ECON 11 LE4

International Trade and Development

• Trade disciplines firms with market power, increasing productivity with technology embodied in intermediate goods.
• Trade expands consumption variety and quality, offering cheaper costs compared to self-sufficiency.
• Comparative advantage arises when opportunity costs of production are lower in one country compared to another, encouraging specialization and trade.
• Ricardian analysis demonstrates specialization based on lower production costs, not absolute advantage.
• For example: if producing food is relatively cheaper in America than in Europe, America should specialize in producing food and export it, importing clothing.

Comparative Advantage Analysis

• Example: America and Europe produce food and clothing, both are more efficient in producing both but different in which is more efficient in producing each item.
• America is more efficient in producing food and clothing
• Opportunity costs of producing food in America is lower than in Europe, vice versa
• This dictates which product should be traded and which imported, specializing based on Comparative Advantage and lower opportunity costs. This means if one country is comparatively better at making one good than the other it should focus on it.

Modern Analysis of Comparative Advantage

• Example productivity schedule displays different production combinations, with optimal choice for countries.
• In pre-trade, each country produces and consumes goods domestically based on their production capability. Prices are dictated solely within the countries' markets.
• Post-trade, the price for commodities adjusts to be between those of each country's domestic prices, creating a new global price point.
• Trade increases combined production given specialization, improving each country's combined prosperity.

Trade Strategies: Import Substitution

• Aims for sustained development by shifting from primary to manufacturing production.
• Requires increased domestic production/ reduced reliance on imports to achieve development.
• Governments introduce policies such as:
  • Tariffs(taxes on imports)
  • Quotas(numerical limits on imports)
  • Subsidies (financial help for domestic producers)

Diagrammatic Analysis of Tariffs

• Raising domestic prices with tariffs reduces imports and increases domestic production and employment.
• Higher domestic prices result in reduced consumption (negative impact on consumers).
• Part of the revenue generated from the tariff can be used towards government services for public welfare. There is a tradeoff.

Exchange Rate Management

• Undervalued exchange rate makes imports expensive, stimulating exports, and generating reserves.
• Foreign exchange reserves are resources used for managing national financial matters and are not used for consumption or investment.
• This strategy has negative impact on consumers due to higher prices on imported goods.

Balance of International Payments (BOP)

• A systematic record of a country's economic transactions with other countries in a given time period.
• Includes current account (trade in goods and services, income, current transfers) and capital/financial account (asset transactions).
• Both sides of the balance will always sum to zero

Determination of Foreign Exchange Rates

• The foreign exchange rate is the price of one currency in terms of another currency.
• It is determined by supply and demand for each currency.
• Factors influencing the rate can include: interest rate differentials, trade imbalances, and government policies.

Supply and Demand Analysis of Trade

• Supply and demand curves interact to determine exchange rates.
• Shifting of the curves occurs in response to various events like recession or government policy changes
• A higher price for a currency results in decreased cost for imports while making its exports more expensive.

International Monetary Systems (IMS) Post-WWII

• The Bretton Woods system established a fixed exchange rate regime, with pegs against the US dollar.
• The system was adjustable when a country's currency deviated too much from the peg.
• This system was replaced by multiple exchange rates when the US dollar lost its credibility in the 1970s due to the Vietnam War.

The International Financial System

• Institutions that facilitate cross-border transactions and manage foreign exchange rates.
• Includes fixed, flexible, and managed exchange rate regimes.
• The Bretton-Woods system fixed exchange rates.