The Gains from International Trade
-World trade has grown much faster than world GDP
-Globalization (often not defined): The quite substantial reduction in transportation costs and
-As these costs decrease the flows of trade grow
-For the most part, in particular with natural resources, we pay the same amount for imports as we
receive for exports.
-Trade isn't about exports from some places and imports from others. It's more about intra-industry
trade, whereby there are two directions of trade.
-We do this because of product differentiation (different versions of the same product)
33.1 The Gains from trade
-Interpersonal, interregional, and international trade.
-In a world without trade, people would have to be self-sufficient
-With trade, people can specialize efficiently and satisfy other needs by trading.
-(Jack of all trades, master of none)
-This basic principle is true for individuals, regions, and countries.
->The gains from trade
Illustrating the Gains from Trade
-One country has an absolute advantage in the production of a specific product if, relative to another
country, it can produce one unit of the product using less resources.
-Cost to produce:
CAN $1 $5
EU $3 $6
Wheat (kg) Cloth (m)
Can 0.2m cloth 5 kg wheat
EU 0.5m cloth 2 kg wheat
-One country has a comparative advantage in the production of a specific product if, relative to another
country, its opportunity cost for producing the product is lower than the other country's.
-World production of all products can be increased if each country specializes in producing the goods in
which it has a comparative advantage.
Wheat (kg) Cloth (m)
CAN 5 -1 EU -4 2
Gain 1 1
-Production Possibilities Boundary slope is the opportunity cost of producing one good in terms of what
you give up of the other
(S=point of specialization)
(Blue line=prices at which the countries trade. Slope is steeper than EU's PPB and flatter than
-Autarchy= World with no trade. You produce what's on your PPB
-Canada specializes in wheat, EU in cloth: Production possibilities increase in BOTH countries
-Blue line should be outside of purple line in order for countries to benefit from trade.
-"Free trade generates benefits for all but costs for some" comment.
-If you have a lower opportunity cost for producing one good, then you have to have a higher
opportunity cost for the other. If opportunity cost is the same for both countries, then there is no gain
from specialization and trade.
Our conclusions are:
-If Canada has a comparative advantage in one product then is must have a comparative disadvantage in
-When opportunity costs are the same in all countries, there are no gains from specialization and trade
-When opportunity costs differ across both countries, global production can be increased by reallocating
The gains from trade with Variable Costs
-If PPF is straight is just simplifying the graph.
-Additional gains from trade may be possible:
-Economies of scale: International trade allows small countries to produce high levels of output to reap
the available scale economies.
-Learning by Doing: Costs may also fall as productive experience increases.
Sources of Comparative Advantage
-Factor endowments. Countries have the CA in products that use their abundant resources relatively
-Climate. Variation in national climates affects comparative advantages. Climate can be considered a
"special" factor of production.
-What happens if the production possibilities boundary is the "regular" shape, but there are neither
scale economies or learning by doing?
33-1: The Gains from Trade More Generally Pd--> Canada exports the product
2. If Pw Canada imports the product
-I.e. Countries export goods whose world price exceeds the autarkic price
-With high world price, demand is lower, supply is higher and the difference (excess supply) is what we
-->Countries export the goods for which they are low-cost producers
Is comparative advantage obsolete?
-The theory that comparative advantage determines trade flows Is NOT obsolete
-But the idea that CA is completely determined by forces beyond the reach of public policy has been
-Although govts MAY influence patterns of CA, it is not necessarily advisable:
-Compare the costs of free-trade related policies with their likely benefits
Applying Economic Concepts 33-2
Comparative Advantage and Global Supply Chains
-Lots of steps to obtaining a product (extract, produce, ship etc..)
The terms of Trade
-The relative prices at which countries trade.
-The division of the gains from trade depends on the terms of trade
-The terms of trade are measured by the ratio of the price of exports to the price of imports:
Terms of trade=(index of export prices/index of import prices)x100
-Terms of trade improvement: Better if exports rises because it means we have to give up fewer
exports to get more imports.
-Terms of trade deterioration: Exports decreases, meaning you have to spend more in exports to
get same amount of imports as previously. Lecture 3
-Terms of trade: ratio of export prices to imports prices
-When it rises we have to give away fewer exports to gain a unit of imports and vice versa
-Past 8 years: big increase in commodity prices=good. (about 30% change)
-In the late 1950's the Dutch discovered natural gases and began exporting them in the early 60s
-Increase in demand for Dutch gas translated into increase in demand for Dutch currency (Gilder), which
increases the value of the Gilder (appreciation). Which is a reduction in the exchange rate (ex: it takes
fewer Dutch Gilder to purchase one US dollar).
-There were lots of producers in Holland producing and exporting other products, such as tulips,
wooden clogs, beer etc… For these foreign consumers, the prices of these products go up because of the
appreciation of the Dutch gilder, resulting in a decrease in demand ("they get hosed"...reduction of
demand for export products due to the appreciation of the currency). For the country as a whole,
national income increases (even though exporters suffer), but the distribution income went up in
natural gas sector but went down in other sectors.
-Let's suppose the Dutch had natural gas in the 30's, and didn’t find any new gas in the 50's. Say there is
a big increase in the world price of natural gas, resulting in the exact same thing as above in Holland.
Dalton McGuinty said last year, that the increase in oil demand increased it's price and the CDN Dollar
appreciates. Premier of Alberta rebuttled saying that this is good for Canada. Tom Mulcair (leader of
NDP) says that CDN $ is driven up and making life difficult for the rest of the economy.
-CDN $ appreciat