A revision presentation on aspects of international trade theory

1. A2 Macro:
International Trade

2. Free Trade
• Trade free from artificial barriers
• Trade flows from …..
• Specialization: Specialisation in the use of
scarce factors resources
• Exchange: Exchange is in part based on
comparative advantage in supplying different
goods and services

3. Gains from Trade
• Increased competition for producers
– Increased market contestability
– Pressure on suppliers to keep prices down
– Improved allocative & productive efficiency
• Better use of scarce resources
– Benefits from specialisation (i.e. from the deeper
division of labour)
• Key source of economic growth and development
• Dynamic efficiency gains
– Transfer of ideas / technology spill-overs
– Greater choice for consumers

4. Why is Trade important for Development?
• Successful international trade provides:
1. A source of foreign exchange to help a nation’s balance
of payments (trade surplus countries build up $ reserves)
2. An important way of financing imports of essential
capital equipment / technology and energy
3. An injection of demand into the circular flow of income
and spending + positive multiplier effects
4. Increased employment in export industries and
ultimately rising per capita incomes and improved
development outcomes (e.g. higher HDI score)

5. Why is Trade important for Development?
• But overseas trade also has risks
– Volatile global prices affecting export revenues and
profits
– Risks that exports will be affected by geo-political
uncertainty and cyclical shifts in demand
– Opening up an economy to trade and investment may
cause rising structural unemployment in some
industries as the pattern of demand changes over time

6. Comparative Advantage –
A Worked Example

7. Comparative Advantage
• Comparative advantage exists when
– Comparative advantage exists when a country has
a ‘margin of superiority’ in supplying a product i.e.
where the marginal supply cost is lower
– Basic rule – specialize in the things that you are
relatively best at
– This opens up important gains from trade

8. Factor endowment model
• Countries with a relative factor abundance can
specialize and trade
• Abundance of skilled labour → specialisation →
export → exchange for goods and services
produced by countries with abundance of
unskilled labour
• Exports embody the abundant factor
• Imports embody the scarce factor
• Assumes a high degree of factor mobility

9. Comparative Advantage - Example
Half of each
country’s available
resources are
allocated to each
industry
Freezers
(000s per year)
Dishwashers
(000s per year)
Germany 1000 500
Italy 800 200
Total Output

10. Total output before specialisation
Half of each
country’s available
resources are
allocated to each
industry
Freezers
(000s per year)
Dishwashers
(000s per year)
Germany 1000 500
Italy 800 200
Total Output 1800 700

11. Germany specializes in dishwashers
Gain in total output
after specialisation
Freezers
(000s per year)
Dishwashers
(000s per year)
Germany 400 (-600) 800 (+300)
Italy 800 200
Total Output

12. Italy specializes in freezers
Gain in total output
after specialisation
Freezers
(000s per year)
Dishwashers
(000s per year)
Germany 400 (-600) 800 (+300)
Italy 1600 (+800) 0 (-200)
Total Output

13. Result: Higher total output
Gain in total output
after specialisation
Freezers
(000s per year)
Dishwashers
(000s per year)
Germany 400 (-600) 800 (+300)
Italy 1600 (+800) 0 (-200)
Total Output 2000 (+200) 800 (+100)

14. Beneficial Terms of Trade
• A beneficial terms of trade is an agreed rate of
exchange of one product for another than leaves
both countries better off from trade
• Consider the domestic terms of trade for each
country
– Without trade, Germany gets 2 extra freezers for
every dishwasher that is gives up
– Without trade, Italy has to give up 4 freezers for every
extra dishwasher it produces
• Is there a mutually beneficial terms of trade?
• Yes – trade 3 freezers for each dishwasher

15. Beneficial Terms of Trade
• A beneficial terms of trade is an agreed rate of
exchange of one product for another than leaves
both countries better off from trade
• Consider the domestic terms of trade for each
country
– Without trade, Germany gets 2 extra freezers for
every dishwasher that is gives up
– Without trade, Italy has to give up 4 freezers for every
extra dishwasher it produces
• Is there a mutually beneficial terms of trade?
• Yes – trade 3 freezers for each dishwasher

16. Gains from Trade
Final output in
after trade
Freezers
(000s per year)
Dishwashers
(000s per year)
Germany 1150
(+750 .. import)
550
(-250 ..export)
Italy 850
(-750 .. export)
250
(+250 .. import)
Total Output 2000
At start: (1800)
800
At start: (700)

17. Trade Theory Assumptions

18. Assumptions behind the theory
Constant
returns to scale
Mobility of
factor inputs
No
externalities
Trade finance
available
Barriers to
trade are small

19. Assumptions behind the theory
Constant
returns to scale
Mobility of
factor inputs
No
externalities
Trade finance
available
Barriers to
trade are small

20. Assumptions behind the theory
Constant
returns to scale
Mobility of
factor inputs
No
externalities
Trade finance
available
Barriers to
trade are small

21. Assumptions behind the theory
Constant
returns to scale
Mobility of
factor inputs
No
externalities
Trade finance
available
Barriers to
trade are small

22. Assumptions behind the theory
Constant
returns to scale
Mobility of
factor inputs
No
externalities
Trade finance
available
Barriers to
trade are small

23. Intra-Industry Trade

24. Intra-Industry Trade
• Intra-industry trade is when a country exports
and imports the same products
• It is an important feature of the changing global
economy
• Developed economies and emerging economies
(e.g. Hong Kong, China; Singapore; Mexico,
Malaysia and Thailand) tend to engage in more
intra-industry trade
• Resource-rich developing economies and Less
Developed Countries tend to have relatively little
intra-industry trade

25. Intra-Industry Trade For the UK

26. Intra-Industry Trade For Mexico

27. Index of Intra-Industry Trade for selected Countries
Country 2011
World Developed Developing
Hong Kong 66 30 61
Singapore 65 38 59
USA 62 68 51
EU (27) 60 63 51
Zambia 17 4 18
Central African Republic 2 3 4

28. Zambia – Low Intra-Industry Trade Ratio
Source:
http://atlas.media.mit.edu/explore/tree_map/hs/export/zmb/al
l/show/2012/
Zambian Economy Background
1. Low intra-industry trade largely
due to a lack of economic
diversification. Copper accounts
for 80% of Zambia’s exports and
mining is key to the economy
2. Agriculture accounts for 20% of
GDP, and 70% of employment) –
the economy is highly vulnerable
to external shocks.
3. Low human development. With a
GDP per capita of around USD
1,600, income levels are low and
uneven (Gini coefficient: 52% vs. a
SSA average of 45%).
4. Zambia scores low in terms of
health and education. Physical and
social infrastructure is weak, due
to many decades of under-
investment and human capital
deficiencies.
Pattern of Zambian Exports of Goods in 2012

29. Central African Republic (CAR)
Source:
http://atlas.media.mit.edu/explore/tree_map/hs/export/caf/all/sh
ow/2012/
CAR Economic Background
1. Central African Republic is part of a
region of Africa that relies heavily
on output of primary commodities
and extractive industries – making
higher-paid job creation and
inclusive growth a major challenge
2. CAR has one of the lowest intra-
industry trade ratios in the world
according to the WTO research

30. Examples of Regional Trade Agreements
• The number of RTAs has risen from around 70 in 1990 to over 300 now
• The World Trade Organisation (WTO) permits the existence of trade blocs,
provided that they result in lower protection against outside countries
than existed before the creation of the trade bloc
• EU– a customs union, a single market and now with a single currency
• North American Free Trade Agreement (NAFTA) (1994)
• Mercosur – Brazil, Argentina, Uruguay, Paraguay and Venezuela
• Association of Southeast Asian Nations (ASEAN) Free Trade Area (AFTA)
• Common Market of Eastern and Southern Africa (COMESA)
• Pacific Alliance – 2013 – a regional trade agreement between Chile,
Colombia, Mexico and Peru
• Trans-Pacific Partnership (TPP) - a proposed free trade agreement being
negotiated between Australia, Brunei, Chile, Canada, Malaysia, Mexico,
New Zealand, Peru, Singapore, the United States, and Vietnam

31. A2 Macro: International Trade