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Topic 12 - Int'l Trade Theory.docx

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Economics 1021A/B
Arvin Dar

Topic 12: International Trade Theory – no lyryx 1. The case for trade 2. Gains from specialisation 2.1 The case of absolute advantage 2.2 The case of relative (comparative) advantage 3. The case for protectionism 4. Methods of protectionism 1-7 5. Co-operation? GATT and WTO 1. The case for trade i. Not all countries are going to have the skills and the resources to produce things they wish to consume. In other words, some countries are going to be lacking resources to have things that they need in their everyday operation (i.e. not being able to produce aircrafts, but wanting an airport) ii. There may be economies of scale (i.e. small population base cannot use all the material from a large factory, so you produce more and sell it) iii. There may be gains from specialisation (remember that movie with the hillbilly farmers with milk and cheese) 2. Gains from specialisation Wheat Cloth Canada 10 20 UK 20 10 Plugging one unit of resource, you get an output. Each commodity’s output is different, and each country’s output for each commodity is different again. Whichever country is better at each commodity, gets to specialise and then you buy whatever you don’t produce. 2.1 The case of absolute advantage Wheat Cloth Canada +10 -6 UK -5 +10 +5 +4 Canada wins wheat, UK wins cloth. This is not complicated. Trade is beneficial since each country can specialise in the commodity they have absolute advantage in. Net benefit: Canadians lose 6 bolts of cloth, and gain 10 bushels of wheat. UK loses 5 bushels of wheat and gains ten bolts of cloth. Net gain: Canadians produce an extra five bushels of wheat and the UK produce an extra 4 cloth 2.2 The case of relative (comparative) advantage Wheat Cloth Canada 100 60 UK 5 10 Canada has an absolute advantage in both items. Is trade beneficial? Yes We say to the British, you don’t produce wheat – focus solely on cloth. (Lose five wheat, gain ten cloth) You cannot say unambiguously that trade will be beneficial because one side will be positive and the other will be negative. Every time we transfer one unit, they transfer ten. Canada has a comparative or relative advantage in the production of wheat, therefore Canada should specialise in such and the UK cloth. Look at the opportunity cost to help clarify. Canada 100 wheat costs 60 cloth Put your resource into producing wheat, but then you’re not working in the cloth sector (bam, cost) 1 wheat costs .6 cloth The opportunity cost of one bushel of wheat is only 0.6 yards of cloth that is sacrificed. UK 5 wheat costs 10 cloth (1*10/5) 1 wheat costs 2 cloth The opportunity cost of one bushel of wheat is relatively higher in UK, so ignore wheat & love cloth If they are different like this, then trade is lovely. Wheat Cloth Canada 100 60 UK 10 6 How does this change the opportunity cost? Canada (nothing changed) = 0.6 UK (changed) = 0.6 When the opportunity costs are identical, then Canada has no comparative advantage in the production of wheat. Trade is just silly :3 Dept. in a university – looking at two professors with tenure The administration wants to allocate resources Professor A: terrible at teaching everyone, but he has tenure so you’re stuck Professor B: awesome at teaching everyone Can you tell Professor A to go home and just get paid to do nothing and tell Professor B to tell ALL the courses? No. You say “Although you’re better at everything, we’re going to give her the courses she has a relative advantage in (i.e. fourth year)” Economics in marriage: Dividing housework 50/50 doesn’t work for most couples – if Nancy is better at both dishes and tidying, whichever she has a relative advantage in she should do and her husband should do the other. Tidying Up Dishes Nancy +10 minutes (cost) – does -20 minutes (benefit) – not Eric -60 minutes (benefit) – not +30 minutes (cost) – does Nancy has an absolute advantage in both, but a relative/comparative advantage in tidying up. We want the lowest number, because we’re not looking at dollars, but time efficiency Reading along the first row, Nancy gains ten minutes. Reading the second row, Eric gains thirty minutes. Assuming they do this three times in a week, Nancy gains 30 minutes and Eric gains 90; 3. The case for protectionism (the case against free trade) Three reasons against free trade: 1. Strategic reasons  If you choose to produce just a few commodities, there may come a time when you would need commodities that you are not producing, yet you are in dire need of.  Example time, birches: I’m going to import all my tractors, planes, weapons from the country next door because I’m selling them wheat. But what if we break up? Then we can’t speak anymore and I need tanks and guns to protect myself from their rage resulting from our unfair breakup and all I’ll have is wheat. If I grind it into flour, I can bake them into oblivion! I need the ability to have my own tanks and vehicles. 2. Diversification of risk  Looking at the pros and cons of free trade: don’t put all your eggs in the same basket because you will be exposing your economy to possible fluctuations in your national income.  Example time, birches: You produce nothing but cuckoo clocks and yo-yos. You trade to get what else you need… but the world decides to hate your products and demand falls. Then you’re buggered, because you have no buyers but you need to buy everything you need, because you suck :3 3. Infant industry argument  When a country sets up a new industry or a new sector, those new industries or sectors are like infants; they need protection and to be taken care of. If you do not support/protect them then they are murdered by other industries/sectors.  Example time, birches: We don’t have a beer industry (OH THE HORROR) and we import all our beer. “Oh hey, let’s produce our own beer!” A few breweries are set up, but they have no experience, no economies of scale and no advertising. And they die a brutal death. It’s painful. They need the government’s protection, but if you protect them too much, then they’ll be weak and fragile and easy to kill. 4. Tools/methods of protectionism 1. Tariffs  A tax placed on a foreign commodity that is bought and sold in a domestic economy  May be specific (i.e. a constant tax on each unit of a commodity) or an ad valorem tariff (i.e. a tax on the price of the commodity – percentage) P S D
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