Download 21 Why do countries trade

Why do countries trade?
Ch 21 IB International Economics
The gains from international trade
 Lower prices
 Consumers can buy at lower prices than domestic
 Producers can buy less expensive raw materials and
semi manufactured goods
 Prices may be lower in some countries because they
have
 access to natural resources
 Differences in quality of labour
 Differences in quality of capital
 Different levels of technology
 The main cause of lower prices is
comparative advantage (see later)
 Greater choice
 Consumers have access to domestic and
international products
International
trade: the
exchange of
goods and
services
between
countries
The gains from international trade
 Differences in resources
 There will be resources that a country needs to produce other
goods but does not have and has to import
 Copper, diamonds, oil
 Singapore imports almost every natural resource but has a high
level of exports to fund their imports
 Saudi has oil while Japan has none
 Costa Rica has the climate to grow bananas whereas the UK
cannot
 The USA has a large stock of skilled workers when Sudan’s is
comparatively unskilled etc
 These differences lead to trade
 Economies of scale
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The size of the market increases
Demand increases
Production can increase
Production becomes more efficient
Division of Labour and Specialisation can increase
Managers become more knowledgeable
This leads to economies of scale
If countries specialise they acquire experience and expertise
(they move down the learning curve – the LRAC curve)
 In the long run with larger production and larger markets export
industries should get more efficient and competitive leading to a
reduction in long-run
Singapore
has to import
almost every
natural
resource –
even water!
The gains from
international trade
Increased
competition
Prices reduce
Quality improves
Innovation
improves giving
more variety
Task - Find out
what Bahrain
exports and
imports (include
values)
HL only
Comparative Advantage
 Which goods should a country
produce for export and which
should it import
 The answer lies in the concept
of comparative advantage
 Watch these videos
 Gardening parable http://www.youtube.com/watch?
v=RpfV0Oerfr8
 Mjmfoodie http://www.youtube.com/user/mj
mfoodie#p/u/67/38hvvAzgXZY
Comparative Advantage
 An example for absolute advantage
 This table shows the production
outcomes where 2 countries are
using the same quantities of
resources to produce lamb and
cloth
 Half of their resources are being
used for lamb and the other for
cloth
 Australia has absolute advantage in
producing lamb (it can produce 6
kilos vs 4 kilos with the same
resources)
 China has absolute advantage in
producing cloth (it can produce 3
kilos vs 1 kilo)
 In this situation Australia should
specialise in lamb and China in cloth
Absolute advantage – If a country
has absolute advantage it can
produce a good using fewer
resources than another country
Country
Kilos of
lamb
Metres of cloth
Australia
6
1
China
4
3
Total without
trade
10
5
Country
Kilos of
lamb
Metres of cloth
Australia
12
0
China
0
6
Total without
trade
12
6
Comparative Advantage
 If Australia uses all of its resources
for lamb it will double its output
(assuming constant returns to scale)
and make 12
 This gives a total of 12 which is 2
more than before (there is an
advantage to them specialising)
 If China uses all of its resources to
make cloth it will double its output
to 6
 The new total of 6 instead of 5
 This situation, where each country
has an absolute advantage in the
production of one product is known
as reciprocal absolute advantage
Absolute advantage – If a country
has absolute advantage it can
produce a good using fewer
resources than another country
Country
Kilos of
lamb
Metres of cloth
Australia
6
1
China
4
3
Total without
trade
10
5
Country
Kilos of
lamb
Metres of cloth
Australia
12
0
China
0
6
Total without
trade
12
6
Comparative Advantage
 What happens if there is not a
situation of reciprocal absolute
advantage?
 David Ricardo (19th Century)
proved mathematically that
trade could still be beneficial to
both countries when one
country had an absolute
advantage in producing all
goods
 He looked at the opportunity
cost of production to explain
comparative advantage
 This table shows the production
outcomes of France and Poland
for wine and cheese
 France has absolute advantage
in producing both goods
comparative
advantage – If a
country has
comparative
advantage it can
produce a good at a
lower opportunity
cost than another
country; Country A
has to give up fewer
units of other goods
to produce the good
in question than
country B
Country
Litres
of
wine
Opportunity
cost of 1
litre of wine
Kilos
of
cheese
Opportunity
cost of 1
kilo of
cheese
France
3
4/3 kilos of
cheese
4
¾ litre of
wine
Poland
1
3 kilos of
cheese
3
1/3 litre of
wine
Comparative Advantage
 In terms of comparative
advantage France has a
comparative advantage in
production of wine
 France has to give up 4/3
kilos of cheese to produce a
litre of wine
 Poland would have to give up
3 kilos of cheese to produce a
litre of wine
 4/3 is smaller than 3 so
France has the comparative
advantage
 Poland has a comparative
advantage in production of
cheese
 (1/3 is smaller than ¾)
 The theory of comparative
advantage tells us that France
should specialise in wine and
Poland should specialise in cheese
 France will consume that wine
that they wish and use the extra
to trade for cheese
Country
Litres
of
wine
Opportunity
cost of 1
litre of wine
Kilos
of
cheese
Opportunity
cost of 1
kilo of
cheese
France
3
4/3 kilos of
cheese
4
¾ litre of
wine
Poland
1
3 kilos of
cheese
3
1/3 litre of
wine
Comparative Advantage
 We can illustrate this using
production possibility curves
 The diagram shows exactly the
same as the table
 When a country has an absolute
advantage in producing both
goods (France) and the scale of
the axes is the same
 The comparative advantage for
the better producer is in the
good where the distance
between the production
possibilities is the greatest (a)
 The comparative advantage for
the less efficient producer is
where the distance between the
production possibilities is least
(b)
 Thus France has the
comparative advantage in Wine
and Poland cheese
 The slope of the line shows the
opportunity costs which is
always a constant opportunity
cost
Country
Litres
of
wine
Opportunity
cost of 1
litre of wine
Kilos
of
cheese
Opportunity
cost of 1
kilo of
cheese
France
3
4/3 kilos of
cheese
4
¾ litre of
wine
Poland
1
3 kilos of
cheese
3
1/3 litre of
wine
Comparative Advantage
 This only works if the opportunity costs are different
 If they are the same there would be no point in trade taking
place
 The slopes are the same
 The opportunity costs are the same
What give a country
comparative Advantage?
 To a large extent this is
due to a country’s factor
endowments
 If a country has a large
amount of arable land it
may develop a
comparative advantage in
agricultural products
 A country with beautiful
beaches and a
favourable climate may
develop its comparative
advantage in the output
of tourist services
(climate can be a factor
of production!)
Limitations of the theory of comparative advantage
 The theory is based upon a number of
assumptions
 These assumptions limit the application of the
theory in real life
 Producers have perfect knowledge and are aware
of where the least expensive goods may be
purchased
 There are no transport costs
 There are only 2 economies producing goods –
not so much of a problem with the use of computer
simulations
 Costs do not change and returns to scale are
constant (no economies or diseconomies of scale)
 Goods being traded are identical
 This may be ok with commodities but not goods like
consumer durables
 Factors of production remain in the country
 It may be the factors of production that move rather
than the goods
 Developed countries may invest capital in LDCs to
produce goods
 Labour may migrate from low-wage to high-wage
countries
Test your
understanding
http://www.youtub
e.com/watch?v=vc
324aHB2m8
Limitations of the theory of
comparative advantage
 In spite of limitations,
comparative advantage is at the
core of international theory
 It goes a long way to explain
patterns of trade
 HL homework - Using a
diagram explain the concept of
comparative advantage (10
Marks)
 All - Research the WTO ready
for class discussion