ECONOMICS 120
SUMMARY
CHAPTER 18: INTERNATIONAL TRADE
LEARNING OUTCOMES
• The economic basis for trade
• Th graphical model of comparative advantage, specialisation, and the gains from trade
• The different trade barriers
• How economists analyse the economic effects of tariffs and quotas
• The rebuttals to the most frequently presented arguments for protectionism.
In this chapter, we build on a deeper analysis of the benefits of international trade and a fuller appraisal of the
arguments for protectionism (the theory or practice of shielding a country's domestic industries from foreign
competition by taxing imports.)
THE ECONOMIC BASIS FOR TRADE
International trade allows nations to specialise their production, enhance their resource productivity and acquire
more goods and services. Sovereign countries can gain by specialisation in the products they can produce with
greatest relative efficiency and by trading for the goods they produce as efficiently.
The reason nations trade hinges on three facts:
1. The distribution of natural, human, and capital resources among nations is uneven: nations differ in
their endowments of economic resources.
2. Efficient production of various goods requires different technologies or combinations of resources.
3. Products are differentiated as to the quality and other non-price attributes. A few or many people may
prefer certain imported goods to similar goods made domestically.
Specialising based on comparative advantage enables nations to reduce the cost pf obtaining the goods and
services they desire.
COMPARATIVE ADVANTAGE: GRAPHICAL ANALYSIS
Labour Productivity = Output per Worker
The principle of comparative advantage says that total output will be greatest when each good is produced by
the nation that has the lowest domestic opportunity cost for that good.
TERMS OF TRADE
If wheat = x and meat = y:
, At what ratio will each nation trade at its products? If m=1 (or 1/1 from y/x) then the ratio will be 1:1 (x: y). If
m=2 the ratio will be 1:2 (x: y) (or 2/1 from y/x). When exchanging m=1, one product can be exported to import
its equivalent alternative. When exchange m=2, two products will be exported to import its equivalent
alternative.
The actual exchange ratio depends on world supply and demand for the two products.
m=2/1:
If the overall demand for meat (y) is weak relative to its supply and the demand for wheat is strong relative to its
supply, the price of meat will be lower and the price of wheat (x) will be higher. The exchange rate will be
1x:2y.
m=1/1:
If the overall demand for meat (y) is strong relative to its supply and the demand for wheat (x) is weak relative
to its supply, the price of meat (y) will be higher and the price of wheat (x) will be lower. The exchange rate will
be 1x:1y.
GAINS FROM TRADE
The possibility of trading on terms of trads permits each nation to supplement its domestic production
possibilities curve with a trading possibilities line.
The ideal exchange rate for a country to get to 1(x):1(y). This is so that they can afford to buy other resources.
Specialisation and trade create a new exchange ratio between wheat and meat, reflected in each nation's trading
possibilities line.
Example:
By specialising in wheat and trading for Namibia's meat, South Africa can obtain more that 1 to of meat for 1
ton of wheat.
By specialising in meat and trading for South Africa's wheat, Namibia can obtain 1 ton of wheat for less than 2
tons of meat.
In both cases self-sufficiency is not desirable.
Added output.
Specialisation according to comparative advantage results in a more efficient allocation of world resources, and
larger outputs of both products are therefore more available to both nations.
Specialisation + International Trade = Optimal mix
The outcome of international specialisation and trade is equivalent to having more and better resources or
discovering improved production techniques.
TRADE WITH INCREASING COSTS
As the cost ratios for both countries fall from South Africa (1=1) and rise from Namibia (1=2), the two ratios
will meet at a midpoint that is equal for both nation: South Africa (1=1,75) and Namibia (1=1,75). At this point
specialisation and trade have disappeared and no longer economical. The change in cost ratio is a result
expanding production and increasing opportunity costs.
SUMMARY
CHAPTER 18: INTERNATIONAL TRADE
LEARNING OUTCOMES
• The economic basis for trade
• Th graphical model of comparative advantage, specialisation, and the gains from trade
• The different trade barriers
• How economists analyse the economic effects of tariffs and quotas
• The rebuttals to the most frequently presented arguments for protectionism.
In this chapter, we build on a deeper analysis of the benefits of international trade and a fuller appraisal of the
arguments for protectionism (the theory or practice of shielding a country's domestic industries from foreign
competition by taxing imports.)
THE ECONOMIC BASIS FOR TRADE
International trade allows nations to specialise their production, enhance their resource productivity and acquire
more goods and services. Sovereign countries can gain by specialisation in the products they can produce with
greatest relative efficiency and by trading for the goods they produce as efficiently.
The reason nations trade hinges on three facts:
1. The distribution of natural, human, and capital resources among nations is uneven: nations differ in
their endowments of economic resources.
2. Efficient production of various goods requires different technologies or combinations of resources.
3. Products are differentiated as to the quality and other non-price attributes. A few or many people may
prefer certain imported goods to similar goods made domestically.
Specialising based on comparative advantage enables nations to reduce the cost pf obtaining the goods and
services they desire.
COMPARATIVE ADVANTAGE: GRAPHICAL ANALYSIS
Labour Productivity = Output per Worker
The principle of comparative advantage says that total output will be greatest when each good is produced by
the nation that has the lowest domestic opportunity cost for that good.
TERMS OF TRADE
If wheat = x and meat = y:
, At what ratio will each nation trade at its products? If m=1 (or 1/1 from y/x) then the ratio will be 1:1 (x: y). If
m=2 the ratio will be 1:2 (x: y) (or 2/1 from y/x). When exchanging m=1, one product can be exported to import
its equivalent alternative. When exchange m=2, two products will be exported to import its equivalent
alternative.
The actual exchange ratio depends on world supply and demand for the two products.
m=2/1:
If the overall demand for meat (y) is weak relative to its supply and the demand for wheat is strong relative to its
supply, the price of meat will be lower and the price of wheat (x) will be higher. The exchange rate will be
1x:2y.
m=1/1:
If the overall demand for meat (y) is strong relative to its supply and the demand for wheat (x) is weak relative
to its supply, the price of meat (y) will be higher and the price of wheat (x) will be lower. The exchange rate will
be 1x:1y.
GAINS FROM TRADE
The possibility of trading on terms of trads permits each nation to supplement its domestic production
possibilities curve with a trading possibilities line.
The ideal exchange rate for a country to get to 1(x):1(y). This is so that they can afford to buy other resources.
Specialisation and trade create a new exchange ratio between wheat and meat, reflected in each nation's trading
possibilities line.
Example:
By specialising in wheat and trading for Namibia's meat, South Africa can obtain more that 1 to of meat for 1
ton of wheat.
By specialising in meat and trading for South Africa's wheat, Namibia can obtain 1 ton of wheat for less than 2
tons of meat.
In both cases self-sufficiency is not desirable.
Added output.
Specialisation according to comparative advantage results in a more efficient allocation of world resources, and
larger outputs of both products are therefore more available to both nations.
Specialisation + International Trade = Optimal mix
The outcome of international specialisation and trade is equivalent to having more and better resources or
discovering improved production techniques.
TRADE WITH INCREASING COSTS
As the cost ratios for both countries fall from South Africa (1=1) and rise from Namibia (1=2), the two ratios
will meet at a midpoint that is equal for both nation: South Africa (1=1,75) and Namibia (1=1,75). At this point
specialisation and trade have disappeared and no longer economical. The change in cost ratio is a result
expanding production and increasing opportunity costs.
