TOPIC 7

International Trade
 Definitions:
• Trade or trading:
refers to the
transactions or the
exchanges of
ownership of goods
and services.
and,
•Domestic Trade:
refers to the transactions made
domestically among the domestic
traders in a country only.
while,
•International Trade (IT):
refers to transactions made
among different countries
in the world, whereby
involves export and import.
• Why do countries tend to
trade with the rest of the
world?

• Why don’t they become

self-sufficient?
• Indeed, large countries like China and
America would also like to trade with
other nations in the global economy.
– they do not want to become self-
sufficient:
i.e. to produce all goods they
consume and restrict foreign
goods into their country.
• While China now tend to become an “open
economy” i.e. widely open to their trading partners
– allowing exports and imports activities.
this explains how important is the
International Trade.
 International Trade
can also be referred as:
INTERNATIONAL
SPECIALISATION
- Specialisation is said as
the basis for trade.
- The benefit receives from
specialisation is that it may
improves economic growth.
 M’sia Real GNP with Net Exports
1999 2000 2001 2002 2003 2004*
• Real GNP (RM Billion) 101.7 179.8 190.3 192.8 200.6 212.2
• Net Merchandise
Exports (RM Billion) 0.5 73.1 92.6 53.7 51.1 53.1

(source: Malaysia key economic indicators: Malaysian Export Directory of

Manufacturers)
 M'sian Real GNP with Net Exports

250

200
RM(Billion)

150

100

50

0
1999 2000 2001 2002 2003 2004*

year

•Real GNP (RM Billion) •Net Merchandise Exports

 Growth rates and export performance of
selected secondary outward-looking countries
Growth in real GDP and in real exports of goods
and services: total OECD countries
Growth in real GDP and in real exports of goods
and services: total OECD countries

Growth in GDP
Growth in real GDP and in real exports of goods
and services: total OECD countries

Growth in GDP
Growth in real GDP and in real exports of goods
and services: total OECD countries
Growth in exports of
goods and services

Growth in GDP
Growth in real GDP and in real exports of goods
and services: total OECD countries
Growth in exports of
goods and services

Growth in GDP
 Specialisation
means
- one country will specialise
in a good that she is best at
and will trade among them.
 WHAT are the
REASONS
for COUNTRIES to
TRADE
INTERNATIONALLY ?
Since there’re so much
benefits or advantages
that may bring these
countries to involve in
international trading,
which are:
 The advantages of Int.Trade
i. To obtain the benefit from
specialisation:
Theories of specialisation proves that ;
after specialisation, their production, consumption and
thus standard of living has increased; and at the same
time lower the cost and benefit countries that involves
in trading.
- and this proves that self-sufficient is inefficient.
2 types of specialisation :
i) absolute advantage or
ii) comparative advantage.
 The advantages of Int.Trade
ii. Wider consumer choice –
varieties of goods to choose:
may enjoy different
types of goods.
Differences in taste
across countries
prompt the global
trading and large
demand.
 The advantages of Int.Trade
iii. To expand the market and may
benefits from Economies of Scale –
decreasing cost:
countries can gain
from huge demand
of global market by
lowering its long run
average cost; which
declines as the rate
of production increases.
 The advantages of Int.Trade
iv. Increases national income:
specialisation
helps to increase Growth in exports of
the volume of goods and services

exports and
raises GDP

Growth in GDP
 The advantages of Int.Trade
v. Different factor endowments:
raw materials, climate, specialist
labour, capital or technology that
may caused to produce different
types of goods.
 The advantages of Int.Trade
vi. Limited mobility of factors:
human capital usually are non-mobile:
higher cost of production
– costly to produce,
so import goods from
cheap countries.
 The advantages of Int.Trade
vii. Increases Competition
– the benefits from large competition may
result to greater efficiency and better quality
of goods:

Large competition may arise in global trading

among countries in the world which may
results to perfect competitive market,
and thus, might benefit them in terms of both
the productive and allocative efficiency.
 The advantages of Int.Trade
viii. Non-economic advantages –

improves relationship and promote

political links.
 The advantages of Int.Trade
ix. Exchanging knowledge and
technological advancement.
 The differences between
International and Domestic Trade:
1. Size of market and volume of transactions.
2. Greater specialisation in countries which
involves in international trade.
3. Involves the use of different units of
currency.
4. Different nations produce varieties of goods
as world production.
5. Large competition between nations may lead
to better quality of goods.
6. Higher cost of transportation – involves
longer distance of journey.
7. Subject to government policy and controls.
 The benefits from Specialisation in
INTERNATIONAL TRADE:
• will specialise in its own best production
of goods.

TWO TYPES OF SPECIALISATION in

international trade:
- may gain either through the:
 Absolute advantage or
 Comparative advantage.
 1. ABSOLUTE ADVANTAGE
• is the benefit received when one country
is relatively more efficient than the other
country in a production process:
i) either in terms of the ability to produce
the same amount of goods is relatively
less costly (or using fewer resources)
than the other country;
ii) or with the same resources, it is
beneficial and efficient if one country
might be able to produce more goods
than the other country.
 Scarcity of resources relative to
material human wants
• permits the use of resources efficiently
with larger production.
• Specialisation able to increase efficiency
and volume of production.
• One country may specialise in production
of goods that has relatively lower cost or
greater efficiency with higher output.
Mutual Benefit from Absolute
Advantage:
• After specialisation, each of them
can benefit from absolute
advantage in the production that
they are relatively more efficient,
then is said to gain from absolute
advantage.
 to understand the theory of
specialisation, it is
assumes that:
i. only two (2) countries trading in the
world market.
ii. produces two (2) goods only.
iii. constant cost of production (resulting
to linear production possibility curves)
iv. fixed resources
v. no transportation cost or trading
barriers.
 For Example:
Production possibilities for two countries
country product
Furniture Computers
(units) (units)
MALAYSIA 1800 2500
JAPAN 1500 3000
TOTAL 3300 5500

Production Before Specialisation

The Opportunity Cost
country product
or Relative Price Furniture Computers
of furniture versus MALAYSIA
(units)
1800
(units)
2500
computers: JAPAN 1500 3000
TOTAL 3300 5500
In Malaysia;
1 unit of furniture = 2500/1800
= 1.4 units of computers
(has to be forgone)
In Japan;
1 unit of furniture = 3000/1500
= 2 units of computers.
In this case, Malaysia has a lower opportunity
cost for the production of furniture than Japan.
Therefore, Malaysia will specialize in the
production of furniture.
The Opportunity Cost
country product
or Relative Price Furniture Computers
of computers versus MALAYSIA
(units)
1800
(units)
2500
furniture : JAPAN 1500 3000
TOTAL 3300 5500
In Malaysia;
1 unit of computer = 1800/2500
= 0.7 units of furniture.
(has to be forgone)
In Japan;
1 unit of computer = 1500/3000
= 0.5 units of furniture.
In this case, Japan has a lower opportunity cost
for the production of computers,
therefore Japan will specialize in the production
of computers.
 The Relative Prices can be
scheduled as:
Opportunity cost (units)
Country 1 furniture 1 computer

MALAYSIA 1.4 computers 0.7 furniture

JAPAN 2 computers 0.5 furniture
The Opportunity Cost
PRODUCTION AFTER SPECIALISATION
country product
Furnitures Computers
(units) (units)
MALAYSIA 3600 xx
JAPAN xx 6000
TOTAL 3600 6000
After specialization, total production of both
goods in the world increases.
World production before: furniture= 3300, computers= 5500.
World production after : furniture= 3600, computers= 6000.
PRODUCTION AFTER SPECIALISATION
country product
Furnitures Computers
(units) (units)
MALAYSIA 3600 xx
JAPAN xx 6000
TOTAL 3600 6000
After specialization, total production of both
goods in the world increases.
World production before: furniture= 3300, computers= 5500.
World production after : furniture= 3600, computers= 6000.
 Terms of Trade (TOT)
refers to:
the ratio of exchange between
two commodities traded.
 Terms of Trade
• can be stated by looking at the opportunity cost of two
countries;
In Malaysia;
1 unit of furniture = 1.33 units of computers.
In Japan;
1 unit of furniture = 2 units of computers.
So, Terms of Trade agreed can be:
1 unit of furniture : 1.5 unit of computers
OR 1 unit of furniture : 0.8 units of computers
OR 1 unit of furniture : 1.33 < computers < 2
OR 1 unit of furniture: 1.33 + 2 = 1.67 computers.
2
 CONSUMPTION AFTER
SPECIALISATION
country product
Furnitures Computers
(units) (units)
MALAYSIA 2100 2550
JAPAN 1500 3000
TOTAL 3600 6000

With Terms of Trade (TOT);

1 FURNITURE : 1.7 COMPUTERS
Can these countries trade,
if only one country has the
absolute advantage in
producing both goods?
 still they can benefit from
specialisation through
comparative advantage.

• If absolute advantage does not exist for

both countries that trade still they can
have the mutual benefit from trading.
2. COMPARATIVE ADVANTAGE

The law of or benefit from comparative

advantage:
– is the ability of a country to specialise and
produce goods at a relatively less
opportunity cost than another country,
even though only one country has the
absolute advantage in all goods.
 Instead,
• when only one country was more efficient
at producing both goods,
specialization still may gain both
countries;
(provided that one country has a greater
comparative advantage of one good.)
- thus, one country will specialize in the
good that she has relatively greater
comparative advantage.
 So … what’s the difference between
Absolute and Comparative Advantages.

• Absolute Adv: is the benefit enjoyed in the

production process when one country can
produce more output than the other country
with the same resources used.
• Comparative Adv: is the benefit enjoyed in the
production process when one country can
produce at a lower opportunity cost than the
other country.
 Example of
Comparative Advantage:
Production possibilities for two countries
country product
Vegetable Fish
(units) (units)
INDONESIA 200 150
THAILAND 300 400
TOTAL 500 550
Production Before Specialisation
 country product
The Opportunity Cost Vegetable Fish
(units) (units)
or Relative Price INDONESIA 200 150
of vegetables versus fish: THAILAND 300 400

In Indonesia; TOTAL 500 550

1 unit of vegetable = 150/200

= 0.75 units of fish
(has to be forgone)
In Thailand;
1 unit of vegetable = 400/300
= 1.33 units of fish.
In this case, Indonesia has a lower opportunity
cost for the production of vegetable than
Thailand.
Therefore, Indonesia will specialize in the
production of vegetable.
 country product
The Opportunity Cost Vegetable Fish
(units) (units)
or Relative Price INDONESIA 200 150
of fish versus vegetables : THAILAND 300 400
TOTAL 500 550
In Indonesia;
1 unit of fish = 200/150
= 1.33 units of vegetable.
(has to be forgone)
In Thailand;
1 unit of fish = 300/400
= 0.75 units of vegetable.
In this case, Thailand has a lower opportunity
cost for the production of fish,
therefore Thailand will specialize in the
production of fish.
 The Relative Prices can be
scheduled as:
Opportunity cost (units)
country 1 vegetable 1 fish

INDONESIA 0.75 fish 1.33 vegetable

THAILAND 1.33 fish 0.75 vegetable

The Opportunity Cost

PRODUCTION AFTER SPECIALISATION
product
country Vegetable Fish
(units) (units)
INDONESIA 400 xx
THAILAND xx 800
TOTAL 400 800
After specialization, total production of goods in
the world increases.
World production before: vegetable= 500, fish = 550.
World production after : vegetable= 400, fish = 800.
 Terms of Trade
• looking at the opportunity cost of two countries.
In Indonesia;
1 unit of fish = 1.33 units of vegetable.
In Thailand;
1 unit of fish = 0.75 units of vegetable.

So, Terms of Trade agreed can be:

1 unit of fish : 1 unit of vegetable. OR
1 unit of fish : 0.8 units of vegetable OR

1 unit of fish : 1.33 > vegetable > 0.75

 Trading/exchange will occur:
If the Terms of Trade agreed is:
1 unit of fish = 1 unit of vegetable
country product
Vegetable Fish
(units) (units)
INDONESIA 200 200
THAILAND 200 600
TOTAL 400 800
Total Consumption after specialization
(Indonesia exports 200 vegetables to Thailand and
instead receives 200 fish in return as imports from
Thailand, since the TOT is 1Veg : 1 Fish
The Terms of Trade (TOT)
can also be stated as:

» PX / PM
The terms of trade can be stated also as
the ratio of prices of exports to imports.
 LET’S HAVE A
5 MINUTES
BREAK
….and LET’S TRY THE
EXERCISES IN THE
“Question to Ponder.”
 QUESTION 1
COMMODITY
SHOES CLOTHS
COUNTRY (units) (units)

INDIA 400 2000

CHINA 1200 2400

BEFORE SPECIALISATION
Table of Opportunity Cost
COMMODITY
COUNTRY 1 SHOE 1 CLOTH

INDIA 5 CLOTH 0.2 SHOE

CHINA 2 CLOTH 0.5 SHOE

b) COMPARATIVE ADVANTAGE OF
PRODUCING SHOES AND CLOTHS.
c) Which country specialise in Cloth?

COMMODITY
SHOES CLOTHS
COUNTRY (units) (units)

INDIA xx 4000
CHINA 2400 xx

AFTER SPECIALISATION
d) Suggestion for TERMS OF TRADE

1 SHOE : 2 < CLOTH < 5

OR
1 CLOTH : 0.2 < SHOE < 0.5
2.a) Define comparative advantage. 
b) There are two (2) countries, M and N which
produce two (2) products by using all their
existing resources. Country M can produce either
360 tonnes of paddy or 120 tonnes of palm oil and
country N can produce either 72 tonnes of paddy
or 60 tonnes of palm oil. Constant cost prevails in
each country.
Explain using appropriate schedule to how these
two countries will have a comparative advantage
over another and show the gains after
international trade. Then, if the term of trade
agreed between these two countries is 1 palm oil
for 2 paddy, build a consumption table after
specialization.
 The following table shows the total production of
two countries that produce only two goods. Both
countries have the same number of population.

a) Calculate the opportunity cost to produce 1

bar of butter and 1 litre of milk in both countries.
b) Identify the comparative advantage gained by
each of the country.
– Based on the comparative advantage principle,
show how the total world output can increase by
calculating the total world output before and after
specialization is practiced.
 
 THANK YOU
Try to solve a few questions in
the MANUAL:
“Question To Ponder”
AND
More Questions in;
MODEL ANSWER (HABIBAH)
page 189…. Q4, 5 and 6.
PROTECTIONISM
 Sometimes too much freedom to the
International Trade is not advisable.

Some restrictions has to be imposed on

International Trade.
 PROTECTIONISM /
TRADE BARRIERS
( Methods of restricting trade)
(Protectionist Policy):
 tariff
 quota
 embargo
 foreign exchange control
 import licences
 export subsidies and grants
 administrative barriers
Arguments for Restricting Trade
(Reasons for protectionism):
 To protect infant and local industries.
 To reduce the deficit in BOP.
 To diversify economy.
 To prevent dumping.
 To control recession and
unemployment.
 To increase government revenue.
 For retaliation purposes.
 Trading Blocs
• Types of preferential trading arrangement
– Free Trade Areas (e.g. NAFTA)
– customs unions (e.g. European Union)
– common markets

Reasons:
• internal and external economies of scale
• better terms of trade
• increased competition between members etc.
 Trading Blocs
Free Trade Areas (FTA)
The launching of the FTA negotiations for a
Malaysia-US FTA hope to pave the way for
stronger investment and trade.
- FTA were expected to focus on:
. Liberalisation of trade.
. To Promote and facilitate trade flows.
. Cooperation to address impediments to trade:
such as in the areas of intellectual property
rights, standards, and conformance and
development of Mutual Recognition
Arrangements.
. Collaborate to enhance competitiveness:
in specific sectors such as tertiary education,
healthcare and tourism, capacity building
and technical assistance.
 THANK YOU

HAVE A NICE DAY!

 PRODUCTION POSSIBILITY CURVE
MALAYSIA JAPAN
Furniture Furniture
(units) (units)
1800

1500

2500 3000
Computers
Computers
(units)
(units)
 PRODUCTION POSSIBILITY CURVE
MALAYSIA JAPAN
Furniture Furniture
(units) (units)
1800

1500

2500 3000
Computers
Computers
(units)
(units)
Arguments for Restricting Trade
• Arguments for restricting trade (cont.)
– to prevent establishment of a foreign-based
monopoly
– to spread risks
– externalities
– pursuing national interests (but against
world interests)
• exploiting monopoly power
• protecting declining industries
– non-economic arguments
Arguments for Restricting Trade

• Problems with protection

– protection as ‘second best’

– world multiplier effects

– retaliation

– cushions inefficiency

– bureaucracy
 World Attitudes towards
Trade and Protection

• History of protection

– Pre-war growth in protection

– Post-war reduction in protection and the

role of GATT
• the growth in world trade
 World Attitudes towards
Trade and Protection
• History of protection
– Pre-war growth in protection
– Post-war reduction in protection and the
role of GATT
• the growth in world trade
– Re-emergence of protectionism in the
1980s
 World Attitudes towards
Trade and Protection
• History of protection
– Pre-war growth in protection
– Post-war reduction in protection and the
role of GATT
• the growth in world trade
– Re-emergence of protectionism in the
1980s
• the use of non-tariff barriers
 World Attitudes towards
Trade and Protection
• History of protection
– Pre-war growth in protection
– Post-war reduction in protection and the
role of GATT
• the growth in world trade
– Re-emergence of protectionism in the
1980s
• the use of non-tariff barriers
– The Uruguay Round
 World Attitudes towards
Trade and Protection
• History of protection
– Pre-war growth in protection
– Post-war reduction in protection and the
role of GATT
• the growth in world trade
– Re-emergence of protectionism in the
1980s
• the use of non-tariff barriers
– The Uruguay Round
• aims of the Uruguay round negotiations
 World Attitudes towards
Trade and Protection
• The Uruguay Round settlement and the
creation of the WTO
– problems in reaching agreement
– the agreement
– the work of the WTO
• dispute settlement
• conflicting interests in trade disputes
– efficiency in trade versus environmental and
social interests
– international protests
 Trading Blocs
• Types of preferential trading arrangement
– free trade areas
– customs unions
– common markets
• features of a full common market

• Direct effects of a customs union

– trade creation
– trade diversion
 Trading Blocs
• Long-term effects of a customs union
– longer-term advantages
• internal economies of scale
• external economies of scale
• better terms of trade
• increased competition between members
– longer-term disadvantages
• certain regions of the union may suffer
• possibility of oligopolistic collusion
• administrative costs
 Trading Blocs

• Preferential trading in practice

– the EU

– NAFTA
• differences between the EU and NAFTA

– other examples
 The European Union
• Historical background
• From customs union to common market
– Common Agricultural Policy
– regional policy
– competition policy
– tax harmonisation
– social policy
 The European Union
• The single market
– historical background
– the Single European Act
– completing the single market
– benefits of the single market
• trade creation
• reduction in the direct costs of barriers
• economies of scale
• greater competition
 The European Union
• The single market (cont.)
– criticisms of the single market
• radical economic change is costly
• adverse regional multiplier effects
• development of monopoly/oligopoly power
• trade diversion
– evidence
– the future of the EU
• effect of new members
 Trade and Developing Countries

• Trade strategies
– primary outward looking

– secondary inward looking

• import-substituting industrialisation (ISI)

– secondary outward looking

• possibly complemented by primary inward
looking
 Trade and Developing Countries
• Approach 1: exporting primaries
– justification for exporting primaries
• exploits comparative advantage
• a 'vent for surplus'
• an 'engine for growth'
– problems with traditional trade theory
• comparative costs change over time
• benefits may not flow to nationals
• trade my lead to greater inequality
• externalities from mines and plantations
 Trade and Developing Countries
• Exporting primaries (cont.)
– long-term problems for primary exporting
countries
• low income elasticity of demand
• protection in advanced countries
• technological developments
– synthetic substitutes
– miniaturisation
• rapid growth in imports
• adverse movements in terms of trade
 Trade and Developing Countries
• Approach 2: ISI
– justifications
• problems of primary exporting
• dynamic potential in manufacturing
– infant industries
– rapid technological advance
– patterns of protection
• selecting industries for protection
• tariff and quota escalation
• attracting multinational investment
 Trade and Developing Countries
• Approach 2: ISI (cont.)
– adverse effects of ISI
• often counter to comparative advantage
• tends to cushion inefficiency
– encourages establishment of monopolies
• artificially low interest rates
– use of capital-intensive techniques
• encourages rural–urban migration
• adverse effects on rural sector
• leads to greater inequality
• environmental problems
• limit to home market
 Trade and Developing Countries
• Approach 3: exporting manufactures
– transition from inward-looking to outward-
looking industrialisation
• a neutral trade approach
• active promotion of manufactured exports
– benefits from exporting manufactures
• conforms with comparative advantage
• increased competition
• increased investment
• more employment and greater equality
• faster growth
 Trade and Developing Countries
• Approach 3: exporting manufactures
(cont.)
– drawbacks of exporting manufactures
• possible retaliation from advanced countries
– but attitudes of WTO
• competition from other developing countries
• vulnerability to world fluctuations
– world recessions
– speculation
– trade between developing countries
• trade blocs of developing countries