International Trade: Basics

Dr. Katherine Sauer

Global Economic Issues
ECON 241
I. Why do nations trade?

Why do nations export?

- individuals/firms produce more than can be consumed
at home
- sellers could receive a higher price in a foreign market

Why do nations import?

- some goods can’t be produced at home (or not enough)
- some goods are produced at a lower cost or more
efficiently elsewhere
- consumers like variety
II. Absolute and Comparative Advantage

Due to differences in supply conditions, a country may be able

to produce more of a good at a lower cost.
- superior technology
- large factor (resource) endowments

Absolute advantage is the ability to produce a good at the lowest

cost.

It implies a potential trade pattern.

ex: tropical countries produce and export bananas
coastal countries produce and export seafood

It gives an incentive to specialize in a good and export it.

 Suppose Japan and Vietnam both produce rice.
- The demand for rice is roughly the same in each.
- Due to low production costs (abundant land suitable for
growing rice), supply is higher in Vietnam.

Domestic Markets for Rice

Vietnam Japan
P P S

S Pj

Pv
D D

Q Q
The domestic price of rice is lower in Vietnam.

Vietnam has an incentive to specialize in the production of rice

and to export it.

Japanese consumers could get rice more cheaply if they

imported it from Vietnam.

So, suppose the two countries open up to trade.

- Once a country opens to trade, its domestic price no
longer matters.
- Only the world price will matter.
 The world price is determined by world supply and world
demand.

World Vietnam
P P

S S

Pw

Pv
D
D

Q Q
 Vietnam Japan
P P S

S Pj
Pw Pw

Pv

D D

QD QS Q QS QD Q

At the world price:

In Vietnam: In Japan:
QS > QD QS < QD
domestic surplus domestic shortage
export the surplus import to satisfy shortage
How are consumers and producers affected by the countries
trading?
 Vietnam Japan
P P S

S Pj
Pw Pw

Pv

D D

QD QS Q QS QD Q
Consumers used to pay Pv, now Consumers used to pay Pj, now
they pay the higher Pw and buy they pay the lower Pw and buy
less. (worse off, CS is less) more. (better off, CS is greater)

Producers used to sell at Pv, now Producers used to sell at Pj, now
they sell at the higher Pw and sell they sell at the lower Pw and sell
more. (better off, PS is greater) less. (worse off, PS is less)
 Vietnam Japan
P P S

S Pj
Pw Pw

Pv

D D

QD QS Q QS QD Q

CS = CS =
PS = PS =
CS transferred to PS = PS transferred to CS =
PS gained from trade = CS gained from trade =
TS = TS =
Overall with trade:

The gain to producers is larger than the loss to consumers in

Vietnam.

Society as a whole in Vietnam is better off. (TS is larger)

The gain to consumers is larger than the loss to producers in

Japan.

Society as a whole in Japan is better off. (TS is larger)

Summary:
1) Differences in supply conditions across countries lead to
complementary patterns of absolute advantage.

2) Complementary patterns of absolute advantage lead to

complementary patterns of trade.

superior technology
in a sector
absolute tendency to
and/or advantage in export from
a sector that sector
large factor
endowments in a
sector

3) Trade can make countries as a whole better off, but there are
winners and losers among producers and consumers.
Absolute advantage alone is not sufficient to fully explain
international trade.

- The opportunity cost of producing an item may

exceed the cost of trading for it.

An opportunity cost is the value of everything that must

be sacrificed in order to get something.

International trade is based on comparative advantage.

Comparative Advantage is the ability to produce at the lowest

opportunity cost.
Even if a nation has absolute advantage in nothing, it can have a
comparative advantage.

When countries specialize in producing goods they have

comparative advantage in, and then trade those goods, they can
consume more goods and services than they could produce on
their own.

In a nutshell, this is why international trade is good and can be

good for all countries involved.
III. Trade in Theory and in Practice

In reality, specialization and trade don’t work exactly as the

theories of absolute and comparative advantage suggest:

- no country specializes exclusively in the production

and export of a single product

- countries produce at least some goods that could be

produced elsewhere more efficiently

- a lower income country may be able to produce more

cheaply than a high income country but may not be able
to identify potential customers or to transport the item
cheaply or quick enough
However, in general…

Countries with a relative abundance of low-skilled labor tend to

specialize in and export items having low-skilled labor as a
major cost component.

Countries with a relative abundance of capital tend to specialize

in and export items having capital as a major cost component.
IV. Trade Pattern
(what a country imports and exports and who its trading partners are)

India
exports: engineering goods, gems/jewelry, textiles, agricultural
goods, chemicals (US, China, UAE, UK)

imports: petroleum, capital goods, gold & silver, electronics,

gems (US, Belgium, China, Singapore)

Chile
exports: copper, fruit, paper products
(US, Japan, China, South Korea, Netherlands)

imports: intermediate goods, capital goods, consumer goods

(Argentina, US, Brazil, China, Germany)
Bangladesh
exports: clothing, fish, jute goods, leather
(US, Germany, UK, France, Italy)

imports: capital goods, textiles & yarn, fuels, cereal & dairy
goods
(India, China, Singapore, Kuwait, Japan)

Germany
exports: vehicles, machinery, chemicals, telecoms technology,
electricity devices
(France, US, UK, Italy, Netherlands, Belgium)

imports: chemicals, vehicles, fuels, machinery, computer

technology (France, Netherlands, US, Italy, UK, China)
China
exports: office equipment, telecoms equipment, clothing,
electrical machinery
(US, Hong Kong, Japan, South Korea, Germany)

imports: electrical machinery, petroleum products,

professional
& scientific instruments, office equipment
(Japan, Taiwan, South Korea, United States, Germany)

Kenya
exports: horticultural products, tea, coffee, fish products
(Uganda, UK, US, Netherlands)

imports: industrial supplies, machinery & transport equipment,

consumer goods, food and drink
(UAE, Saudi Arabia, South Africa, US)
V. The Relative Importance of Trade

Over time, trade has accounted for a larger and larger proportion
of world GDP.

year world exports world GDP exports as % GDP

1970 $317b $3,378b 9.4%
1980 $2,408b $11,742b 20.5%
1990 $4,256b $22,721b 18.7%
2000 $7,819b $31,649b 24.7%
2006 $14,464b $47,766b 30.3%

For an individual country, the total trade value as a share of GDP

is an indication of how important trade is in the country’s
economy.
 total trade value = exports value + imports value

trade value as a share of GDP = total trade value x 100

GDP

TTV IM
Country GDP EX IM . Trade value %GDP %GDP
China $2,229b $762b $660b $1,422b 63.8% 30%
Djibouti $0.702b $0.40b $0.32b $0.72b 103% 47%
Thailand $178b $110b $118b $228b 128% 66%

Another useful measure is the ratio of imports to GDP.

VI. The Trade Balance

The trade balance is the difference between the value of a

country’s exports and the value of its imports. It is also called
net exports.

TB = EX – IM

If exports > imports, then there is a trade surplus.

If exports < imports, then there is a trade deficit.

When you hear that a country’s trade balance has “worsened”, it

means that there is less of a surplus or more of a deficit.
- imports are increasing
or
- exports are decreasing
Factors that influence a country’s trade balance:

1) prices of goods manufactured at home

- if home goods are relatively expensive, then a country
will import cheaper goods

2) exchange rates
- if a country’s currency is strong against other currencies,
then it is “cheap” to import while its exports are
“expensive” to other countries

3) trade agreements
- when a country signs a Free Trade Agreement, both
its exports and imports will likely increase
4) trade barriers
- if a country imposes tariffs on imports, then imports
are reduced
- if a country subsidizes exports, then exports will rise

5) the business cycle at home or abroad

- in an expansion at home, consumer incomes are
increasing, in general this will increase imports

- in an expansion abroad, consumer incomes elsewhere

are increasing so the home country exports more

Most economists don’t believe that trade deficits/surpluses are

inherently good or bad. The economic impact of a surplus or
deficit depends on the specific circumstances surrounding it.
Arguments:
A Trade Deficit is Bad (a Trade Surplus is Good)
A trade deficit
- signifies economic weakness because it reflects an
excessive reliance on foreign products

- represents an expenditure of future growth because

whenever a nation purchases more than it produces,
funds that could have been used for investment (future
growth) are being used for consumption in the present

- large trade deficits create conditions favorable for a

financial crisis

Ex: In 8/06, New Zealand announced a wider than expected

trade deficit. The NZdollar lost value.
A Trade Deficit may be Good

A trade deficit means

- consumers can enjoy a higher standard of living than if
they were limited to domestically produced goods

- could be a sign of economic strength because imports

are known to increase during times of economic growth

In industrial countries, trade deficits have not sparked economic

crisis.

Ex: In Mexico, the July 2006 trade deficit was $319m and in
August it was $783m. The increase in imports was due to an
increase in consumer wages. This import increase suggests that
domestic demand is strengthening.
A Trade Surplus may not be Good

A trade surplus could mean a country is too reliant on foreign

demand for its goods.

The surplus could be the result of an undervalued currency.

Ex: In August 2006, China announced a trade surplus of

$18.8billion. It has been accused of keeping its currency
undervalued in order to make its exports cheaper.