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03.27 - International Trade

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University of British Columbia
ECON 102
Lanny Zrill

International Trade 03-27-2013 Case for International Trade importance: Rate at which people trade stuff has exponentially increased more than the rate at which people produce stuff Gains from International Trade  Without trade, people must be self-sufficient  With trade, people can specialize in production and acquire other goods through trading  This is true for individuals, firms and countries The remarkable thing is specialization and trade increases production (and consumption) possibilities overall  So called Gains from Trade Absolute Advantage 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 fewer resources.  Canada has absolute advantage over EU in terms of wheat and cloth Comparative Advantage One country has a comparative advantage in the production of a specific product if, relative to another country, its OC for producing the product is lower.  Canada has comparative advantage with respect to wheat  EU has comparative advantage with respect to cloth Specialization World production of both goods can be increased if each country specializes in producing the goods for which it has a comparative advantage.  Get table from slides  By Canada and the EU shifting their resources to the thing you’re good at, you maximize the total production of that product and you can use it in trade. Advantages of trade:  Opportunity to specialize  Increase in total quantity of goods and services available Sources of Comparative Advantage  Factor endowments o Ex. Canada has a lot of raw materials – minerals, oil, lumber, precious metals – has C.A.  Climate  Human capital o Ex. Canada has very little people – comparative disadvantage o Prediction: you’ll see Canada without a very large manufacturing sector (not labour intensive) but involved in resource extraction Note: Comparative advantage is a dynamic concept and can change over time. Patterns of Trade  The Law of One Price: when an easily transported product is internationally traded, arbitrage will guarantee a single world price o The price should be the same in two different regions of the world if it is easily transportable  Comparing the world price to the autarkic price (domestic price) o Pw > Pd – Canada will export the product o Pw < Pd – Canada will import the product  “Autarky” – self sufficient in the sense that all goods and services consumed by Canadians are produced by Canadians; closed to international trade Exports  Canadian market for certain commodity  Without international trade, price will be determined by Pd and Qd  Sellers of this product can now receive Pw (higher)  Now producers will supply at Qw  Export: difference Q and Qw because Canadian producers supplying more than Canadian customers want at Pw Example: Oil  Canadian producer of oil trying to max profits  If you can sell oil for a higher price, why wouldn’t you do it?  Sell it at world price Pw to the rest of the world.  Now have to charge Canadian customers the higher price (no protection for Canadian customer in this sense)  Advantage: comes from logic of circular flow diagram o Income generated in production process will make its way to Canadian households  Imports  Canada is not very good at producing a certain good or service  World price is below domestic price  Import: difference Q and Qw because Canadian producers are not willing to produce at a lower Pw Example: Wheat subsidies: Pw < Pd – world price is so low that they cant make a profit. Government subsidizes so they’ll still produce food for domestic consumers. The Foreign Exchange Market All international trades require two transactions:  Acquisitions of the required foreign currency  Purchase of the commodity Hence, both the exchange rate and the product’s price affect the cost. Must first acquire proper foreign currency needed to make that purchase, then make the purchase of that desired commodity. Exchange Rate  The exchange rate is defined here as the quantity of domestic currency required to purchase one unit of foreign currency*  The current exchange rate is 1.01 ex. it takes $
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