International Trade: An Overview

International Trade Introduction

• International trade's effects are evident in supermarkets with goods like South American bananas, Brazilian coffee, and South African wine
• International trade expands markets for goods and services
• A variety of car brands from different countries exist because of international trade
• Increased competition and lower prices are results of international trade

What is International Trade?

• Exchange of goods and services between countries gives rise to a world economy
• Prices are affected by global supply, demand, and political events
• Global trade provides access to products not available domestically
• Almost every product is traded internationally, including services like tourism and banking
• Exports are products sold to the global market
• Imports are products bought from the global market
• Imports and exports are part of a country's current account

Benefits of Trade

• Voluntary exchange is mutually beneficial
• Benefit from lower prices due to global division of labor, leading to higher output with less resources
• Consumers and producers can buy inexpensive products and raw materials respectively
• Trade allows countries to leverage different factor endowments
• No two countries have the same resources
• Some countries must import commodities they lack
• Exporting goods and services enables countries to earn foreign currency to buy needed resources
• Enables economies of scale via access to larger markets, thus increasing production levels and unit size
• Access to more variety as businesses offer different goods and levels of satisfaction
• Acquisition of needed resources, which can range from those that are impossible to produce
• International trade can improve competition and provide consumers with more diverse goods
• Trade and integration encourage compromise and resolution, requiring relationships and promoting stability
• Merchants desire predictable supply and reliable output, disliking business disruptions
• Countries are less likely to fight when they are linked via trade

Understanding Trade with Production Possibilities

• Production possibilities curve (PPC) shows the maximum production level of one commodity, given the production level of another
• PPC is based on existing factors and tech
• Points outside the PPC are unattainable without external trade
• Without economic exchange, countries limited to consuming what they produce
• Specialization and exchange allow consumption beyond national economic self-sufficiency

Key Terms

• Production Possibilities Frontier is a graph that shows the combinations of two commodities that could be produced using the same total amount of each of the factors of production

Laissez-Faire vs Interventionist Approaches

• Countries implement policies, including trade policies, to achieve economic and political goals
• Policies determine production efficiency and import competition
• Laissez-faire allows market forces to dictate trade
• Free-trade eliminates government intervention, as emphasized by absolute and comparative advantage theories
• Mercantilism and neomercantilism involve significant government intervention

Trade Theories and Business

• Trade theories help businesses understand how policies impact competitiveness
• These provide insights on export locales, products, and production facility locations

Interventionist Theories

• Mercantilism and neomercantilism support governmental intervention in trade

Mercantilism

• Wealth is measured by gold
• Countries should export more, import less, and accumulate gold reserves
• Gold allowed governments to build armies and national institutions
• Restricted imports and subsidized exports to achieve trade surplus
• Colonies supplied commodities and ran trade surpluses for colonial powers
• The concept of balance of trade still exists; a favorable balance is a trade surplus, while the opposite is a trade deficit
• Terms like "favorable" and "unfavorable" do not mean "benefit" or "disadvantage"

Neomercantilism

• Achieving favorable trade balances to meet political goals, such as job creation
• Policies encourage domestic production while exporting excess goods
• Goal of political influence is achieved by exporting more goods than imports, often through government aid or loans tied to purchases

Free Trade Theories

• Trade occurs because countries want more goods and services

Absolute and Comparative Advantage

• Both theories support unregulated trade with no import limits or export promotion, letting the market decide
• Production specialization and trade for domestic consumption

Absolute Advantage

• Absolute advantage states that a producer with smaller inputs to produce a good has absolute advantage

Theory of Absolute Advantage

• Adam Smith stated that wealth comes from goods and services available to a country's citizens
• Countries should freely trade and specialize to have a competitive advantage
• Countries increase efficiency via labor skill, no switching production, and effective methods
• They country should specialize in either a natural advantages from nature, or an acquired advantage
• Advantage comes from process technology, such as Japan's new labor practices

Theory of Comparative Advantage

• Comparative advantage addresses what happens when one country has absolute advantage
• Global efficiency rises as countries specialize in what they produce most efficiently
• International specialization and trade equates to nations gaining better resources and improving their production
• Comparative advantage means producing goods or services at a lower opportunity cost
• Comparative advantage drives lowest opportunity cost, leading to increased productivity
• Some policymakers confuse absolute and comparative advantage
• Comparative advantage and absolute disadvantage exist simultaneously with the production of a product

Sources of Comparative Advantage

• Advantage lies in a country's resources
• Farmable land has advantage in agriculture
• Untapped fossil fuels has comparative advantage
• Skilled workforces has financial advantage

Perils of Extreme Specialization

• Overspecialization poses risks, limiting potential development
• Sectors may not compete with cheaper imports
• Dependence for a good or resource on another country causes high unemployment

Heckscher-Ohlin Model

• Countries export efficiently and import what is difficult to produce

Examples of the Heckscher-Ohlin Model

• Some countries have oil reserves while others have precious metals
• The country focuses on resources that are naturally abundant
• Countries benefit exporting these resources while importing the resources that they lack

The World Trade Organization (WTO)

• Ensures smooth trade flow
• The organization originated from the General Agreement on Tariffs and Trade (GATT)
• The WTO seeks to expand trade with some objectives
• WTO members subscribe to Most Favoured Nation (MFN) status, so that there is no discrimination.
• Free trade through negotiating
• Trading is predictable through binding and transparency.
• Members promise to keep tariffs at a certain rate
• Trade should be fair and against theft
• Development should be encouraged through special trade.