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International Economics Mordecai E. Kreinin Part I International Trade Relations Copyright ©2002 South-Western/Thomson Learning. All rights reserved. CHAPTER 2 Why Nations Trade C1-2 Sources of International Commodity Trade Data Standard International Trade Classification (SITC) Commodity Trade Statistics Main Economic Indicators U.S. Census Bureau report of exports and imports United States Commodity Imports and Exports as Related to Output C1-3 Why Nations Trade The Principle of Comparative Advantage Comparative Opportunity Cost Absolute Advantage and Wage Rates Summary of Policy Implications Dynamic Gains from International Trade C1-4 Important Concepts Comparative advantage Anti-inflationary trade Country “in isolation” Absolute advantage Terms of trade Industry ranking Demand consideration Static gains from trade Relative wage rates Dynamic gains from trade C1-5 Principle of Comparative Advantage Gains from Trade Maximized profits Relative cost-price positions determined by comparative advantage Comparative Advantage, inverse of comparative cost Absolute advantage Resource or opportunity cost Direction of trade Demand Considerations Supply conditions provide trade limits Reciprocal demand determines exchange ratio Terms of Trade (export price divided by import price) Commodity gain ratio vs. utility ratio Differentiated Products C1-6 Additional Insights: Why Complete Specialization? Constant costs not real world scenario Increasing cost situations force prices in two trading countries to converge No trade inducement Prices can easily equalize before complete specialization is reached C1-7 FIGURE 2.1 Supply Curves of Wheat and Textiles Under Constant Cost Conditions C1-8 Comparative Opportunity Cost Who Exports What? Necessary to measure joint productivity of all factors (in monetary value). Unit production cost = aggregate resources used in production of one output unit Limits to Mutually Beneficial Exchange C1-9 FIGURE 2.2 Region of Mutually Beneficial Trade C1-10 Additional Insights: Limits to Sustainable Exchange Rates Exchange rate limits can be translated from commodities to money by assigning to each commodity the price it commands in producing country More than two commodities Internal ranking—multi-industry care Examples from U.S. Trade Iron and steel Autos High Technology C1-11 Absolute Advantage and Wage Rates Absolute advantage determines relative wage rates in each country. Relative wage rate must conform to comparative advantage for mutually beneficial trade. Wage rate limits equal to and determined by productivity ratios. Exchange rate and safe ratios Expressed in terms of currencies, comparative advantage yields limits to sustainable exchange rate. Expressed in terms of labor production costs, it yields limits to wage ratio. C1-12 Summary of Policy Implications Improved resource use efficiency, raised real income Comparative advantage ranking and exchange rate determine trade Rank—distorting policies allocate resources inefficiently and reduce income to community Gainers—industries in which the country has comparative advantage Losers—industries in which the country has comparative disadvantage Policy debates result from gainers vs. losers disputes Gains outweigh losses Inflation reduction Government helps losers adjust (financial assistance, retraining) C1-13 Dynamic Gains from International Trade Static effects—reallocation of resources Dynamic benefits—additional resources available Higher income from more efficient use of resources Increased savings, more resources available for investment Technological spillover Increased size of national market Economies of scale and benefits to economy at large Competitive pressure on prices Product improvement Technological advancement Increased labor pool Infrastructure development Inflation dampening C1-14 Summary Comparative advantage determines trade Exchange ratio, determined by demand Mutual benefit of trade Ranking and limits to sustainable exchange rate Absolute advantage and wage rates Anti-inflationary Increased GDP Introduction of goods, inputs, technology Increased market size C1-15 FIGURE 2.2A International Trade Under Constant Opportunity Costs C1-16 FIGURE A2-1.1 Consumer Indifference Curve C1-17 FIGURE A2-1.2 Consumer Indifference Map C1-18 FIGURE A2-1.3 Constant Opportunity Cost (In Millions of Units) C1-19 FIGURE A2-1.4 Increasing Opportunity Cost (In Millions of Units) C1-20 FIGURE 2.2A1.5 Equilibrium in Isolation C1-21 FIGURE 2.2A1.6 Equilibrium with Trade: Different Transformation Curves C1-22 FIGURE 2.2A1.7 Equilibrium with Trade: Different Indifference Curves C1-23