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ECO102H1 (54)
Chapter 33

ECO100Y1 Chapter 33 Notes

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University of Toronto St. George
Robert Gazzale

ECO100Y1 Textbook Notes Chapter 33  International trade: the exchange of goods and services that takes place across international boundaries.  Corn Laws: tariffs on the importation of grains into the UK.  The volume of world trade has grown much faster than world GDP over the past 60 years. o Real GDP has had an annual growth rate of about 3.7%. o Volume of world trade has had an annual growth rate of about 6.1%.  Three key points from graph: o Canada exports and imports large volumes of goods in most industries.  In 2008, exports = $490 billion; imports = $440 billion.  Each flow (exports/imports) amounts to about 35% of GDP. o The volume of trade > the balance of trade  Balance of trade: exports – imports o In most industry groupings, there are significant amounts of both imports and exports. 33.1 The Gains from Trade  Open economy: an economy that engages in international trade.  Closed economy: an economy that has no foreign trade.  Autarky: a situation in which a country does no foreign trade.  Without trade, everyone must be self-sufficient; with trade, people can specialize in what they do well and satisfy other needs by trading.  Since no one can be fully self-sufficient, a world of individual self-sufficiency would be a world with extremely low living standards.  With trade, each individual, region, or country is able to concentrate on producing goods and services that it produces efficiently while trading to obtain goods and services that it does not produce efficiently.  Gains from trade: the increased output attributable to the specialization according to comparative advantage that is made possible by trade.  Absolute advantage: the situation that exists when one country can produce some commodity at lower absolute cost than another country. o Absolute cost: the dollar cost of labour, capital, and other resources required to produce the goods.  Fewer resources = lower absolute cost.  Some countries, because they have access to cheap natural resources or better-trained workers or more sophisticated capital equipment, are low- cost producers for a wide range of products.  The gains from international trade do not depend on the pattern of absolute advantage.  Dave Riccardo developed the theory of comparative advantage.  Comparative advantage: the situation that exists when a country can produce a good with less forgone output of other goods than can another country. o Based on opportunity costs rather than absolute costs.  A country may have an absolute advantage in all goods but it cannot have a comparative advantage in all goods. o A country may not have an absolute advantage in any goods but it will have a comparative advantage in some good.  The gains from specialization and trade depend on the pattern of comparative, not absolute, advantage.  World output increases if countries specialize in the production of the goods in which they have a comparative advantage.  Specialization of production against the pattern of comparative advantage leads to a decline in total world output.  The slope of the production possibilities curve indicates opportunity costs. o Where the PPC is concave, the opportunity cost for each good is higher when more of that good is being produced.  Summary: o Country A has a comparative advantage over Country B in producing a product when the opportunity cost of production in Country A is lower.  This implies that it has a comparative disadvantage in some other product(s). o The opportunity cost of product X is the amount of output of other products that must be sacrificed in order to increase the output of X by one unit. o When opportunity costs for all products are the same in all countries, there is no comparative advantage and there is no possibility of gains from specialization and trade. o When opportunity costs differ in any two countries and both countries are producing both products, it is always possible to increase production of both productions by a suitable reallocation of resources within each country.  If costs vary with the level of output, or as experience is acquired via specialization, additional gains are possible.  With the formation of the European Common Market (now EU), economists expected that specialization would occur according to the theory of comparative advantage, instead, much of the vast growth of trade was in intra-industry trade. o Intra-industry trade: trade of goods/services within the same broad industry. o Similar occurrence with the trade agreement between Canada-U.S.  The free trade agreements in Europe and NA allowed a proliferation of differentiated products, with different countries each specializing in different sub-product lines.  In industries with significant scale economies, small countries that do not trade will have low levels of output and therefore high costs. o With international trade, small countries can produce for the larger global market and thus produce at lower costs.  International trade therefore allows small countries to reap the benefits of scale economies.  Learning by doing: the reduction in unit costs that often results as workers learn through repeatedly performing the same tasks. It causes a downward shift in the average cost curve.  Policy makers can seek to develop new comparative advantages through such means as: o Education o Tax incentives  According to the Heckscher-Ohlin theory, countries have comparative advantages in the production of goods that use intensively the factors of production with which they are abundantly endowed. o I.e. a country with abundant land and little labour will have comparative advantages in producing land intensive products as opposed to labour intensive products.  Canada is extremely well endowed with forests (comparative advantage in forestry products). o Often called the
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