IBDP International Trade


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  • Resource: International Labor Organization
  • Europe’s Common Agricultural Policy (CAP)
  • 1999 WTO protests video
  • IBDP International Trade

    1. 1. INTERNATIONAL ECONOMICS ABHISHEK MAITY 2013 Abhishek Maity, KIS, 2013 1
    2. 2.  Chapter 1:  Chapter 2:  Chapter 3:  Chapter 4:  Chapter 5:  Chapter 6: International Trade Protectionism Exchange Rates Balance of Payments Economic Integration Terms of Trade Abhishek Maity, KIS, 2013 2
    3. 3. INTERNATIONAL TRADE ABHISHEK MAITY SEMESTER 2, 2013 Abhishek Maity, KIS, 2013 3
    4. 4.  GAME:  OBJECTIVE: To build a castle  To construct a castle you need to gather:  4 Rock (pebble)  1 Food (candy)  1 Gold (coin)  2 Wood (pencils)  You are allowed to communicate and talk to other teams  WINNER: Team with most GOLD left over  TIME LIMIT: 15 minutes Abhishek Maity, KIS, 2013 4
    5. 5.  VOLUNTARY TRADE IS MUTUALLY BENEFICIAL  Lower Prices  China!  Taking advantage of different factors of endowments  Economies of scale  Increased variety and choice  Acquisition of needed resources  Competition can improve efficiency  Political benefits  Efficiency and exports = growth and development Abhishek Maity, KIS, 2013 5
    6. 6.  Objectives:  Explain the theory of Absolute Advantage (AA).  Explain, using a diagram, the gains from trade arising from a country’s AA in the production of a good.  Explain the theory of Comparative Advantage (CA).  Describe the sources of CA.  Draw diagrams to show CA.  Calculate opportunity costs from a given set of data and illustrate it on a graph. Abhishek Maity, KIS, 2013 6
    7. 7.  Adam Smith (left)  Ricardo (right) Abhishek Maity, KIS, 2013 7
    8. 8. Absolute Advantage Country Guns per unit of time Roses per unit of time USA 30 5 Costa Rica 3 15 • USA should specialize in Guns and Costa Rica in Roses Abhishek Maity, KIS, 2013 8
    9. 9. “Absolute advantage is the situation that occurs when one country can produce more of a given product with the same or less resources than another country.”  The country with absolute advantage in one good should specialize and trade. Abhishek Maity, KIS, 2013 9
    10. 10. Absolute Advantage Country Guns per Roses Opportunity Cost of Opportunity Cost unit of per unit 1 Gun of 1 Rose time of time USA 30 5/30 units of roses 5 6 units of guns Costa Rica 3 5 units of roses 15 1/5 units of guns  Absolute Advantage PPC [DIAGRAM]  Calculate the opportunity cost.  Are they better of trading? What is a feasible new terms of trade?  Show new PPC after trading. Abhishek Maity, KIS, 2013 10
    11. 11. Some countries might be better at making everything than others, should these countries bother to trade? Abhishek Maity, KIS, 2013 11
    12. 12. Comparative Advantage Country Output of Opportunity Output of Opportunity Cost TVs Cost of 1 TV Smartphones of 1 Smartphone USA 10 5 Costa Rica 20 15 “Comparative Advantage is when a country produces a good at a lower opportunity cost than another country.” Abhishek Maity, KIS, 2013 12
    13. 13.  Even in the case of one country having absolute advantage in both products, you still benefit from trade.  How?  Terms of Trade  Absolute and comparative advantage with PPC [DIAGRAM] Abhishek Maity, KIS, 2013 13
    14. 14.  Occurs when the opportunity costs of the two trading partners are identical… then there is no room for trade.  [DIAGRAM] Comparative Advantage Matrix Country Input time for 1 unit of Iron (hours) Opportunity Cost of producing 1 unit of iron Input time Opportunity Cost for 1 unit of of producing 1 butter unit of butter (hours) USA 20 0.5 butter 10 2 irons Costa Rica 10 0.5 butter 5 2 irons Abhishek Maity, KIS, 2013 14
    15. 15.  Fill in the table and draw the PPC for the scenario below before and after trade. Comparative Advantage Matrix Opportunity Cost of producing 1 unit of iron Input time Opportunity Cost for 1 unit of of producing 1 butter unit of butter (hours) Country Input time for 1 unit of Iron (hours) USA 25 15 Costa Rica 10 5 Abhishek Maity, KIS, 2013 15
    16. 16.  Assume the table below. On a PPC show how both countries gain through trade in a general setting. Comparative Advantage Matrix Country Opportunity Opportunity Cost Production of Cost of Production of producing 1 wheat (1 kg) producing 1 kg of oil (1 liter) liter of oil of wheat USA 15 20 Costa Rica 5 10 Abhishek Maity, KIS, 2013 16
    17. 17.  Supply and demand diagram of domestic equilibrium and world price… Autarky vs. Free Trade argument. [DIAGRAM]  Assumptions:  Perfectly competitive market  Homogenous product  Small country – i.e. world price not affected by the country’s demand Abhishek Maity, KIS, 2013 17
    18. 18.  Factors of “endowment”  Example: Arable land  agricultural advantage  Well educated public  financial services  Abundant unskilled labor  cheap manufacturing goods Abhishek Maity, KIS, 2013 18
    19. 19.  Perils of extreme specialization  Unrealistic Assumptions  Perfect knowledge  No transport costs  Very basic theory assuming a two country world  We assume linear PPC, constant returns to scale  Identical products across countries  Factors of production remain in the country  Free trade Abhishek Maity, KIS, 2013 19
    20. 20.  “Perils of extreme specialization”  Unrealistic Assumptions  Perfect knowledge  No transport costs  Very basic theory assuming a two country world  We assume linear PPC, constant returns to scale  Identical products across countries  Factors of production remain in the country  Free trade Abhishek Maity, KIS, 2013 20
    21. 21.  Your task for next class – Research about the WTO and be ready to discuss it in class. This will contribute towards your classroom participation grade.  History  Aims and objectives  Success  Milestones  Pros and cons  Failures  Alternative ideas Abhishek Maity, KIS, 2013 21
    22. 22.  Born out of the General Agreement on Tariffs and Trade (GATT) in 1948 at the Bretton-Woods Conference.  Created in 1993.  “deals with the global rules of trade between nations…”  Trade without discriminations  Free trade  Predictability and transparency  Fair competitive practices  Encourage development Abhishek Maity, KIS, 2013 22
    23. 23.  Functions:  Provide a forum for trade negotiation  Execute WTO agreements  Evaluate and rule on trade complaints by member countries  Provide technical assistance to developing countries on issues of trade  Track changes in member states’ trade policies Abhishek Maity, KIS, 2013 23
    24. 24.  For Argument:  WTO promotes peace through trade. Abhishek Maity, KIS, 2013 24
    25. 25.  Against Argument:  WTO favors the rich. Abhishek Maity, KIS, 2013 25
    26. 26. Are there moral as well as economic reasons in favor of free trade? Do economies that are open to trade grow faster? Are rich countries more protectionist than poor ones? Does agricultural protectionism in the rich world worsen global poverty? Abhishek Maity, KIS, 2013 26
    27. 27. PROTECTIONISM ABHISHEK MAITY SEMESTER 2, 2013 Abhishek Maity, KIS, 2013 27
    28. 28. To protect domestic employment. To protect infant industries To counteract domestic tax difference Prevent dumping Diversify production base Enforce product standard To raise government revenue Protect against unfairly low labor costs Protect strategic industries Overcome BOP deficits Improve Terms of Trade 28 Abhishek Maity, KIS, 2013
    29. 29. Misallocation of resources Escalation to a trade war Protectionism as a corruption magnet Domestic complacency causes higher prices and costs Higher import costs Reduced export competitiveness Abhishek Maity, KIS, 2013 29
    30. 30. World price and import levels [DIAGRAM] Abhishek Maity, KIS, 2013 30
    31. 31. Tariffs – tax imposed on imports [DIAGRAM] Affect on domestic producers Affect on foreign producers Affect on the government Affect on the consumers Welfare loss Abhishek Maity, KIS, 2013 31
    32. 32. Subsidy – subsidy to the domestic market [DIAGRAM] Affect on domestic producers Affect on foreign producers Affect on the government Affect on the consumers Welfare loss Abhishek Maity, KIS, 2013 32
    33. 33. Quota – quota for imports [DIAGRAM] Affect on domestic producers Affect on foreign producers Affect on the government Affect on the consumers Welfare loss Abhishek Maity, KIS, 2013 33
    34. 34. Tariffs or Duty – taxes on imports Subsidy to domestic industry Quota on imports Nationalistic advertising campaigns Price floor on imports “Red Tape” Health, safety, and environmental standards Embargoes Abhishek Maity, KIS, 2013 34
    35. 35.  Using a diagram, explain the likely effects of a quota on imported shoes on the shoe market.  [See DIAGRAM] – Pg. 279  World price is $1/liter of oil  What happens after free trade  A subsidy of 40 cents/liter is given – show on graph.  Calculate the following changes from the subsidy:  Consumer spending, Revenue of foreign producers, cost to the government.  Explain the impact to any two stakeholders in the oil market. Abhishek Maity, KIS, 2013 35
    36. 36. EXCHANGE RATES ABHISHEK MAITY SEMESTER 2, 2013 Abhishek Maity, KIS, 2013 36
    37. 37. The value of one currency expressed in terms of another. Sometimes against a basket of currencies – Exchange Rate Index – like the CPI Determined by several factors including the FOREX market London, New York, Frankfurt, Tokyo, and Zurich Abhishek Maity, KIS, 2013 37
    38. 38. Australia uses something known as a “trade weighted index” (TWI)  Why is it called a TWI?  What are the current weightings?  What are the current values compared to a year ago?  Which currencies have contributed the most to the change? Abhishek Maity, KIS, 2013 38
    39. 39. Fixed Exchange Rate  The exchange rate is pegged or fixed to another currency, a basket of currencies or a commodity  Revaluation – increase in the value of the currency  Devaluation – decrease in the value of the currency  Maintained by government intervention in the FOREX market  [DIAGRAM] – Buy back  [DIAGRAM] – Sell  Make it illegal to trade at any other rate…  Relatively ineffective – black markets Abhishek Maity, KIS, 2013 39
    40. 40. Floating Exchange Rate  Equivalent of a free market for currency – determined purely by supply and demand.  [DIAGRAM]  Appreciation – increasing value  Depreciation – decreasing value  Impacts?  Purchasing power Abhishek Maity, KIS, 2013 40
    41. 41. Floating Exchange Rate (Quick Calc) The US dollar is currently trading against the Euro at a rate of USD 1 = 0.8E. What is the rate for 1E? With the above rate, what is the cost of a good selling for USD 75 in Euros? If the rate changes to USD 1 = 0.9E, explain what would happen to the Euro price of a US manufactured shirt that was being exported from the USA at the cost of USD 150. Abhishek Maity, KIS, 2013 41
    42. 42. Managed Exchange Rate A midway between a free-market (Floating) and centrally-planned (Fixed) exchange rate regimes. The government or central bank keeps an upper and lower bound on the rates The rates are usually kept secret Abhishek Maity, KIS, 2013 42
    43. 43. Floating Exchange Rate (Why do rates change?) US dollars are demanded when: Buy exports and travel to that country Invest in that country (FDI or portfolio) Savings in that country’s banks Make money speculating on the future value of the currency. Abhishek Maity, KIS, 2013 43
    44. 44. Floating Exchange Rate (Why do rates change?) Increase in demand for US goods and services: US inflation rates are lower than EU rates. So US goods will be relatively less expensive. An increase in the income level in the EU A change in taste favoring US goods US investment prospects US interest rates increase Speculators think the US dollar will appreciate in value. [DIAGRAM] Abhishek Maity, KIS, 2013 44
    45. 45. Floating Exchange Rate (Why do rates change?) Will cause an increase in the supply of USD: Increase in demand for EU goods and services: US inflation rates are higher Increase in US income levels A change in taste for European goods. EU investment prospects improve EU interest rates increase Speculators think that the US dollar will fall. [DIAGRAM] Abhishek Maity, KIS, 2013 45
    46. 46. Downward pressure on inflation More imports can be bought Forces domestic producers to become more efficient Abhishek Maity, KIS, 2013 46
    47. 47. Damage to exporting industries Damage to domestic industries Abhishek Maity, KIS, 2013 47
    48. 48. Greater employment in exporting industries Greater employment in domestic industries Abhishek Maity, KIS, 2013 48
    49. 49. Inflationary pressure Fewer imports can be bought Domestic firms may become lax Abhishek Maity, KIS, 2013 49
    50. 50. High currency value  lower inflation (?)  unemployment (?) Low currency value  low unemployment (?)  inflationary pressures (?) Abhishek Maity, KIS, 2013 50
    51. 51. Using a suitable diagram, explain why a high value of a currency may worsen unemployment in a country. With the help of a diagram, explain why a low value of a currency may create inflationary pressure in a country. [Page 289 – Student Workpoint 23.6] Abhishek Maity, KIS, 2013 51
    52. 52. Why might the government want to meddle in the FOREX Market? Lower exchange rate Raise the exchange rate to fight inflation Maintain a fixed exchange rate Avoid large fluctuations in floating rates Stability – good for business confidence Improve the current account defecit Abhishek Maity, KIS, 2013 52
    53. 53. Using their foreign exchange reserves to buy, or sell, foreign currencies By using Monetary Policy Changing interest rates to attract foreign savings Caveat – difference between attracting investments and savings. Abhishek Maity, KIS, 2013 53
    54. 54. No uncertainty or speculation.  Not always the case. Forces sensible government policies on inflation Abhishek Maity, KIS, 2013 54
    55. 55. Maintain high levels of foreign exchange reserves if balancing the rate by FOREX market trades Deflationary or inflationary effects on the economy if manipulating by use of interest rates Judgment error in determining what the rate should be! International disagreements Abhishek Maity, KIS, 2013 55
    56. 56. Page 290, Student Workpoint 23.7 Abhishek Maity, KIS, 2013 56
    57. 57. Interest rates can be used for domestic policy alone. In theory, the exchange rate should always “correct” itself. Opportunity cost of keeping large foreign exchange reserves. Abhishek Maity, KIS, 2013 57
    58. 58. Uncertainty Affected by various non market factors Floating exchange rates can make inflation rates worse… Abhishek Maity, KIS, 2013 58
    59. 59. BALANCE OF PAYMENTS ABHISHEK MAITY SEMESTER 2, 2013 Abhishek Maity, KIS, 2013 59
    60. 60. Current Account Capital Account Credit/Asset Debit/Liability Abhishek Maity, KIS, 2013 60
    61. 61. Balance of trade in goods (tangible) Balance of trade in services (intangible) Net income from abroad Current transfers – remittances, aid Abhishek Maity, KIS, 2013 61
    62. 62. Current Account Balance = Balance of trade in goods + Balance of trade in services + Net income flow + Net transfers Abhishek Maity, KIS, 2013 62
    63. 63. Usually a small component of Balance of Payments Capital Transfers  Debt forgiveness, sale of fixed assets, transfer of goods and financial assets from migration, gift tax, inheritance tax, death duties et al Transactions in non-produced, non-financial assets  Rights, patents, copyrights, brand names Abhishek Maity, KIS, 2013 63
    64. 64. Net change in foreign ownership of domestic financial assets. Direct Investment  Purchase of long-term assets (FDI)  IMF ruling – at least 10% ownership Portfolio Investment  Short-term investment in stocks and bonds and savings Reserve Assets  Gold and foreign currencies Abhishek Maity, KIS, 2013 64
    65. 65. Current Account = Capital Account + Financial Account + Error (Statistical Discrepancy) Abhishek Maity, KIS, 2013 65
    66. 66. Excel Sheet Abhishek Maity, KIS, 2013 66
    67. 67. A simplified scenario Abhishek Maity, KIS, 2013 67
    68. 68. Why is a current account deficit a bad thing? How does a government deal with deficits? Can this happen indefinitely? Deficit  Downward pressure on exchange rate Surplus  Upward pressure on exchange rate A bigger problem in fixed exchange rates Short run v. Long run Abhishek Maity, KIS, 2013 68
    69. 69. If current account is in deficit, then the capital/financial account must be in surplus. Current Account Deficit: Use of Forex reserves Threat to economic sovereignty Borrowing – currency crisis Abhishek Maity, KIS, 2013 69
    70. 70. If current account is in surplus, then the capital/financial account must be in deficit. Current Account Surplus: May lead to protectionism Impact on imports and exports Abhishek Maity, KIS, 2013 70
    71. 71. How big is a “big” current account deficit or surplus. Always calculate as a percent of GDP to be comparable. Please do not confuse current account deficit with national debt. Abhishek Maity, KIS, 2013 71
    72. 72. Encouraging a switch from Imports to Domestic goods Government depreciates or devalues their currency Protectionist measures Might violate WTO agreements Abhishek Maity, KIS, 2013 72
    73. 73. Contractionary Policy Reduce overall expenditures imports Deflationary fiscal policy Deflationary monetary policy including on Abhishek Maity, KIS, 2013 73
    74. 74. PEDExports + PEDImports > 1 Elasticity increases in the long run. Abhishek Maity, KIS, 2013 74
    75. 75. Suppose India and US have an exchange rate of Rs. 50 = $1. Initially, the US exports 1000 units of Widgets @ Rs. 100 per unit to India and India exports 500 units of Golas @ Rs. 100 per unit to the US. Now, India depreciates their currency by 10%. Calculate how this depreciation affects the current account balance between India and the US if: PEDexports = 0.5 and PEDimports = 0.4 PEDexports = 0.5 and PEDimports = 0.8 Abhishek Maity, KIS, 2013 75
    76. 76. According to the Marshall-Lerner condition, as the currency depreciates, initially, the Current Account deficit will actually become worse before it becomes better. [DIAGRAM] Abhishek Maity, KIS, 2013 76
    77. 77. Explain the possible effect on consumers and producers when a specific tax is imposed on cigarettes. [10 marks] – Pg 75 of Blink and Dorton Abhishek Maity, KIS, 2013 77
    78. 78. ECONOMIC INTEGRATION ABHISHEK MAITY SEMESTER 3, 2013 Abhishek Maity, KIS, 2013 78
    79. 79. Free trade is based on the principal of comparative advantage and an ideal that would promote maximum allocative efficiency. But alas! That is not to be. … but we are trying. Abhishek Maity, KIS, 2013 79
    80. 80. Preferential trade agreements (PTA) Bilateral v. Multilateral (WTO) PTA gives preferential access to certain goods, from certain countries, by reducing or eliminating tariffs or other arrangements.  South Asian Preferential Trade Arrangement (SAPTA) 2007  Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, Sri Lanka  Goods Only! Is this ethical? Abhishek Maity, KIS, 2013 80
    81. 81. Four major types: Free trade areas Customs unions Common markets Economic (and Monetary) unions Abhishek Maity, KIS, 2013 81
    82. 82. Two or more countries can form a free trade area: Tariffs and non-tariff barriers are abolished or phased out Maintain individual tariff with non-members NAFTA (USA, Mexico, Canada) EFTA (Iceland, Norway, Liechtenstein, Switzerland) Abhishek Maity, KIS, 2013 82
    83. 83. Two or more countries can form a customs union: FTA with the following clause: Maintain common tariff and trade policy with non-members MERCOSUR – 1991 – Argentina, Brazil, Paraguay, Uruguay, Venezuela EU and Turkey 1996 East African Customs Union Abhishek Maity, KIS, 2013 83
    84. 84. If in addition to a Customs Union, a Common Market has: Unrestricted factor of production flow Free cross-border movement of labor and capital Free flow of goods, services, labor and capital SAPTA became SAFTA in 2004 (to be enacted by 2016) Belarus, Kazakhstan, Ukraine, Russia (2003) Abhishek Maity, KIS, 2013 84
    85. 85. A Common Market become an Economic Union when: When the member states agree on certain macroeconomic and regulatory policies. If they adopt a common currency they become a Monetary Union The EU is the only such example. Abhishek Maity, KIS, 2013 85
    86. 86. Dismantling of trade-barriers leads to greater competition among firms of the member countries. NOTE: PTAs are discriminatory while WTO multilateral trade agreements are nondiscriminatory Abhishek Maity, KIS, 2013 86
    87. 87. Trading Blocs Monetary Union Abhishek Maity, KIS, 2013 87
    88. 88. Pg. 316 (Blink and Dorton) – End of Chapter Review Questions, Q#3 Evaluate the consequences of membership of a monetary union. Be sure to use a real world example. Abhishek Maity, KIS, 2013 88
    89. 89. TERMS OF TRADE ABHISHEK MAITY SEMESTER 3, 2013 Abhishek Maity, KIS, 2013 89
    90. 90. Terms of Trade is the ratio of export prices to import prices TOT = Index of average export prices / Index of average import prices x 100 Lower  deterioration Better  improvement NOTE: Do not confuse price with total value of imports and exports! Abhishek Maity, KIS, 2013 90
    91. 91. Year 1 2 3 4 5 6 Index of average Index of average Calculation of Terms of Improvement or export prices import prices Terms of Trade Trade deterioration? 100 100 109 116 120 120 100 105 105 112 110 125 Index year Abhishek Maity, KIS, 2013 91
    92. 92. What can we conclude about the “Buying Power” of a country using ToT? Is a “deterioration” of ToT a bad thing? Abhishek Maity, KIS, 2013 92
    93. 93. Can language be used to confuse or exclude access to knowledge?  Consider language that economists use that could be misleading or difficult for noneconomists. Abhishek Maity, KIS, 2013 93
    94. 94. Changes in conditions of demand and supply  Change in demand  change in price of exports  Competitive price of exports  Income in importing country  Change in consumer tastes  Change in supply  change in price of exports  Good weather for agriculture?  New technology? Abhishek Maity, KIS, 2013 94
    95. 95. Changes in relative inflation rate  Higher inflation  price of exports increase  Might lead to a short run improvement in ToT  Eventually exports become less competitive Changes in exchange rates  Relative exchange rate will change the relative price of exports to imports Abhishek Maity, KIS, 2013 95
    96. 96. Changes in Income Improvement in Productivity and Technology Abhishek Maity, KIS, 2013 96
    97. 97. Improvement in TOT through increase in demand [DIAGRAM] Through inflation and elasticity Commodities are usually inelastic Most other goods are elastic Inelastic  Elastic Abhishek Maity, KIS, 2013 97
    98. 98. Country Primary Commodities (%) Manufacturing (%) Services (%) Benin 93.8 6.2 Burkina Faso 93.5 6.5 Ethiopia 91.0 9.0 Mali 93.6 6.4 Angola 99.3 0.7 Yemen 95.1 4.9 Bangladesh 12.4 87.6 Nepal 28.0 72.0 Maldives 32.5 67.5 Abhishek Maity, KIS, 2013 98
    99. 99. Not all LDCs have the same problems. Commodities v. Oil v. Manufacturing v. Service The non-oil commodities problem. [DIAGRAM] Abhishek Maity, KIS, 2013 99
    100. 100. Changes in supply Technology Dumping Changes in demand Synthetic goods Inelastic and developed Miniaturization Average Commodity Prices have been falling since the 1950s Abhishek Maity, KIS, 2013 100
    101. 101. More exports needed for imports  leads to production of more commodities  leads to further fall in commodity prices. Increase in debt levels Negative externalities  unsustainable CURSE OF NATURAL RESOURCES! Abhishek Maity, KIS, 2013 101