International Economics Faculty: Prof. Sunitha Raju Session 1: Introduction and International Trade Theory Session Date: 06.07.13.

International Economics

Faculty: Prof. Sunitha Raju

Session 1: Introduction and International Trade Theory

Session Date: 06.07.13

MBA(PT)2012-15

International Economics/ Session: 1

Globalization - Meaning

Integration of national Economies into an international economy

Integration through trade investment, capital flows, technology and migration

MBA(PT)2012-15


Globalisation Trends

Promotion of Free Trade Elimination of tariffs subsidies Elimination of capital controls Reduction in transportation costs

Integration of production activities Wider choice of goods & services Creates competition for local firms & keeps costs

low Promotes specialisation Can lead to economic problem of unemployment

& deindustrialisation

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Review of Trends in Global TradeReview of Trends in Global Trade

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Trade to GDP Ratios

Source: UNCTAD Handbook of Statistics

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Composition of Exports By Regions

Year 1980 1990 2000 2005 2009

World 2035542 3485651 6448493 10504579 12419054

Developing Economies 29.46 24.32 31.8 36.2 39.5

Transition Economies 4.19 3.4 2.3 3.4 3.8

Developed Economies 66.34 72.2 65.7 60.3 56.6

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Total Merchandise Exports, 1995-2006

Reporter Name

Partner Name

1995 2000 2006

Value ($ billions)

Share in WLD to

WLD (%)

Value ($ billions)

Share in WLD to

WLD (%)

Value ($ billions)

Share in WLD to

WLD (%)

World World 5,037.5 100.0 6,316.1 100.0 11,565.8 100.0

Developing economies

World 1,417.4 28.1 2,061.7 32.6 4.110.8 35.5



570.2 11.3 786.6 12.5 1,824.2 15.8

Source: UNCTAD’s South-South Trade Information System

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Composition of Exports of Developing Countries- Regional Groups

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Export Structure by Product Group: World

All Food Items

Agriculture Raw Material

Ores & Metals

Fuels Manufacturing Goods

Total

1995 9.0 2.7 4.6 7.4 73.9 100

2005 6.5 1.6 4.7 13.8 70.5 100

2009 7.9 1.4 5.5 14.1 67.9 100

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Export Structure of Commodities by Regions

Developed Economies Developing Economies Transition Economies

Item 1995 2005 2009 1995 2005 2009 1995 2005 2009

All Products 3385250 6849291 7373358 1536381 3269916 4602463 95802 260403 359190

All Food Items 67.3 68.2 62.0 28.9 27.3 33.0 4.4 4.5 4.6

Agriculture Raw Material

67.7 61.0 52.8 31.5 37.2 44.8 0.8 1.8 2.4

Ores & Metals 68.9 60.2 52.2 30 38.2 68.9 1.2 1.5 1.1

Fuels 68.7 66.6 58.0 28.9 31.6 30 2.7 1.8 2.1

Manufacturing Goods

67.4 65.8 60.4 31.1 28.2 8.5 1.5 2.6 3.1

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Top 10 Economies in South-South Trade, 2003 (Percentage shares of total South-South Trade)

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Applied Tariffs in Developed and Developing Countries by Selected Product Group,

1994 and 2005 (percent)

Pro

du

cts

and

Mar

ket

s

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Trade and Investment Trends

Exports of Goods & Services 2010 2012 2015 2017

(i) World 18820.672

(100.0)

22847.769

(100.0)

26899.298

(100.0)

30552.711

(100.0)

(ii) Advanced Economies 11987.352

(63.692)

13870.86

(60.709)

16012.693

(59.528)

17852.059

(58.430)

(iii) Newly Industrialised Asia 1834.153

(9.745)

2185.931

(9.567)

2696.216

(10.023)

3145.178

(10.294)

(US $ billions)

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World Trade Trends

a) Why do some countries trade more than others

b) Why is there a significant increase in the trade in manufactures compared to primary commodities

c) Why is there a growing importance of developing countries in world trade

d) Why is there a significant increase in south-trade

e) What role do national trade policies have in defining the trade pattern

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Framework for International Trade

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Preview Questions

1. What is the basis for trade between countries?

2. How are gains from trade defined/ measured?

3. What determines the structure/pattern of trade flows?

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Basis for Trade

1. Mercantilism

2. Standard Trade Model Absolute Advantage Comparative Advantage Heckscher-Ohlin Theorem

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Absolute Advantage: Illustration

US will export wheat and import cloth from UK

UK will export cloth and import wheat

Absolute cost differences between countries lead to trade

US UK

Wheat (bushels/man-hour) 6 1

Cloth (Yards/man-hour) 4 5

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Comparative Advantage: Illustration

US UK

Wheat (bushels/man-hour) 6 1

Cloth (Yards/man-hour) 4 2

US has absolute advantage in both wheat & cloth

UK has absolute disadvantage in both wheat & cloth

Can trade take place?

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Principle of Comparative Advantage(Ricardo)

Comparison of relative advantage or disadvantage between countries

US has 6 to 1 advantage in wheat and 2 to 1 advantage in textiles (over UK)

UK has greater disadvantage in wheat than in cloth.

Wheat : 1 to 6

Cloth : 1 to 2

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Comparative Advantage: Resource Cost

US

Domestically, 6W can be produced if 4C is given up (opportunity cost)

1C costs 1½ W and 1W costs W

UK

2C can be produced if 1W is given up 1C costs ½ W and 1W costs 2C

Therefore, cloth is relatively cheaper in UK and wheat in USA

3

2

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Comparative Advantage: Gains from Trade 1

US (Cloth) Import of cloth takes place if 6W can be

exchanged for greater than 4Cif 1C is less than 1½ W

UK (Cloth) Export of cloth takes place if 2C can be

exchanged for greater than 1WIf 1C is greater than ½ W

Both US & UK gain if the price of cloth (in terms of wheat) is 1W

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Countries can gain from trade even when one of the countries has absolute disadvantage (cost) in both products

Relative Advantage / Disadvantage will define the implicit resource cost for production of goods

Relative prices determine the direction and volume of trade

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Benefits from trade can be assessed when compared to a situation without trade (Autarky)

In Autarky, resource allocation decision is based on production and consumption decisions of a country

Possible production trade-offs between goods X and Y given the available resources and technology (production possibility curve for a country)

Trade-offs between consumption of goods X and Y subject to consumer preferences (consumer indifference curve for a country)

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Comparative Advantage and Trade: Production Possibility Schedule (PPS)

PPS shows various combinations of 2 goods that a country can produce when all inputs (land, labour capital & Entrepreneurship) are used most efficiently.

Under constant cost conditions, relative cost of producing one good in terms of other remains same

MRT = cloth

wheat

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Production Possibility Frontier

Production Possibility Schedules for Wheat and Cloth in the United States and the United Kingdom

United States United Kingdom

Wheat Cloth Wheat Cloth

180 0 60 0

150 20 50 20

120 40 40 40

90 60 30 60

60 80 20 80

30 100 10 100

0 120 0 120

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Consumption/Demand Issues

Consumer demand is underlined by tastes/ preferences or utility

How much of the goods produced will be consumed depends on consumer preferences

Consumer Indifference Curve

Slope of the Indifference Curve represents consumers’ trade off between two goods, i.e. Marginal Rate of Substitution

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Slope = ∆ Y/∆ X = MRSA

UA

2

AU

A1

U0

YA

0 XA

Indifference Curves

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Equilibrium in Autarky

Consumption utility maximized subject to the constraints of Production Possibility Frontier

Slope = -(bLX/bLY) = MRTB

Slope = MRSB

YB

YB

XB0 XB

UB B

2

UB1

UB0

LB/ bLY

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120

80

60

40

20

100

30 60 90 120 150 180

•

••

••

•

•

A

Clo

th

120

80

60

40

20

100

20 60

•

••

••

•

Clo

th40


Wheat Wheat

• •0 0

A′

•

Production Possibility Frontier: Equilibrium under Autarky

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Equilibrium in Open Economy

120

70

60

90 110 180

•

••

•

E

Clo

th


Wheat

•0

A

B

120

50

40

60 7040

•

••E′

Clo

thWheat

•0

B′

A′

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Equilibrium-Relative Prices with Trade

With specialisation in production & trade, each nation can consume outside its production frontier.

The relative prices that balances trade (i.e. export of 1 country = import by another country)

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Exports

Imports

E*

S

DE

A

B

P3

P2

P1

SX

International Trade in Commodity X

Nation 1’s Market for Commodity X

Nation 2’s Market for Commodity X

SX

A’

E’B’

A’’

DX

P3

B*

A*

XXO O O

.

..

.

. .

.

.

.

.

The Equilibrium-Relative Commodity Price

Panel A Panel B Panel C

Dx

Y

XP

P

Y

XP

PY

XP

P

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Trading under Constant Costs

Basis for Trade Slopes of the production possibilities schedules give

the relative cost of one product in terms of other Differences in relative costs provide the basis for

mutually favourable trade

Production gains from Specialisation

A country will specialise in the production of the good in which it has comparative advantage

A country will trade part of this production for the good in which it has comparative disadvantage

(a)

(b)

Contd..

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International Economics/ Session: 1 Consumption gains from Trade

Consumption alternatives limited by the domestic production possibilities schedules

The exact consumption will be determined by the tastes & preferences

Specialization & free trade care achieve post-trade consumption outside domestic production possibilities schedules trade results in consumption gains for both countries

Terms of Trade Domestic terms of trade represents the relative prices at which

goods are exchanged at home A country will exports/import goods internationally if the terms

of trade are more favourable than domestic terms of trade

(d)

(c)

Trading under Constant Costs

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Production Possibility Schedule under Increasing Costs

(i) Increasing opportunity costs mean that more of one commodity is to be given up (to release resources) for additional production of another commodity

(ii) Increasing costs result when inputs are not perfect substitutes

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0 0

Nation 1 Nation 2

Production Frontiers of Nation 1 and Nation 2 with Increasing Costs

10 30 50 70 90 110

130

∆X

-∆Y

A

B

X

Y

20

40

60

80

100

120

140

∆Y

-∆X

A’

B’

Y

Slope of the PPS (or MRT) varies at different points on the schedule

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0 0

Nation 1 Nation 2

10 30 50 70 90 110

130

A

B

X

Y

20

40

60

80

100

120

140

A’

B’

Y

20

40

6070

80

.

I

4

1AP

140

20 40 60 80

.

.

I’

85

PA’=4

Trade Under Increasing Cost

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0 0

Nation 1 Nation 2

10 30 50 70 90 110

130

A

B

X

Y

20

40

60

80

100

120

140

A’

B’

Y

20

40

6070

80

.

I

20 40 60 80

.

.

I’

100

... III

E

150

PB=1C

100

120

III

E’C’

PB’=1

Trade Equilibrium Under Increasing Costs

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Trading under Increasing Costs

Supply factors and Demand factors together determine the point at which a country chooses to consume along the PPS.

In Autarky, a country is in equilibrium which the PPS is tangent to the highest indifference curve

This tangency determines the equilibrium relative prices of commodities in each country.

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Determining Relative Prices

(i) Terms of Trade (Net barter terms of trade) Ratio of price of export commodity to the price of

import commodity Assume 2 countries :

– Home → Exports Food

→ terms of trade

– Foreign → exports manufactures

→ terms of trade

M

F

P

P

F

M

P

P

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Sources of Comparative Advantage

a) Factor Endowments

b) Technology

c) Consumer Tastes (Demand Issues)

International Economics Faculty: Prof. Sunitha Raju Session 1: Introduction and International Trade Theory Session Date: 06.07.13.

Documents

international trade

global trade slide

trade pattern slide

trade investment

migration slide

world trade dwhy

national trade policies

south trade ewhat role