All Rights Reserved Ch. 16: 1 Principles of Economics second edition © Oxford Fajar Sdn. Bhd. ( T) 2010

All Rights Reserved Ch. 16: 2 Principles of Economics second edition © Oxford Fajar Sdn. Bhd. ( T) 2010 INTERNATIONAL TRADE TOPIC 9

All Rights Reserved Ch. 16: 3 Principles of Economics second edition © Oxford Fajar Sdn. Bhd. ( T) 2010 DEFINITIONS INTERNATIONAL TRADE International trade refers to exchange of goods and services between the people of two countries of the world. INTERNAL TRADE (DOMESTIC TRADE) Internal trade refers to exchange of goods and services within the political boundaries of a country.

All Rights Reserved Ch. 16: 4 Principles of Economics second edition © Oxford Fajar Sdn. Bhd. ( T) 2010 Size of Market and Total Transaction Protectionism Immobility of Factors of Production Natural Resources Monetary Units National Policies Documentation

All Rights Reserved Ch. 16: 5 Principles of Economics second edition © Oxford Fajar Sdn. Bhd. ( T) 2010 DIFFERENCES BETWEEN INTERNATIONAL AND DOMESTIC TRADE 1. Immobility of factors of production -labors are free to move within a country (domestic trade) -immobile or less mobile between one country to another -due to financial constraints, language and cultural differences 2. Availability of natural resources -different countries have different type of resources 3. Monetary units or currencies -within Malaysia, currency used is RM -in international trade, currencies are different

All Rights Reserved Ch. 16: 6 Principles of Economics second edition © Oxford Fajar Sdn. Bhd. ( T) 2010 DIFFERENCES BETWEEN INTERNATIONAL AND DOMESTIC TRADE 4. National policies -Within the country, the laws and regulations are the same -In international trade, laws in other countries are different 5. Documentation -documentations for international trade are greater than domestic trade 6. Protectionism -practiced only in international trade to protect local industries 7. Size of market -production is bigger in internationally compared to domestic

All Rights Reserved Ch. 16: 7 Principles of Economics second edition © Oxford Fajar Sdn. Bhd. ( T) 2010 ABSOLUTE ADVANTAGE THEORY DEFINITION (Adam Smith) The ability of a country to produce more efficiently than another country. Assumptions: 1.There are only two countries in the world. 2.Only two goods are produced. 3.Free trade exists between these two countries. 4.No transportation costs are involved. 5.Identical production functions between trading countries.

All Rights Reserved Ch. 16: 8 Principles of Economics second edition © Oxford Fajar Sdn. Bhd. ( T) 2010 CountryCottonRice Malaysia2060 China4020 TOTAL6080 Malaysia and China are producing cotton and rice. a) Production before specialization China has an absolute advantage in producing cotton. Therefore, China will specialize in the production of cotton. Malaysia has an absolute advantage in producing rice. Therefore, Malaysia will specialize in the production of rice. ABSOLUTE ADVANTAGE THEORY (cont.)

All Rights Reserved Ch. 16: 9 Principles of Economics second edition © Oxford Fajar Sdn. Bhd. ( T) 2010 CountryCottonRice Malaysia0120 China800 TOTAL80120 Malaysia and China will produce rice and cotton respectively. b) Production after specialization Total world output has increased with specialization. ABSOLUTE ADVANTAGE THEORY (cont.)

All Rights Reserved Ch. 16: 10 Principles of Economics second edition © Oxford Fajar Sdn. Bhd. ( T) 2010 CountryCottonRice Malaysia20100 China6020 TOTAL80120 Assume that there is an arrangement to trade 1 tons of cotton for 1 tons of rice. c) Production after international trade takes place Both countries are better off with more goods as a result of international trade. ABSOLUTE ADVANTAGE THEORY (cont.)

All Rights Reserved Ch. 16: 11 Principles of Economics second edition © Oxford Fajar Sdn. Bhd. ( T) 2010 DEFINITION (David Ricardo) The ability of a country to produce goods at a lower opportunity cost than another country. CountryCottonRice Malaysia6015 China2010 TOTAL8025 a) Production before specialization Malaysia has an absolute advantage in producing cotton. Malaysia has an absolute advantage in producing rice. COMPARATIVE ADVANTAGE THEORY

All Rights Reserved Ch. 16: 12 Principles of Economics second edition © Oxford Fajar Sdn. Bhd. ( T) 2010 CountryCottonRice Malaysia15/60 = /15 = 4 China10/20 = 0.520/10 = 2 Opportunity cost is defined as desired goods that one has to forgo to obtain other goods. b) Opportunity Cost Malaysia has lower opportunity cost in the production of cotton. Therefore, Malaysia has comparative advantage in producing cotton. China has lower opportunity cost in the production of rice. Therefore, China has comparative advantage in producing rice. COMPARATIVE ADVANTAGE THEORY (cont.)

All Rights Reserved Ch. 16: 13 Principles of Economics second edition © Oxford Fajar Sdn. Bhd. ( T) 2010 CountryCottonRice Malaysia(15/0.25) + 60 = China0(20/2) + 10 = 20 TOTAL12020 Malaysia will produce cotton and China will produce rice. c) Production after specialization COMPARATIVE ADVANTAGE THEORY (cont.)

All Rights Reserved Ch. 16: 14 Principles of Economics second edition © Oxford Fajar Sdn. Bhd. ( T) 2010 TERMS OF TRADE CountryCottonRice Malaysia8010 China4010 TOTAL12020 Terms of trade Refers to the rate at which goods are exchanged. d) Production after international trade takes place China agrees to trade 10 tons of rice in exchange to 40 tons of rice. Malaysia agrees to trade 40 tons of cotton in exchange to 10 tons of rice. Terms of trade : 1 ton of rice = 4 tons of cotton (1R : 4C) Terms of trade : 1 ton of rice = 4 tons of cotton (1R : 4C)

All Rights Reserved Ch. 16: 15 Principles of Economics second edition © Oxford Fajar Sdn. Bhd. ( T) 2010 ADVANTAGES  Increase world output  Varieties of goods and services  Relationship between trading partners  Higher income and economic growth  Sharing of knowledge and technology  Depletion of country’s reserves  Economic and political dependence  Transportation costs INTERNATIONAL TRADE DISADVANTAGES

All Rights Reserved Ch. 16: 16 Principles of Economics second edition © Oxford Fajar Sdn. Bhd. ( T) 2010 PROTECTIONISM DEFINITION Policy practised by a nation on other nations in which certain barriers are imposed on trade for economic or non-economic reasons. To protect infant industries To protect against unfair trade practices To protect domestic employment Industrial diversification Source of government revenue To correct an adverse balance of payment REASONS FOR PROTECTIONISM

All Rights Reserved Ch. 16: 17 Principles of Economics second edition © Oxford Fajar Sdn. Bhd. ( T) 2010 TOOLS OF PROTECTIONISM TARIFF IMPORT LICENCE EXCHANGE COTROL EMBARGOES QUOTAS INDUSTRY SUBSIDIES

All Rights Reserved Ch. 16: 18 Principles of Economics second edition © Oxford Fajar Sdn. Bhd. ( T) 2010 PROTECTIONISM (cont.) 1. Tariff a) Specific Tariff -fixed tax imposed on a unit of imported goods -eg: RM20 tax on a bottle of imported perfume b) Ad Valorem Tariff -tax imposed based on the value of the imported goods -eg: 20% tax on imported watches TOOLS OF PROTECTIONISM

All Rights Reserved Ch. 16: 19 Principles of Economics second edition © Oxford Fajar Sdn. Bhd. ( T) 2010 PROTECTIONISM (cont.) 2. Quotas -Legal limit on the quantity of goods imported into a country -eg: Malaysia government limit imported TVs to only 10,000 units 3. Embargoes -a law that bars trade with another country -eg: Malaysia bans goods from Israel 4. Import License -control imports by requiring import licenses -eg: limited number of licenses given to firms to import cars from foreign countries

All Rights Reserved Ch. 16: 20 Principles of Economics second edition © Oxford Fajar Sdn. Bhd. ( T) 2010 PROTECTIONISM (cont.) 5. Exchange Control -control the amount of money allowed to be brought into and out of the country -eg: restrictions on the US dollar that can be used by a producer to purchase raw materials from US. 6. Industry Subsidies -government provide subsidies to import-competing or domestic firms that produce export-based output