Chapter 1 International Trade

Chapter 1 International TradeLearning objectives In this chapter, you will learnThe reasons for international trade Benefits of international trade Problems existing in international trade Related economic concepts

Reasons for international trade1. Resource reasons 2. Economic reasons 3. Political reasons

Resource reasonsFavorable climatic conditions and terrain Natural resources Skilled workers Capital resources Favorable geographic location and transport costs Insufficient production

Economic reasonsAbsolute advantageBy Adam Smith

Comparative advantageBy David Ricardo

Adam Smith (1723-1790)British philosopher and economist, An Inquiry into the Nature and Causes of the Wealth of Nations was the first serious attempt to study the nature of capital and the historical development of industry and commerce among European nations. private competition free from regulation Smith believed that private businesses seeking their own interests organize the economy most efficiently, “as if by an invisible hand.” Specialization on the basis of absolute advantage

Absolute-cost exampleDays of labor required to produce Country Scotland Italy Cloth 30 100 Wine 120 20

Production Possibility FrontierGood APPF W X Y Good B

Production Possibility Frontier

Rice 30 10 12 10 12

(12, 20) (24,10) Cloth 36

Comparative advantageDavid Ricardo (1772-1823), British economist The High Price of Bullion, his first work on economic theory, he argued for a sound currency based on metal. Principles of Political Economy and Taxation (1817), his major work, offered several theories based on his studies of the longrange distribution of wealth.

David Ricardo’s theoryThe theory of rent is based on relative land productivity. He supported the classical theory of international trade, emphasizing national specialization and freedom of competition. His labor theory of value, which influenced Karl Marx, states that wages are determined by the price of food, which is determined by the cost of production, itself determined by the amount of labor required to produce the food; in other words, labor determines value.

Comparative-cost example (1)Total output Countr y A B Rice 2 1 Copper 4 1 1R:2C or ½ R:1C 1R:1C Ratio of costs within the country

Comparative-cost example (2)Quantity owned after trading Country A B Rice (4) 1 Copper 4 (2) 1R:1C 1R:2C or ½ R:1C Exchange rates used

Comparative-cost example (3)Total output after specialization Country Rice Copper

A B

0 2

8 0

Comparative-cost example (4)Quantity owned after trading Country A B Rice 2<X<4 1X/4=1/Y

Copper 4 1<Y<2

Factors of ProductionOutput = f (L,L,C,E)Land : natural resources Labor: human resources Capital: man-made aids to production Entrepreneurship: the ability to combine factors of production

Benefits of international tradeCheaper goods Greater variety when goods com from more countries Wider market with increasing number of trading partners Growth of economy