Chapter 32 - Lecture notes 32 PDF

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Chapter 32: The Gains from International Trade Chapter Outline/Learning Objectives Fig. 32-1 The Growth in World Trade, 1950–2013 Fig. 32-2 Canadian Exports and Imports of Goods by Industry, 2014

33.1 The Gains from Trade 

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An open economy is an economy that engages in international trade. A closed economy is an economy that has no foreign trade.

Interpersonal, Interregional, and International Trade Without trade, everyone must be self-sufficient. With trade, people can specialize in what they do well and satisfy other needs by trading.

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With trade, each individual, region, or country is able to concentrate on producing goods and services that it produces efficiently while trading to obtain goods and services that it does not produce efficiently. The gains from trade is the increased output attributable to the specialization that is made possible by trade.

Interpersonal, Interregional, and International Trade Illustrating the Gains from Trade

One region has an absolute advantage over another in the production of good X when an equal quantity of resources can produce more X in the first region than in the second.

Illustrating the Gains from Trade One country has a comparative advantage in the production of good X if the cost of producing X in terms of forgone output of other goods is lower in that country than in another.

Illustrating the Gains from Trade 

World output increases if countries specialize in the production of the goods in which they have a comparative advantage.

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Conclusions: The opportunity cost of producing X is the output of other products that must be sacrificed to increase the output of X by one unit. Country A has a comparative advantage over Country B in producing a product when its opportunity cost of production is lower.

Illustrating the Gains from Trade   

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Conclusions: When opportunity costs for all products are the same in all countries, there is no comparative advantage and no possibility of gains from specialization and trade. When opportunity costs differ in any two countries and both countries are producing both products, it is always possible to increase production of both products by a suitable reallocation of resources within each country.

Illustrating the Gains from Trade

The Gains from Trade with Variable Costs 

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If costs vary with the level of output, or as experience is acquired via specialization, additional gains are possible.

Economies of scale In industries with significant scale economies, small countries that do not trade will have low levels of output and high costs. With international trade, small countries can produce for the large global market and produce at lower costs. International trade allows small countries to reap the benefits of scale economies.

Costs may vary with accumulated experience in producing a product over time. Learning by doing is the reduction in unit costs that often results as workers learn through repeatedly performing the same tasks. It causes a downward shift in the average cost curve.

Learning by Doing Fig. 32-4 Economies of Scale Versus Learning by Doing 

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Economy of scale is shown by the downward sloping LRAC curve. Learning by doing shifts the cost curve from LRAC to LRAC’. The movement from a to b’ incorporates both economies of scale and learning by doing.

Sources of Comparative Advantage  

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Different Factor Endowments According to the Heckscher-Ohlin theory, countries have comparative advantages in the production of goods that use intensively the factors of production with which they are abundantly endowed.

Different Climates

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A country’s comparative advantage is influenced by various aspects of its climate.

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People can acquire skills—human capital—that influence a country's comparative advantage.

Acquired Comparative Advantage With today’s growing international competition and rapidly changing technologies, no country’s comparative advantages are secure unless its firms innovate and keep up with their foreign competitors and its education system produces workers, managers, and innovators with the requisite skills.

Human Capital 33.2 The Determination of Trade Patterns  

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The Law of One Price The law of one price states that when a product is traded throughout the entire world, the prices in various countries (net of any specific taxes or tariffs) will differ by no more than the cost of transporting the product between countries. Aside from differences caused by these transport costs, there is a single world price.

The Patterns of Foreign Trade 

Exports occur whenever there is excess supply domestically at the world price.

Fig. 32-5 An Exported Good

The Patterns of Foreign Trade 

Imports occur whenever there is excess demand domestically at the world price.

Fig. 32-6 An Imported Good

Is Comparative Advantage Obsolete?

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The theory that comparative advantage is a major influence on trade flows is not obsolete. The theory that comparative advantage is completely determined by forces beyond the reach of decisions made by private firms and by public policy has been discredited.

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The terms of trade is the ratio of the average price of a country’s exports to the average price of its imports. A rise in the price of imported goods, with the price of exports unchanged, indicates a fall in the terms of trade. A rise in the price of exported goods, with the price of imports unchanged, indicates a rise in the terms of trade.

The Terms of Trade  

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International trade involves many countries and many products, so we cannot use the simple ratio of the prices of two goods to calculate the terms of trade. So a country’s terms of trade are computed as an index number:

A rise in the index is referred to as a favourable change in a country’s terms of trade. A decrease in the index of the terms of trade is called an unfavourable change. The terms of trade are quite variable, reflecting frequent changes in the relative prices of different products.

Fig. 32-8 Canada's Terms of Trade, 1961– 2015...