International Trade Principles Quiz

International Trade (AgEc442) Study Notes

• International Trade Definition: Deals with business transactions between citizens of different nations, encompassing commercial diplomacy. It includes the theory of trade, commercial policy, foreign exchange markets, and balance of payments adjustments.

Concepts of International Trade

• Definition of International Trade: International trade involves business transactions between different nations, often stemming from commercial diplomacy.

• Pure Theory of Trade: Analyzes the basis and gains from trade.

• Commercial Policy Theory: Explores reasons for and effects of trade restrictions.

• Foreign Exchange Markets: Framework for exchanging one currency for another.

• Balance of Payments: Measures a nation's total receipts and payments to the rest of the world. Adjustments in the balance of payments address imbalances (surpluses or deficits).

• Inter-regional vs International Trade: Inter-regional is trade between regions within a country (domestic/internal), while international trade is between different nations. Key difference is factor immobility—factors of production are often mobile within a country but not easily between countries.

• Differences in Natural Resources: Countries specialize in producing goods where they have abundant resources, trading with countries with scarce resources.

• Geographical and Climatic Differences: Geographical and climatic conditions affect production possibilities, leading to trade specialization.

• Different Markets: International markets differ in languages, habits, tastes, weights, measures and standards, posing challenges.

• Mobility of Goods: Internal trade mobility is restricted by distance and transportation costs. External trade involves greater regulatory and distance hurdles

• Difference in Currencies: International trade involves multiple currencies, contrasting with typically domestic use of a single currency

• Balance of Payments Problem: A constant problem in international trade, absent in internal trade due to greater capital mobility internally

Classical and Neo-Classical Theories of International Trade

• Mercantilism: 16th-century economic nationalism focused on enriching the nation by maximizing exports and minimizing imports. It advocated strict government control.

• Absolute Advantage Theory: (Adam Smith) Nations gain from specializing in and trading goods they produce most efficiently, increasing overall output.

• Absolute Advantage Assumptions: Labor is the only production factor, homogeneous throughout a nation, and immobile between countries; there are no transportation costs, and no trade restrictions; constant returns to scale.

• Comparative Advantage Theory: (David Ricardo) Countries should specialize in producing the goods for which they have the lowest opportunity cost, even if they may be somewhat less efficient at producing other goods. Thus, trade can benefit both countries.

• Comparative Advantage Assumptions: Two countries, two goods, single factor of production (labor), constant returns to scale, identical tastes, and no transport costs.

Criticism on the theory of Absolute Advantage

• Smith's theory was criticized for being too vague and unrealistic. The theory also assumes that developed countries will always have an advantage over less developed countries due to their higher initial level of technology.

• Criticism on the theory of Comparative Advantage:

  • Critics highlighted that the theory depends on a labor theory of value and doesn't account for technological improvement, transportation costs, or factor mobility between countries. The assumption of fixed factors of production and perfect competition is also considered an oversimplification.

Offer Curve and Terms of Trade

• Offer Curve: A graphical representation of a country's willingness to trade its exports for imports at differen relative prices. It is derived from the country's production possibility frontier and preference.

• Terms of Trade: The relative prices of a country's exports and imports (ratio of export prices to import prices).

Heckscher-Ohlin Theory of Trade (H.O Model)

• Factor Endowments: Nations have differing amounts of factors of production (e.g., capital and labor).

• Relationship between Factor Endowments and Comparative Advantage: A country that is abundant in a certain commodity has a comparative advantage in commodity intensive in that factor.

• Factor Price Equalization Theorem: Trade leads to equalization of factor prices, such that wages and returns to capital converge between countries.

• Assumptions of H.O Model: Two countries, two commodities, two factors of production, no transportation costs, perfect competition, constant returns to scale, and similar tastes.

Trade Policies

• Free Trade: Unrestricted exchange of goods and services between countries.

• Protectionism: Policies that limit international trade to protect domestic industries, typically through tariffs, quotas, or subsidies.

• Infant Industry Argument: Protecting new industries, temporarily, allows them to become competitive.

• Diversification Argument: Diversifying industries reduces reliance on a few export sectors and makes a country more economically stable.

• Retaliation Argument: The argument that countries protecting themselves against foreign competition will result in reciprocal retaliatory tariffs leading to reductions in trade and economic loss.

• Employment Argument: Protection boosts domestic employment in selected sectors, but it can cause job losses or reduced efficiency in other areas.

• Balance of payments Argument: Protection reduces imports and increases exports, leading to a better balance of payments.

• Tariff as a bargaining Argument: Tariffs can be used as a negotiating tactic to secure better trade deals.

• Welfare effects of an import Tariff: Consumers pay higher prices, producers benefit, and the government earns tariff revenue.

• Means of Trade Restrictions: Tariffs and quotas restrict trade. Specific and ad valorem tariffs, sliding scale duties and compound duties are forms of tariffs. Quotas limit the quantity of a good that can be trade.

• Tariff Calculation: The effectiveness of protection for domestic industries is evaluated not merely by the nominal tariff rates on imports but also by the rate of effective protection.