1、 Why Counties Trade（the classical model of international trade）Chapter Organization Introduction Trade Based on Absolute Advantage Trade Based on Comparative Advantage Trade Based on Opportunity Costs The Production Possibilities Frontier and Constant Costs The Terms of Trade Trade Under Increasing
2、Opportunity Costs Dynamic Gains from TradeIntroduction In this chapter, we first discuss international trade based on Adam Smiths theory of absolute advantage. Then, we explain the pattern of trade and the gains from trade based on David Richards theory of comparative advantage. We also explain the
3、theory of comparative advantage in terms of opportunity cost. Finally, we describe the gains from trade that are difficult to quantify and occur over time.International Trade Versus Interregional Trade International trade and Interregional trade are similar. international means between two or more c
4、ountries. Inter-regional (domestic trade) means between two or more regions, where a region is a part of a country. Benefits of Trade: -specialization and trade makes total world output of goods and services larger than it would be without trade Difference between international trade and interregion
5、al trade National currency; Trade policy; Market development; Culture and customs; law, etc1.Three basic questions about international trade Why do countries export and import certain goods? At what price are products exchanged in world market? What are the gains from international trade In terms of
6、 production and consumption?2.The Mercantilism and its standpoints During 1500-1700,the doctrine of mercantilism domin-ated political and economic thought . The premise: a country can promote its self-interest by discouraging imports and encouraging exports ;a country wealth was precious metal, gold
7、 and silver A favorable trade balance: a surplus of exports over imports. Mercantilists advocating: tariffs, quotas, and other trading protectionism policies. David Humes price-specie-flow doctrine: a favorable trade balance was possible only in the short run, for over time it would automatically be
8、 eliminated. Video 3 video 23.Adam Smiths theory of absolute advantageAdam Smith: The Wealth of Nations ,1776International trade is not a zero-sum game.The gains from trade are the increase in world output that results from each country specializing its produc-tion according to absolute advantage (a
9、bsolute cost).Absolute advantage is the ability of a country to use fewer resources to produce a good than other countries. assumption :the labor theory of value1. Labor is the only factor of production and is homo-geneous.2. The cost or the price of a good depends exclusively on the amount of labor
10、 a example about absolute advantageAssumption:2-nation:the U.S. and India, 2-product:machine and cloth,1-factor:labor ;technology (constant) ; transportation cost (zero) ;free trade . Absolute advantage is the ability of a country to use fewer resources to produce a good than other countries. The U.
11、S. has an absolute advantage in machine production, while India has an absolute advantage in cloth production. countrymachinescloth U.S.5 machines10 yards of clothIndia2 machines15 yards of clothTable 1 autarky (a closed economy) One person per day of labor ProductsTable 2 open economy countrymachin
12、escloth U.S.+5 machines-10 yards of clothIndia-2 machines+15 yards of clothChanging in world output+3 machines+ 3 yards of clothThe theory of absolute advantage In a two-nation, two-product world , international trade and specialization will be beneficial when one nation has an absolute cost advanta
13、ge in one good and the other nation has an absolute cost advantage in the other good. 4.David Ricardos theory of comparative advantageAn unanswered question: why would trade occur betw-een two countries if one country had an absolute adv-antage in the two goods?countrymachinesCloth relative costU.S.
14、5 machines15 yards of cloth 1M=3CIndia1 machines5 yards of cloth 1M=5C U.S.the degree of absolute advantage: machine 5-to-1,cloth 3-to-1.the U.S. has a comparative advantage in machine. India has a comparative advantage in cloth. countrymachinescloth U.S.+5 machines-15 yards of clothIndia-3 machines
15、+15 yards of clothChanging in world output+2 machines 0 yards of clothFree trade according comparative advantage the gain from specialization and trade is the increase in world output that results from each country specializing its production according to its comparative advantage.The theory of Comp
16、arative advantage The more efficient nation should specialize in and export the goods in which it is re-latively more efficient. The less efficient nation should specialize in and export the goods in which it is relatively less in-efficient. 5.General Trade theories: Based on Opportunity Costs Oppor
17、tunity cost: opportunity cost is the amount of a goodmachine-that must be given up to release enough resources to produce another good-cloth.countrymachinesCloth opportunity costU.S.5 machines15 yards of cloth 1M=3CIndia1 machines5 yards of cloth 1M=5C Marginal rate of transformation (MRT): The MRT
18、shows the amount of one good that a country must sacrifice to get one additional unit of another good. MRT=Cloth/Machine5.1 The gains from trade with opportunity cost For profitable exchange to take place, the price machines relative to the price of cloth would have to be between 1M=3C and 1M=5C. If
19、 1M=4CU.S.IndiaProduction at full employment100 machines0 yards of cloth0 machines300 yards of clothconsumption with trade1M=4C50 machines200 yards of cloth50 machines100 yards of clothAutarkyU.S. 1M=3CIndia 1M=5C50 machines150 yards of cloth40 machines100 yards of clothGains from trade50 yards of c
20、loth10 machines Production possibilities frontier (PPF) shows the different combinations of two goods that can be produced when all of a countrys factors of production are fully employed in their most efficient manner. Constant cost U.S.Indiamachinesclothmachinescloth10006009030505080604010070903015
21、06012020200501501025040180030030210202401027003005.2 The Production Possibilities Frontier and Constant CostsThe opportunity cost or MRT for each country is equal to the slope of the PPF. Under perfectly competitive, Pm/Pc=3( U.S.), Pm/Pc=5(India)Slope=MRT=-3=- Pm/PcSlope=MRT=-5=- Pm/Pc Production a
22、nd Consumption without specializa-tion and trade -Without specialization and trade, the U.S. and India can produce and consume at any point along their respective PPF.- Because the opportunity costs are different in the two countries ,mutually beneficial trade is possible. Production and Consumption
23、 with specialization and trade 1M=4C200EexportimportDF50EFDexportimportTrading triangle: EFD and EFDDG or DG is called trading possibilities curvetheThe terms of trade :1M=4CGG Production and Consumption with specialization and trade as a result of international specialization and trade, the U.S. an
24、d India can both have levels of consumption that are superior to those attainable on their production possibilities frontiers. Changes in the gains from speciation and trade as the terms of trade change (from 1M=4C to 1M=3.5C ), the trading possibilities frontier rotates for both countries. Indias c
25、onsumption point moves from E to F and the U.S. consumption point moves from E to F . the closer the ratio moves toward 1M=3C,the more favorable the exchange is for India.5.3 The terms of trade and distribution of the gains from tradeterms of trade: it measures the relationship between the prices a
26、nation gets for its exports and the prices it pays for its imports. terms of trade = (exports prices index)/(imports prices index) 100%Conclusion:an improvement in a countrys terms of trade does not necessarily reflect an improvement in a countrys overall welfare.1.An improvement in a countrys terms
27、 of trade resulting from a change in international conditions will enhance the country welfare.2.When the terms of trade change as a result of a change in domestic economic conditions. The effect on a countrys welfare is uncertain.5.4 Demand condition and the terms of tradeThe theory of reciprocal d
28、emand (pointed out by John Stuart Mill,1921)suggests that the actual international exchange ratio at which trade takes place depends on each trading partners interacting demands.the reciprocal demand theory indicates that the final international exchange ratio depends on the relative strength of eac
29、h countrys demand for the other countrys product.If two countries are of unequal (population and income), it is possible that the larger countrys demand would be greater than the smaller countrys demand. As a result ,the smaller country gains from than the larger country.5.5 Constant cost 、Complete
30、specialization and PPF Complete specialization: the use of all of a countrys resources to produce only one good. Supply Curves of a Good and the Production Possibilities Frontier Under Constant Cost Conditions Constant opportunity costs lead to straight-line production possibili-ties frontiers and s
31、upply curves for goods that are horizontal.y2y1x2x1x3Y3 5.6 Increasing opportunity cost and PPF Increasing opportunity costs lead to production possibilities frontiers that are concave to the origin and supply curves for goods that are upward slopingIncreasing opportunity costY4X4machinesclothmachin
32、espricesupplyProduction Possibilities Curve with Increasing Costs and the Marginal Rate of Transformation Undetr increasing cost ,the slop of the PPF at point B is equal to the slope of the tangent line DE. Similarly , the slope of the PPF at point C is equal to the slope of the tangent line FG. The
33、 tangent line DE is flatter than the tangent line FG. slopeDE =MRTDE slopeFG =MRTFG 5.7 Production and consumption without specialization and trade Without trade, U.S decides to produce at point A. India decides to produce at point A. Opportunity cost: in the U.S. 1M=3C.In India,1M=5C Comparative ad
34、vantage: U.S. (Machines) India (cloth)clothclothMachinesMachinesAACD CDSlope=MRT=-5Slope=MRT=-3IndiaU.S.as a result of international specialization and trade, the U.S. and India can both have levels of consumption that are superior to those attainable on their production possibilities frontiers. The
35、 U.S. can move from point A on its trading possibilities frontier to point K on its trading possibilities line. India can also move from point A to point KU.S. produce at point H, consume at K,India produce at point H, consume at K5.8 Production and consumption with specializa-tion and trade6. Dynam
36、ic Gains from Trade Gains in world output that result from specialization and trade are the static gains from trade; while dynamic gains from trade are the gains from trade that occur over time because trade induces greater efficiency in the countrys use of existing resources. Dynamic gains: - a cou
37、ntry engaging in international trade uses its resources more efficiently; -there may be even greater benefits from trade for small countries; -international trade not only increase the quantity of the goods we consume but also may increase the quality and variety of the goods. -international trade c
38、an be a very effective way to enhance competition in a countrys domestic market.7. Questions and problems1. What is the theory of absolute advantage?2. What is the theory of comparative advantage?3. What is the meaning of the term reciprocal demand? How does it provide a meaningful explanation of the terms of trade?
