International Trade

& Trade Theories

 All trade is voluntary

 People trade because

they believe that they
will be better off by
trading
 What is International Trade?

The buying and selling of goods and

services across country borders

The selling of goods

and services to buyers
outside the country

The buying of goods from

sellers outside the country
 SHOULD THE
PHILIPPINES PRODUCE
EVERYTHING IT
WANTS TO PRODUCE…?
If the US is better than the PH at
producing everything, would it gain
anything by trading with us..?
of
When countries can specialize in their
area of expertise

High competition consistently brings

down the least possible profitable
price
FACTOR ENDOWNMENTS
ECONOMIES OF SCALE
Increased Variety
Acquisition of Needed Resources
 Production Possibility Curves
(Frontier) also known as PPF

• Production – output of goods and services

• Possibility – maximum attainable amount
• Frontier – border or boundary
• Is a graph that shows the different rates of
production of two goods and/or services that an
economy can produce efficiently during a
specified period of time with a limited quantity
of productive resources,
 PPF example

• 2 goods:
- CDs
- bottled water
• use land, labor, capital to
make these goods
Ex:
Suppose these are 6 possible pairs

Bottled
CDs W ater
(millions per (millions per
yr.) yr.)

A 15 0
B 14 1
C 12 2
D 9 3
E 5 4
F 0 5
We can graph the table & get the
PPF:

Bottled
CDs
CDs W ater
(millions per (millions per
yr.) yr.)

15 A 15 0
9 B 14 1
C 12 2
D 9 3
E 5 4
F 0 5

bottled
3 5
water
How Point X can be
attained..?
Laissez-Faire
Vs.
Interventionist
Approaches
 Adam Smith (1723 – 1790)
o Adam Smith – advocates
free market and free trade
o Government doesn’t
interfere with the market
(laissez-faire )
o Law of supply and demand
determines prices
o Leaving customers and
producers to make their
own decisions
 Mercantilism: mid-16th century

 A nation’s wealth depends on accumulated treasure

 Gold and silver are the currency of trade.

 Theory says you should have a trade surplus.

 Maximize exports through subsidies.
 Minimize imports through tariffs and quotas.

 Flaw: “Zero-sum game

 that the gain of one nation from trade was the loss
of another
Neomercantilism
•  Revived theory of mercantilism emphasizing
trade restrictions and commercial policies as
means of increasing domestic income and
employment

• Controls capital movement, and

centralizes currency decisions in the
hands of a central government.
Neomercantilism

  World Bank
 United Nations
 World Trade Organization
 What is
ABSOLUTE
ADVANTAGE…??
What is
ABSOLUTE
ADVANTAGE…?

 One Country can produce more

of a given product with the
same or less resources than
another country
Natural Advantage
 climatic conditions,
 access to certain natural
resources,
 availability of certain labor
forces.

Acquired Advantage
 Product technology

 Process technology
 Theory of Absolute Advantage

 Adam Smith: Wealth of Nations (1776).

 Capability of one country to produce more of a
product with the same amount of input than
another country.
 Produce only goods where you are most
efficient, trade for those where you are not
efficient.

Trade between countries is, therefore, beneficial.

Production Conditions When Each
Country Is More Efficient in the
Production of One Commodity
• EU workers are more
productive in producing
machines
• The EU has an absolute
advantage in machine
production

• Indian workers are more

productive in producing cloth
• India has an absolute
advantage in cloth production
 Oil/units produced per Wheat/units produced
Country
unit of time per unit of time

Country S 30 5

Country U 3 15

 A glance at this two-country trading

scenario immediately tells you that each
country should specialize and trade.
What if a country has absolute
advantage in several types of
production?
Should those countries bother
to trade with their inferiors or
should they produce everything
and be self-sufficient?
U.S. has an Absolute Advantage in both goods

In this scenario, there is obviously no opportunity to

trade… especially not for U.S.
NO… No … No!!! This is not correct. We need to
introduce the concept of:
Comparative Advantage
 What is
COMPARATIVE
ADVANTAGE…?
What is
COMPARATIVE
ADVANTAGE…?

 The ability of a party to

produce a particular good or
service at a lower opportunity
cost over another
Theory of Comparative Advantage

David Ricardo: Principles of Political

Economy (1817).
Extends free trade argument
Efficiency of resource utilization leads to more
productivity.
Produces the good at a lower opportunity
cost than the other countries
Makes better use of resources
Trade is a positive-sum game.
 Output of
Country Output of TVs
Smartphones

Country C 10 5

Country J 20 15
CALCULATE THE DOMESTIC OPPORTUNITY FOR
THE OUTPUT PROBLEM

OUTPUT Y
OPPORTUNITY COST X = ————————
OUTPUT X
 Opportunity Opportunity
Output of cost of Output of cost of
Country
TVs producing 1 Smartphones producing 1
TV SP

Country C 10 5

Country J 20 15
 Output of Opportunity cost of Output of Opportunity cost of
Country producing 1 TV
TVs Smartphones producing 1 SP

Country C 10 .5 smartphone 5 2 TV

Country J 20 .75 smartphone 15 1.33 TV

 Given a fixed amount of resources Country U and
Country M can produce the number of soybeans and
avocados indicated in the table below. Using the data
draw two PPCs, one for each country.

Country soybeans/tons avocados/tons

Country M 60 15

Country U 90 30
 2. Calculate the opportunity
cost of producing soybeans
and avocados in each country.

3. Identify which country

has a comparative advantage
in soybeans and avocados.
 Input time for output Input time for output
Country
of 1 unit iron/hr of 1 unit butter/hr

Country A 25 15

Country Z 20 10
 CALCULATE THE DOMESTIC
OPPORTUNITY FOR THE INPUT PROBLEM

INPUT X
OPPORTUNITY COST X = ————————
INPUT Y
 Input time for Opp cost of Input time for Opp cost of
Country output of 1 unit producing 1 output of 1 unit producing 1
iron/hr unit iron butter/hr unit butter

Country A 25 15

Country Z 20 10
 Input time for Opp cost of Input time for Opp cost of
Country output of 1 producing 1 output of 1 producing 1
unit iron/hr unit iron unit butter/hr unit butter

Country A 25 1.67 butter 15 .6 iron

Country Z 20 2 butter 10 .5 iron

 Sources of Comparative Advantage:
Resource Endowments

Vast quantities of untapped fossil

fuel or other natural resources

Farmable land- Agriculture

Highly skilled workforces that

provide financial, merchant, and
other services to the world.
 Potential Downsides of Extreme
Specialization:

• Threats to uncompetitive sectors: Some parts of

the economy may not be able to compete with
cheaper or better imports.

• Risk of over-specialization: Global
•Strategic vulnerability: demand may shift, so that there is no
Relying on another country
for vital resources makes a
longer demand for the good or service
country dependent on that produced by a country.
country.

• Poor agricultural economies (developing

countries) might never develop industry or
services sectors,. Low standard of living
 What Happens When the Oil Runs Out?

As the Oil Industry Collapses, What Will

Happen to the Countries That Depend On
It?

At the present rate of around

30 billion barrels per year in
consumption
HECKSCHER-OHLIN MODEL
Countries export what can be most efficiently
and plentifully produced

 Emphasis is placed on the exportation of

goods requiring factors of production that a
country has in abundance

 and the importation of goods that the country

cannot produce as effectively.