LAU san-fatCH7-International Trade-SV6 The Model of Absolute Advantage  Task 2 ： Study the table below and find out which country has the AA in producing goods A and B. Unit(s) of resources required for producing 1 unit of… Good AGood B Country X210 Country Y31

By Mr. LAU san-fatCH7-International Trade-SV7 The Model of Absolute Advantage w The Principle of Absolute Advantage  Limitation: Trade would not occur if countries enjoy NO absolute advantage in production.  It states that countries should specialize in producing goods with absolute advantage.  They would then gain if they follow the principle to trade with other countries

By Mr. LAU san-fatCH7-International Trade-SV8 The Model of Comparative Advantage w Comparative Advantage (CA)  A country is said to have a comparative advantage in producing a good over others if it can produce the good at a lower opportunity cost than other countries.

By Mr. LAU san-fatCH7-International Trade-SV9 The Model of Comparative Advantage w An Illustration Unit(s) of product being produced with 1 unit of resource Good AGood B Country X6or12 Country Y5or3

By Mr. LAU san-fatCH7-International Trade-SV10 The Model of Comparative Advantage w An Illustration Opportunity cost of producing 1 unit of … Good AGood B Country X12B/6 = 2Bor6A/12 = 0.5A Country Y3B/5 = 0.6Bor5A/3 = 1.67A

By Mr. LAU san-fatCH7-International Trade-SV11 The Model of Comparative Advantage  Task 3 ： Study the table below and find out which country has the CA in producing goods A and B. Unit(s) of product being produced with 1 unit of resource Good AGood B Country X6or1 Country Y4or2

By Mr. LAU san-fatCH7-International Trade-SV12 The Model of Comparative Advantage  Task 3 ： Study the table below and find out which country has the CA in producing goods A and B. Unit(s) of product being produced with 1 unit of resource Good AGood B Country X6or1 Country Y4or2 1B/6 = 0.17B 2B/4 = 0.5B Opportunity cost of producing 1 unit of … 6A/1 = 6A 4A/2 = 2A

By Mr. LAU san-fatCH7-International Trade-SV13 The Model of Comparative Advantage  Task 4 ： Study the table below and find out which country has the CA in producing goods A and B. Unit(s) of resources required for producing 1 unit of… Good AGood B Country X210 Country Y39

By Mr. LAU san-fatCH7-International Trade-SV14 The Model of Comparative Advantage  Task 4 ： Study the table below and find out which country has the CA in producing goods A and B. Unit(s) of resources required for producing 1 unit of… Good AGood B Country X210 Country Y39 Opportunity cost of producing 1 unit of … 2/10B = 0.2B 3/9B = 0.3B 10/2A = 5A 9/3A = 3A

By Mr. LAU san-fatCH7-International Trade-SV15 The Model of Comparative Advantage w The Law/Principle of Comparative Advantage  It states that countries should specialize in producing goods with comparative advantage.  They then would gain if they follow the principle to trade with other countries  Total output will be increased by engaging specialization in production.

By Mr. LAU san-fatCH7-International Trade-SV16 The Model of Comparative Advantage w An Illustration  There are two countries only  Each country has 2 man-hours  Each country produces 2 goods only  No country could live on one good only  Without international trade, each country is under self-sufficient

By Mr. LAU san-fatCH7-International Trade-SV17 The Model of Comparative Advantage w Given: Unit(s) of product being produced with 1 unit of resource Good AGood B Country X6or12 Country Y5or3

By Mr. LAU san-fatCH7-International Trade-SV18 The Model of Comparative Advantage w Under Self-sufficient  Assume each country devotes equal amount of resources (i.e. 1 man-hour) to produce both goods. Units of product produced Good AGood B Country X6AND12 Country Y5AND3 Total Output 11 AND 15

By Mr. LAU san-fatCH7-International Trade-SV19 The Model of Comparative Advantage w After Specialization  Country X spends 0.5 man-hour in producing good A and 1.5 man-hours on good B.  Country Y spends all 2 man-hours in producing good A.

By Mr. LAU san-fatCH7-International Trade-SV20 The Model of Comparative Advantage w After Specialization Units of product produced Good AGood B Country X6(0.5) = 3AND12(1.5)=18 Country Y5(2)=10AND3(0)=0 Total OutputAND Total Output under Self-sufficient AND Net IncreaseAND

By Mr. LAU san-fatCH7-International Trade-SV21 Terms of Trade and Gains from Trade w Terms of Trade (TOT) TOT = ?X:1M TOT should be mutually beneficial to trading partners. TOT should be set in-between the opportunity costs of trading partners. TOT refers to the amount of goods that a nation must export for one unit of a good that she imports.

By Mr. LAU san-fatCH7-International Trade-SV22 w Find both countries’ O.C. in their productions from the table below. Unit(s) of product being produced with 1 unit of resource Good AGood B Country X6or12 Country Y5or3 Terms of Trade and Gains from Trade

By Mr. LAU san-fatCH7-International Trade-SV23 Terms of Trade and Gains from Trade w Finding the beneficial TOT: Good A: 0.6B-2B Mutually beneficial TOT: or Good BGood A (5A/3=)1.67A(3B/5=)0.6BCountry Y (6A/12=)0.5A(12B/6=)2BCountry X Opportunity Cost of producing 1 unit of … Good B:0.5A-1.7A

By Mr. LAU san-fatCH7-International Trade-SV24 Terms of Trade and Gains from Trade w Gains from Trade to Importing Country Unit Gains from Trade = Domestic O. C. (saved) - TOT Total Gains from Trade = Unit Gains x Amount Imported

By Mr. LAU san-fatCH7-International Trade-SV25 Terms of Trade and Gains from Trade w Gains from Trade to Exporting Country Units Gains from Trade = TOT - Domestic O. C. Total Gains from Trade = Unit Gains x Amount Exported

By Mr. LAU san-fatCH7-International Trade-SV26 Terms of Trade and Gains from Trade w Task 5a: Find the opportunity cost of both countries in producing goods A and B. Given: Output/1 man-hour: Country X: 6A or 12B Output/1 man-hour: Country Y: 5A or 3B Each country has 2 man-hours only Complete specialization Country X exports 5B

By Mr. LAU san-fatCH7-International Trade-SV27 Terms of Trade and Gains from Trade w The opportunity cost of both countries in producing goods A & B are below: or Good BGood A (5A/3=)1.67A(3B/5=)0.6BCountry Y (6A/12=)0.5A(12B/6=)2BCountry X Opportunity Cost of producing 1 unit of …

By Mr. LAU san-fatCH7-International Trade-SV28 Terms of Trade and Gains from Trade w Task 5b: Find the gains from trade for both countries if the TOT is (a) 1A:1B (b) 1A:2B (c) 2A:1.2B

By Mr. LAU san-fatCH7-International Trade-SV29 Terms of Trade and Gains from Trade w (a) When TOT = 1A:1B Unit Gains from Trade to Importing country, Y = Domestic O. C. (saved) - TOT = 1.67A - 1A = 0.67A (saved) Unit Gains from Trade to Exporting country, X = TOT - Domestic O. C. = 1A - 0.5A = 0.5A

By Mr. LAU san-fatCH7-International Trade-SV30 Terms of Trade and Gains from Trade w (a) When TOT = 1A:1B Total Gains from Trade to Importing country, Y = Unit Gains x Amount Imported = 0.67A(5) = 3.35A (saved) Total Gains from Trade to Exporting country, X = Unit Gain x Amount Exported = 0.5A(5) = 2.5A

By Mr. LAU san-fatCH7-International Trade-SV31 Terms of Trade and Gains from Trade w (b) When TOT = 1A:2B (  1B = 0.5A) Unit Gains from Trade to Importing country, Y = Domestic O. C. (saved) - TOT = 1.67A - 0.5A = 1.17A (saved) Unit Gains from Trade to Exporting country, X = TOT - Domestic O. C. = 0.5A - 0.5A = 0A

By Mr. LAU san-fatCH7-International Trade-SV32 Terms of Trade and Gains from Trade w (b) When TOT = 1A:2B(  1B = 0.5A) Total Gains from Trade to Importing country, Y = Unit Gains x Amount Imported = 1.17A(5) = 5.85A (saved) Total Gains from Trade to Exporting country, X = Unit Gain x Amount Exported = 0A(5) = 0A

By Mr. LAU san-fatCH7-International Trade-SV33 Terms of Trade and Gains from Trade w (c) When TOT = 2A:1.2B(  1B =1.67A) Unit Gains from Trade to Importing country, Y = Domestic O. C. (saved) - TOT = 1.67A A = 0A (saved) Unit Gains from Trade to Exporting country, X = TOT - Domestic O. C. = 1.67A - 0.5A = 1.17A

By Mr. LAU san-fatCH7-International Trade-SV34 Terms of Trade and Gains from Trade w (c) When TOT = 2A:1.2B(  1B =1.67A) Total Gains from Trade to Importing country, Y = Unit Gains x Amount Imported = 0A(5) = 0A (saved) Total Gains from Trade to Exporting country, X = Unit Gain x Amount Exported = 1.17A(5) = 5.85A

By Mr. LAU san-fatCH7-International Trade-SV35 Terms of Trade and Gains from Trade w Task 6 Referring to your findings in Task 5: How is the TOT set to allow the importing country capture ALL the gains from trade? How is the TOT set to allow the exporting country capture ALL the gains from trade? Is it still beneficial for a country to trade if its gains from trade is zero?

By Mr. LAU san-fatCH7-International Trade-SV36 Terms of Trade and Gains from Trade w The importing country will capture ALL the gains from trade if the TOT is set equal to the exporting country’s domestic opportunity cost. w The exporting country will capture ALL the gains from trade if the TOT is set equal to the importing country’s domestic opportunity cost.

By Mr. LAU san-fatCH7-International Trade-SV37 Terms of Trade and Gains from Trade w Country with zero gains from trade will still trade for other benefits: To enjoy goods that it cannot produce. To enjoy higher standard of living. To maintain better international relationship. To improve skills and techniques of production by examining imports

By Mr. LAU san-fatCH7-International Trade-SV38 Terms of Trade and Gains from Trade w Task 7 Given: each country has its own comparative advantage in production trading parties reach a mutually beneficial terms of trade Question: Must trade take place? Answer: NO

By Mr. LAU san-fatCH7-International Trade-SV39 Factors Affecting Trade w Potential trade might be halted if: the transportation cost outweighs the potential gains from trade. the other costs of conducting trade (e.g. insurance cost) becomes prohibitively high when serious political problems occur, e.g. wars.

By Mr. LAU san-fatCH7-International Trade-SV40 Free Trade w Benefits of Free Trade: More output could be produced. Mass production allows firms to enjoy economies of scale. Exchange of technology is allowed. Standard of living is higher with a larger variety of cheaper imports. More employment opportunities Better international relationship

By Mr. LAU san-fatCH7-International Trade-SV41 w Promotion of Free Trade: World Trade Organization, WTO: reducing trade barriers Generalized Schemes of Preference, GSP: low/no tariffs to developing countries Asia-Pacific Economic Cooperation, APEC: promoting free trade & economic cooperation North America Free Trade Agreement, NAFTA: promoting tariff-free trade Free Trade

By Mr. LAU san-fatCH7-International Trade-SV42 w Tariffs Tariffs are taxes on imports. Trade Restrictions(1) Tariffs can be per-unit tax or ad valorem tax (i.e. percentage tax). w Effects of Tariffs on Imports Cost of production increases Supply of imports decreases Import price increases Quantity imported/transacted falls

By Mr. LAU san-fatCH7-International Trade-SV43 w Effects of Tariffs on Imports Trade Restrictions(1) P D S1 0 P1 Q1 Q S2 tax P2 Q2

By Mr. LAU san-fatCH7-International Trade-SV44 w Import Quota Import quota fixes the maximum amount or value of imports during a given period. Trade Restrictions(2) w Effects of Import Quotas on Imports Supply of imports decreases Import price increases Quantity imported/transacted falls Kinked Supply curve resulted

By Mr. LAU san-fatCH7-International Trade-SV45 w Effects of Quota on Imports Trade Restrictions(2) P D S1 0 P1 Q1 Q P2 Q2 S2 Quota

By Mr. LAU san-fatCH7-International Trade-SV46 w Comparison Between Tariffs & Quota Trade Restrictions

By Mr. LAU san-fatCH7-International Trade-SV47 w Subsidies to Local Goods Trade Restrictions (3) A sum of money provided by the government for local production Lower cost allows larger local supply Effects: Local product prices fall leading to more local products demanded Demand for imports falls and thus fewer products being imported

By Mr. LAU san-fatCH7-International Trade-SV48 w Embargo Trade Restrictions (4) A ban on imports Total embargo versus partial embargo It is imposed for political reasons

By Mr. LAU san-fatCH7-International Trade-SV49 w Exchange Control Trade Restrictions (5) A government control on the buying and selling of foreign currencies Imports will be reduced by limiting the amount of foreign currencies available

By Mr. LAU san-fatCH7-International Trade-SV50 w Voluntary Export Restriction Trade Restrictions (6) The exporting countries themselves restrict their exports to some other countries Imports to Country A will then be reduced if Country B restricts her exports voluntarily.

By Mr. LAU san-fatCH7-International Trade-SV51 w To protect local industries Reasons for Trade Restrictions w To enhance employment opportunity w To raise tariff revenue w To reduce balance of payments deficit w To undergo industrial diversification w For political reasons