Trade theory


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Trade theory

  1. 1. Theories of International Trade AG BM 338 Agribusiness in the Global Economy
  2. 2. LEARNING OBJECTIVES <ul><li>After today’s class, you should be able to : </li></ul><ul><li>Understand classical theories of international trade </li></ul><ul><li>Understand modern theories of international trade </li></ul><ul><li>Draw implications for action </li></ul>
  3. 3. Trade Balance <ul><li>trade deficit - An economic condition in which a nation imports more than it exports </li></ul><ul><li>trade surplus - An economic condition </li></ul><ul><li>in which a nation exports more than it imports </li></ul><ul><li>balance of trade - The aggregation of buying (importing) and selling (exporting) by both sides leads to the country-level trade surplus or deficit. </li></ul>
  4. 7. Trade Theories <ul><li>classical trade theories - major theories typically studied consist of mercantilism, absolute advantage, and comparative advantage </li></ul><ul><li>modern trade theories - major theories typically studied consist of product life cycle, strategic trade, and national competitive advantage </li></ul>
  5. 8. The Age of Mercantilism <ul><li>Between 1600 and 1800 most of Western Europe pursued a policy of mercantilism </li></ul><ul><li>What was mercantilism? </li></ul><ul><ul><li>Belief that exports should exceed imports </li></ul></ul><ul><ul><li>Bullionism – the belief that the economic health of a nation was measured by the amount of precious metals (gold and silver) it possessed </li></ul></ul><ul><ul><li>Colonialism – colonies were viewed as sources of raw materials </li></ul></ul><ul><ul><li>Heavy government control of trade, with the goals of trade being the goals of governments </li></ul></ul>
  6. 9. Absolute Advantage <ul><li>Producing a good with fewer inputs (capital, labor, land, raw materials, etc.) per unit of output than other countries </li></ul><ul><li>If input prices are the same in two countries, the country with an absolute advantage in a good will have a lower unit cost of production for that good </li></ul><ul><li>Adam Smith, The Wealth of Nations , 1776 </li></ul><ul><ul><li>A country should produce and export products in which it has an absolute advantage </li></ul></ul><ul><ul><li>A country should import products in which it has an absolute disadvantage </li></ul></ul>
  7. 10. Absolute Advantage: Problems <ul><li>What about a country (like the U.S.) that has an absolute advantage in most products? </li></ul><ul><ul><li>How can it possibly produce enough of everything to satisfy the whole world? </li></ul></ul><ul><ul><li>As production increased, competition for scarce inputs would drive up production costs, taking away many absolute advantages </li></ul></ul><ul><li>What about a country (like Nepal) that has an absolute disadvantage in nearly all products? </li></ul><ul><ul><li>Why should its resources sit around unused? </li></ul></ul><ul><ul><li>As production fell, prices of inputs would fall, lowering production costs and creating some absolute advantages </li></ul></ul>
  8. 11. Comparative Advantage <ul><li>Producing a good at a lower opportunity cost than another country </li></ul><ul><ul><li>Inputs used in the production of one good aren’t available for the production of other goods </li></ul></ul><ul><ul><li>When a country produces a good, what does it give up in foregone production of other goods? </li></ul></ul><ul><li>David Ricardo, The Principles of Political Economy and Taxation , 1817 </li></ul><ul><ul><li>A country should produce and export products in which it has a comparative advantage </li></ul></ul><ul><ul><li>A country should import products in which it has an comparative disadvantage </li></ul></ul>
  9. 12. Opportunity Cost <ul><li>opportunity cost - the cost of pursuing one activity in terms of the foregone return on the next-best alternative activity </li></ul><ul><li>Examples </li></ul><ul><ul><li>The opportunity cost of going to college is what you could have earned working full-time instead </li></ul></ul><ul><ul><li>The opportunity cost of using a plant to manufacture one product is what the company could have earned manufacturing another product at the plant instead </li></ul></ul>
  10. 13. Numerical Example <ul><li>One input (labor) </li></ul><ul><li>Two goods (corn, timber) </li></ul><ul><li>Two countries (A, B) </li></ul><ul><li>Which country has an absolute advantage in </li></ul><ul><ul><li>Corn production? </li></ul></ul><ul><ul><li>Timber production? </li></ul></ul><ul><li>Which country has a comparative advantage in </li></ul><ul><ul><li>Corn production? </li></ul></ul><ul><ul><li>Timber production? </li></ul></ul>
  11. 14. More on Comparative Advantage <ul><li>Even a country at an absolute disadvantage in everything will have a comparative advantage in something </li></ul><ul><li>Each country specializes in the production and export of what it does relatively well </li></ul><ul><li>Prices of goods and inputs in a free-market economy will adjust in order to lead to this outcome </li></ul>
  12. 15. More on Comparative Advantage <ul><li>Countries rely on imports to meet consumer demands for goods in which they don’t have a comparative advantage </li></ul><ul><li>A country can achieve consumption levels beyond what it could achieve on its own </li></ul><ul><li>Government policy can alter free-market outcomes (import tariffs, import quotas, export subsidies, etc.) </li></ul>
  13. 17. Some Definitions <ul><li>factor endowments - extent to which different countries possess various factors, such as labor, land, and technology </li></ul><ul><li>resource mobility - assumption that a resource </li></ul><ul><li>removed from one industry can be moved to another </li></ul>
  14. 18. Factor Proportions (Heckscher-Ohlin) Trade Theory <ul><li>A country that is relatively abundant in a factor of production should export goods that use a lot of that factor in the production process, and import other goods </li></ul><ul><li>Example: a country like China with a lot of labor should export labor-intensive goods </li></ul><ul><li>Why? If a factor is relatively abundant, it will be relatively cheap, and a country will be more globally competitive in products that use a lot of that factor </li></ul>
  15. 19. Modern Trade Theories <ul><li>product life cycle theory - economic theory that accounts for changes in the patterns of trade over time </li></ul><ul><li>strategic trade theory - theory that suggests that </li></ul><ul><li>strategic intervention by governments in certain industries can enhance their odds for international success </li></ul><ul><li>first-mover advantages - Advantages that first entrants enjoy and do not share with late entrants </li></ul><ul><li>strategic trade policy - Economic policies that provide companies a strategic advantage through government </li></ul><ul><li>subsidies </li></ul>
  16. 22. Modern Trade Theories <ul><li>Theory of national competitive advantage of industries (or diamond theory ) </li></ul><ul><li>The theory that the competitive advantage of certain industries in different nations depends on four aspects that form a “diamond” </li></ul><ul><li>Competitive advantage is created by technological and institutional change, not just inherited from a country’s natural endowments </li></ul>
  17. 25. IN-CLASS EXERCISE <ul><li>In groups of 3-5 people… </li></ul><ul><ul><li>Come up with three examples of imported foods eaten by people in your group </li></ul></ul><ul><ul><li>Are there alternatives sources for these foods – either domestically produced or from different countries than the ones you purchase from? </li></ul></ul><ul><ul><li>If so, what factors influence your purchase decisions? </li></ul></ul><ul><li>Present your findings to the class </li></ul>