HKCEE Macroeconomics Chapter 7:International Trade By Mr. LAU san-fat CH7-International Trade-SV Why do Countries Trade? self-sufficiency cannot be achieved cheaper products could be enjoyed raising standard of.
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HKCEE Macroeconomics
Chapter 7:International Trade
By Mr. LAU san-fat CH7-International Trade-SV 1
Why do Countries Trade?
self-sufficiency cannot be achieved
cheaper products could be enjoyed
raising standard of living by enjoying a larger variety of products
By Mr. LAU san-fat CH7-International Trade-SV 2
The Model of Absolute Advantage
Absolute Advantage (AA)
allows a country to produce more of a good with the same resources amount of
allows a country to produce the same amount of a good with less resource
By Mr. LAU san-fat CH7-International Trade-SV 3
The Model of Absolute Advantage
An Illustration Country X Country Y Unit(s) of product being produced with 1 unit of resource Good A 3 1 or or Good B 1 9
AA in producing good A: Country X
AA in producing good B:
By Mr. LAU san-fat CH7-International Trade-SV
Country Y
4
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.
Country X Country Y Unit(s) of product being produced with 1 unit of resource Good A 6 4 or or Good B 1 2
By Mr. LAU san-fat CH7-International Trade-SV 5
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.
Country X Country Y
By Mr. LAU san-fat
Unit(s) of resources required for producing 1 unit of… Good A Good B 2 3 10 1
CH7-International Trade-SV 6
The Model of Absolute Advantage
The Principle of Absolute Advantage
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
Limitation: Trade would not occur if countries enjoy in production.
NO absolute advantage
By Mr. LAU san-fat CH7-International Trade-SV 7
The Model of Comparative Advantage
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.
8 By Mr. LAU san-fat CH7-International Trade-SV
The Model of Comparative Advantage
An Illustration Country X Country Y Unit(s) of product being produced with 1 unit of resource Good A 6 5 or or Good B 12 3
By Mr. LAU san-fat CH7-International Trade-SV 9
The Model of Comparative Advantage
An Illustration Country X Country Y Opportunity cost of producing 1 unit of … Good A Good B 12B/6 = 2B or 6A/12 = 0.5A
3B/5 = 0.6B
or 5A/3 = 1.67A
By Mr. LAU san-fat CH7-International Trade-SV 10
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.
Country X Country Y
By Mr. LAU san-fat
Unit(s) of product being produced with 1 unit of resource Good A Good B 6 4
CH7-International Trade-SV
or or 1 2
11
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.
Country X Country Y
By Mr. LAU san-fat
Unit(s) of product being produced with 1 unit of resource Good A Good B
CH7-International Trade-SV
or or
12
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.
Country X Country Y
By Mr. LAU san-fat
Unit(s) of resources required for producing 1 unit of… Good A Good B 2 3
CH7-International Trade-SV
10 9
13
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.
Country X Country Y
By Mr. LAU san-fat
Unit(s) of resources required for producing 1 unit of… Good A Good B
CH7-International Trade-SV 14
The Model of Comparative Advantage
The Law/Principle of Comparative Advantage
It states that countries should specialize in producing goods with comparative advantage.
Total output will be increased by engaging specialization in production.
They then would gain if they follow the principle to trade with other countries
By Mr. LAU san-fat CH7-International Trade-SV 15
The Model of Comparative Advantage
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-fat CH7-International Trade-SV 16
The Model of Comparative Advantage
Given: Country X Country Y Unit(s) of product being produced with 1 unit of resource Good A 6 5 or or Good B 12 3
By Mr. LAU san-fat CH7-International Trade-SV 17
The Model of Comparative Advantage
Under Self-sufficient
Assume each country devotes equal amount of resources (i.e. 1 man-hour) to produce both goods.
Country X Country Y Total Output Units of product produced Good A Good B 6 5 11 AND AND AND 12 3 15
By Mr. LAU san-fat CH7-International Trade-SV 18
The Model of Comparative Advantage
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.
19 By Mr. LAU san-fat CH7-International Trade-SV
The Model of Comparative Advantage
After Specialization Country X Country Y Total Output Total Output under Self-sufficient Units of product produced Good A Good B 6(0.5) = 3 5(2)=10 AND 12(1.5)=18 AND 3(0)=0 Net Increase
By Mr. LAU san-fat CH7-International Trade-SV 20
Terms of Trade and Gains from Trade
Terms of Trade (TOT)
•
TOT refers to the amount of goods that a nation must export for one unit of a good that she imports.
• •
TOT = ?X:1M TOT should be mutually trading partners. beneficial to
•
TOT should be set in-between the opportunity costs of trading partners.
By Mr. LAU san-fat CH7-International Trade-SV 21
Terms of Trade and Gains from Trade
Find both countries’ O.C. in their productions from the table below.
Country X Country Y Unit(s) of product being produced with 1 unit of resource Good A Good B 6 5 or or 12 3
By Mr. LAU san-fat CH7-International Trade-SV 22
Terms of Trade and Gains from Trade
Finding the beneficial TOT: Country X Opportunity Cost of producing 1 unit of … Good A (12B/6=) 2B or Good B (6A/12=) 0.5A
Country Y (3B/5=) 0.6B
or (5A/3=) 1.67A
•
Mutually beneficial TOT: Good A: 0.6B-2B
By Mr. LAU san-fat
Good B: 0.5A-1.7A
CH7-International Trade-SV 23
Terms of Trade and Gains from Trade
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-fat CH7-International Trade-SV 24
Terms of Trade and Gains from Trade
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-fat CH7-International Trade-SV 25
Terms of Trade and Gains from Trade
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-fat CH7-International Trade-SV 26
Terms of Trade and Gains from Trade The opportunity cost of both countries in producing goods A & B are below: Country X Opportunity Cost of producing 1 unit of … Good A Good B (12B/6=) 2B or (6A/12=) 0.5A
Country Y (3B/5=) 0.6B
or (5A/3=) 1.67A
By Mr. LAU san-fat CH7-International Trade-SV 27
Terms of Trade and Gains from Trade
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-fat CH7-International Trade-SV 28
Terms of Trade and Gains from Trade
(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-fat CH7-International Trade-SV 29
Terms of Trade and Gains from Trade
(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-fat CH7-International Trade-SV 30
Terms of Trade and Gains
from Trade (b) When TOT = 1A:2B (
1B = 0.5A)
•
Unit Gains from Trade to country, Y Importing = 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 = 0 A
By Mr. LAU san-fat CH7-International Trade-SV 31
Terms of Trade and Gains
from Trade (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) = 0 A
By Mr. LAU san-fat CH7-International Trade-SV 32
Terms of Trade and Gains
from Trade (c) When TOT = 2A:1.2B(
1B =1.67A)
•
Unit Gains from Trade to Importing country, Y = Domestic O. C. (saved) - TOT = 1.67A - 1.67A = 0 A (saved)
•
Unit Gains from Trade to Exporting country, X = TOT - Domestic O. C.
= 1.67A - 0.5A = 1.17A
By Mr. LAU san-fat CH7-International Trade-SV 33
Terms of Trade and Gains
from Trade (c) When TOT = 2A:1.2B(
1B =1.67A)
•
Total Gains from Trade to Importing country, Y = Unit Gains x Amount Imported = 0A(5) = 0 A (saved)
•
Total Gains from Trade to Exporting country, X = Unit Gain x Amount Exported = 1.17A(5) = 5.85A
By Mr. LAU san-fat CH7-International Trade-SV 34
Terms of Trade and Gains from Trade
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-fat CH7-International Trade-SV 35
Terms of Trade and Gains from Trade
The importing country will capture ALL the gains from trade if the TOT is set equal to the exporting country’s domestic opportunity cost.
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-fat CH7-International Trade-SV 36
Terms of Trade and Gains from Trade
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-fat CH7-International Trade-SV 37
Terms of Trade and Gains from Trade
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-fat CH7-International Trade-SV 38
Factors Affecting Trade
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.
39 By Mr. LAU san-fat CH7-International Trade-SV
Free Trade
Benefits of Free Trade:
•
More output could be produced.
• •
Better international relationship 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
By Mr. LAU san-fat CH7-International Trade-SV 40
Free Trade
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
By Mr. LAU san-fat CH7-International Trade-SV 41
Trade Restrictions(1)
Tariffs
•
Tariffs are taxes on imports.
•
Tariffs can be per-unit tax or ad valorem tax (i.e. percentage tax).
Effects of Tariffs on Imports
•
Cost of production increases
•
Supply of imports decreases
•
Import price increases
•
Quantity imported/transacted falls
By Mr. LAU san-fat CH7-International Trade-SV 42
Trade Restrictions(1)
Effects of Tariffs on Imports P S2 D tax S1 P2 P1 0
By Mr. LAU san-fat
Q2 Q1
CH7-International Trade-SV
Q
43
Trade Restrictions(2)
Import Quota
•
Import quota fixes the maximum amount or value of imports during a given period.
Effects of Import Quotas on Imports
•
Supply of imports decreases
•
Quantity imported/transacted falls
•
Import price increases
•
Kinked Supply curve resulted
By Mr. LAU san-fat CH7-International Trade-SV 44
Trade Restrictions(2)
Effects of Quota on Imports P D Quota S2 S1 P2 P1 0
By Mr. LAU san-fat
Q2 Q1
CH7-International Trade-SV
Q
45
Trade Restrictions
Comparison Between Tariffs & Quota
Tariffs Quota Nature Import tax Output limit Effects ↑ P → Q ↓ ↓ Q →↑ P By Mr. LAU san-fat △ Q depending on Ed of M Tariffs revenue △ Q is certain Quota revenue only if by auction CH7-International Trade-SV 46
Trade Restrictions (3)
Subsidies to Local Goods
•
A sum of money provided by the government for local production
•
Effects:
•
Lower cost allows larger local supply
•
Local product prices fall leading to more local products demanded
•
Demand for imports falls and thus fewer products being imported
By Mr. LAU san-fat CH7-International Trade-SV 47
Trade Restrictions (4)
Embargo
•
A ban on imports
•
Total embargo versus partial embargo
•
It is imposed for political reasons
By Mr. LAU san-fat CH7-International Trade-SV 48
Trade Restrictions (5)
Exchange Control
•
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-fat CH7-International Trade-SV 49
Trade Restrictions (6)
Voluntary Export Restriction
•
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.
50 By Mr. LAU san-fat CH7-International Trade-SV
Reasons for Trade Restrictions
To protect local industries
To enhance employment opportunity
To raise tariff revenue
To reduce balance of payments deficit
To undergo industrial diversification
For political reasons
By Mr. LAU san-fat CH7-International Trade-SV 51