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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 selfsufficient:
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
RM(Billion)
200
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
Average
annual growth
in real GDP
(%)
Share of
manufactures in
merchandise
exports (%)
Annual average
growth rate of
exports
(%)
1970–99
1970
1998
1970–80
1980–98
Brazil
4.2
15
55
8.5
5.6
Malaysia
6.6
8
79
4.8
15.9
South Korea
8.4
76
91
23.5
11.6
Singapore
7.4
31
86
4.2
14.2
Hong Kong
6.7
96
95
9.7
11.4
All developing
countries
4.1
27
68
3.9
6.4
Growth in real GDP and in real exports of goods
and services: total OECD countries
12
11
10
Real growth rate (%)
9
8
7
6
5
4
3
2
1
0
-1
-2
1970
1975
1980
1985
1990
1995
2000
Growth in real GDP and in real exports of goods
and services: total OECD countries
12
11
10
Real growth rate (%)
9
8
7
6
5
4
3
2
1
Growth in GDP
0
-1
-2
1970
1975
1980
1985
1990
1995
2000
Growth in real GDP and in real exports of goods
and services: total OECD countries
12
11
10
Real growth rate (%)
9
8
7
6
5
4
3
2
1
Growth in GDP
0
-1
-2
1970
1975
1980
1985
1990
1995
2000
Growth in real GDP and in real exports of goods
and services: total OECD countries
12
Growth in exports of
goods and services
11
10
Real growth rate (%)
9
8
7
6
5
4
3
2
1
Growth in GDP
0
-1
-2
1970
1975
1980
1985
1990
1995
2000
Growth in real GDP and in real exports of goods
and services: total OECD countries
12
Growth in exports of
goods and services
11
10
Real growth rate (%)
9
8
7
6
5
4
3
2
1
Growth in GDP
0
-1
-2
1970
1975
1980
1985
1990
1995
2000
Specialisation
means
- one country will specialise
in a good that she is best at
and will trade among them.
WHAT ARE THE REASONS or
FACTORS FOR COUNTRIES TO
TRADE INTERNATIONALLY
OR
TO DO SPECIALISATION?
The factors that may lead
these countries to involve in
international trading are:
The reasons for IT to occur:
i. Different factor endowments:
raw materials, climate, specialist
labour, capital or technology that
may caused to produce different
types of goods.
The reasons for IT to occur:
i. Different factor endowments:
raw materials, climate, specialist
labour, capital or technology
that may caused to different
types of goods produced.
ii. Limited mobility of factors:
human capital usually are non-mobile:
higher cost of production – costly to produce, so
import goods from cheap countries.
The reasons for IT to occur:
iii. To obtain the benefit from
Specialisation:
The theories of specialisation proves that
countries which trade internationally (after
specialisation) may increase their production,
consumption and thus standard of living.
2 types of specialisation to be gained either:
i) absolute advantage or
ii) comparative advantage.
Specialisation improves the volume of
production and lower the cost and benefit
countries that involves in trading.
- This proves that self-sufficient is inefficient.
The reasons for IT to occur:
iv. 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 reasons for IT to occur:
v. 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.
vi. Increases national income:
specialisation helps to increase the
volume of exports and raises GDP.
The reasons for IT to occur:
vii. Increases Competition –the benefits from large
competition may result to greater efficiency
and better quality of goods:
Competition among domestic traders is
relatively small.
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.
viii. Non-economic advantages – improves
relationship and promote political links.
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
MALAYSIA
Furniture
(units)
1800
Computers
(units)
2500
JAPAN
TOTAL
1500
3300
3000
5500
Production Before Specialisation
The Opportunity Cost
or Relative Price
of furniture versus
computers:
country
MALAYSIA
JAPAN
product
Furniture
(units)
Computers
(units)
1800
1500
2500
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
or Relative Price
of computers versus
furniture :
country
MALAYSIA
JAPAN
product
Furniture
(units)
Computers
(units)
1800
1500
2500
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
MALAYSIA
JAPAN
TOTAL
product
Furnitures
(units)
Computers
(units)
3600
xx
xx
6000
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
MALAYSIA
JAPAN
TOTAL
product
Furnitures
(units)
Computers
(units)
3600
xx
xx
6000
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
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
(units)
Computers
(units)
MALAYSIA
2100
3000
JAPAN
1500
3000
3600
6000
TOTAL
With Terms of Trade (TOT);
1 FURNITURE : 1.5 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 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 in terms of
the other goods than the other country.
Example of
Comparative Advantage:
Production possibilities for two countries
country
product
INDONESIA
Vegetable
(units)
200
Fish
(units)
150
THAILAND
TOTAL
300
500
400
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
TOTAL
500
550
In Indonesia;
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.
The Opportunity Cost
or Relative Price
of fish versus vegetables :
country
product
INDONESIA
Vegetable
(units)
200
Fish
(units)
150
THAILAND
TOTAL
300
500
400
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
(units)
Fish
(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
INDONESIA
THAILAND
TOTAL
product
Vegetable
(units)
200
200
400
Fish
(units)
200
600
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 ONE
EXERCISE (Q1) IN THE
“Question to Ponder.”
QUESTION 1
COMMODITY
COUNTRY
SHOES
(units)
CLOTHS
(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
COUNTRY
SHOES
(units)
CLOTHS
(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
THANK YOU
And
Try to solve a few more
questions in the “Question To
Ponder”
AND ALSO
Questions in MODEL ANSWER
BOOK 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 in goods,
services and investment,
.
Promote and facilitate trade and
investment flows.
.
Cooperation to address impediments to trade 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.
LET’S LOOK AT
YOUR EXERCISES!
MODEL ANSWER:
• ANY PROBLEMS?
THANK YOU
HAVE A NICE DAY!
PRODUCTION POSSIBILITY CURVE
MALAYSIA
Furniture
(units)
JAPAN
Furniture
(units)
1800
1500
2500
Computers
(units)
3000
Computers
(units)
PRODUCTION POSSIBILITY CURVE
MALAYSIA
Furniture
(units)
JAPAN
Furniture
(units)
1800
1500
2500
Computers
(units)
3000
Computers
(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 outwardlooking 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