Introduction to International Trade: Definition, History, and Forms

1. INTERNATIONAL TRADE 武汉理工大学 王恕立

2. International Trade Chapter 1 Introduction to International Trade 1.1 The definition of international trade International trade can be defined as the exchange of goods and services produced in one country (or district) with those produced in another country(or district).

3. The reasons for international trade • The uneven distribution of natural resources B. International specialization C. Different Patterns of demand among nations D. Economies of scale E. Innovation or variety of style

4. Even the IBM PC Isn’t All-American Total manufacturing cost: US$860 Portion made overseas: US$625 In u.s. owned plants $230 In foreign-owned plants $395 $625 $860 73%

5. Distribution of Manufacturing Parts Monitor Korea Semiconductors Japan Power supply Japan Graphics Printer Japan Floppy Disk Drives Singapore Assembly of disk drives U.S Keyboard Japan Case and final Assembly U.S

6. Even the Boeing 777 Isn’t All American The suppliers come from U.S. ,Japan, France, Canada, Italy, Australia, South Korea, United Kingdom So it is increasingly difficult to say what is a “U.S.” product; what is “Japanese” product.

7. 1.2. The history of international trade development The first beginning of international trade The development of international trade in different social period

8. 1.3. The different forms of international trade 1.3.1.Export Trade / Import Trade / Transit Trade Re-Export / Re-Import; Net Export / Net Import 1.3.2. General Trade / Special Trade General Trade: country territory. (Japan,United Kingdom, Canada Australia, East Europe) General Import / General Export Special Trade: Customs Territory.(German, Italy, Swiss)

9. 1.3.3. Visible Trade / Invisible Trade 1.3.4 Direct Trade / Indirect Trade / Entrepot Trade 1.3.5 Trade by Roadway / Trade by Seaway / Trade by Airway / Trade by Mail Order 1.3.6 Free-Liquidation Trade / Barter Trade

10. 1.4 . Another basic concepts about international trade 1.4.1. amount of foreign trade total amount of import and export for a country in definite period. 1.4.2. amount of international trade total amount of export for all countries in definite period. 1.4.3. trade balance favorable balance: export >import (surplus) adverse balance: export<import (deficit)

11. 1.4.4.  commodity structure primary commodities Industry commodities (finished goods) • 1.4.5. factors of production • capital, • human resources or labor • property resources including land

12. 1.5 The difference between domestic trade and international trade 1.5.1. different effect to economy development 1.5.2. different environment social and culture / law and economic policy currency system 1.5.3. difficult movement for factors of production among nations 1.5.4.more risks when you do international business Credit; Business; Price; exchange rate; Transportation; Politics.

13. 外运公司 保险公司 进口商 生产厂家 商检局 银行 海关 税务局 1.6 国际商务环境 出口商

14. Chapter 2 Foundations of Modern Trade Theory 2.1 The Mercantilism The mercantilists’ views on trade If a country could achieve a favorable trade balance (a surplus of exports over imports), it would enjoy payments received from the rest of the world in the form of gold and silver. The more precious metals a nation had, the richer and more powerful it was. To promote a favorable trade balance, the mercantilists advocated government regulation of trade. Tariffs, quotas, and other commercial policies were proposed by the mercantilists to minimize imports in order to protect a nation’s trade position.

15. During the period 1500-1800 In Europe (England, Spain, France, Portugal, and the Netherlands) A group of men (merchants,bankers,government officials, and even philosophers) William Stafford, 1554—1612 The early stage mercantilism ------ The theory of currency balance Thomas Mum, 1571—1641 The later period mercantilism ----- The theory of trade balance

16. 2.2. The theory of absolute advantage 2.2.1 Adam Smith, (1723 – 1790) a classical economist, was leading advocate of free trade (Laissez-Faire) “Inquiry into the Nature and causes of the Wealth of Nations” 1776 ---- The wealth of Nations 2.2.2 The main view on trade Trade is based on absolute advantage and benefits both nations. When each nation specializes in the production of the commodity of its absolute advantage and exchanges part of its output for the commodity of its absolute disadvantage, both nations end up consuming more of both commodities.

17. X product X product Y product Y product output output Labor time Labor time output output Labor time Labor time A country A country 8 4 1 2 0 1 o 1 B country B country 3 0 2 0 6 2 3 1 2.2.3 Illustration of absolute advantage Before Specialization in production 5 Labor time ----- 7X + 3Y After Specialization in production 5 Labor time ------ 8X + 6Y > 7X + 3Y

18. X product Y product output Labor time output Labor time A country 4 1 3 1 B country 3 2 2 1 But if one nation has absolute advantage for both commodities,how to do?

19. 2.3 The theory of comparative advantage 2.3.1 Economists - David Ricardo (1772-1823) He was born in 1772 and was the third of 17 children. His parents were very successful and his father was a wealthy merchant banker. They lived at first in the Netherlands and then moved to London. David himself had little formal education and went to work for his father at the age of 14. However, when, at the age of 21, he married a Quaker (against his parents wishes) he was disinherited and so set up on his own as a stockbroker. He was phenomenally successful at this and was able to retire at 42 and concentrate on his writings and politics. He developed many important areas of economic theory much of the theory he developed is still used and taught today.

20. “Principles of Political Economy and Taxation” 1817 2.3.2. The key views on trade(The law of comparative advantage) Even if a nation has an absolute cost disadvantage in the production of both goods, a basis for mutually beneficial trade may still exist. The less efficient nation should specialize in the production and export of the commodity in which it has a comparative advantage (where its absolute disadvantage is less) The more efficient nation should specialize in and export that commodity in which it is relatively more efficient (where its absolute advantage is greater).

21. X product X product Y product Y product output output Labor time Labor time output output Labor time Labor time A country A country 8 4 1 2 0 3 0 1 B country B country 3 0 2 0 2 6 3 1 Before specialization in production 5 Labor time: 7x + 5y After specialization in production 5 Labor time: 8x + 6y > 7x + 5y

22. U.S. U.K. Wheat (unit/man-hour) 6 1 Cloth (unit/man-hour) 4 2 2.3.3 The gains from trade If trade is possible 6W > 4C (since 6w=4c in the united states) 2C > 1W (since 2c=1w in the united kingdom) so, 12C > 6W > 4C Suppose the United States could exchange 6W for 6C with the United Kingdom The United States would then gain 2C (or save 1/2 hour of labor time) The United Kingdom gain 6C (or save three hours of labor time) So both nations can gain from the trade.

23. 2.3.4 A lot of simplifying assumptions: a. only two nations and two commodities b. free trade c. perfect mobility of labor within each nation but immobility between the two nations d. constant costs of production e. no transportation costs f. no technical change g. the labor theory of value either labor is the only factor of production or labor is used in the same fixed proportion in the production of all commodities. labor is homogeneous

24. 2.4. The opportunity cost theory 2.4.1. the definition of the opportunity cost The opportunity cost of a commodity is the amount of a second commodity that must be given up to release just enough resources to produce one additional unit of the first commodity. 2.4.2. the law of comparative cost The nation with the lower opportunity cost in the production of a commodity has a comparative advantage in that commodity; and a comparative disadvantage in the second commodity.

25. U.S. U.K. Wheat (unit/man-hour) 6 1 Cloth (unit/man-hour) 4 2 In the U.S.A. 6w/4c=1w/? ?=2/3(c) So the opportunity cost of wheat is two-thirds (2/3) of a unit of cloth. In the U.K. 1w/2c=1w/? ?= 2 c So the opportunity cost of wheat is two (2) of a unit of cloth The opportunity cost of wheat is lower in the united states than in the united kingdom. The united states would have a comparative cost advantage over the united kingdom in wheat.

26. 2.4.3. Transformation schedules production possibility curve; production possibility frontier This schedule shows various alternative combinations of two goods that a nation can produce when all of its factor inputs (land, labor, capital, entrepreneurship) are used in their most efficient manner.

27. United States United Kingdom Wheat Cloth Wheat Cloth 180 150 120 90 60 30 0 0 20 40 60 80 100 120 60 50 40 30 20 10 0 0 20 40 60 80 100 120 Production possibility schedules for wheat and cloth in the United States and the United Kingdom Under constant costs cloth United States 120 100 80 60 40 20 0 30 60 90 120 150 180 wheat

28. United States United Kingdom Wheat Cloth Wheat Cloth cloth 180 150 120 90 60 30 0 0 20 40 60 80 100 120 60 50 40 30 20 10 0 0 20 40 60 80 100 120 United Kingdom 120 100 80 60 40 20 wheat 0 20 40 60

29. cloth cloth United States United Kingdom 120 120 100 100 80 60 40 20 80 60 40 20 wheat 0 30 60 90 120 150 180 0 20 40 60 wheat For each 30W that the United States gives up, just enough resources are released to produce an additional 20C. That is, 30W=20C ,so 1W=2/3C Thus,the opportunity cost of one unit of wheat in the United States is 2/3C

30. cloth cloth United States United Kingdom 120 120 100 100 80 60 40 20 80 60 40 20 wheat 0 30 60 90 120 150 180 0 20 40 60 wheat In U.S.A Marginal rate transformation MRT= Cloth / Wheat = slope = 120/180 = 2/3 Same, the opportunity cost of wheat in the U.K. is 1W=2C Marginal rate transformation MRT= Cloth / Wheat = slope = 120 / 60 = 2

31. 2.4.4. Opportunity Costs and relative commodity prices On the assumptions that prices equal costs of production and that the nation does produce both some wheat and some cloth, the opportunity cost of wheat = the price of wheat relative to the price of cloth In the United States Pw / Pc = 2/3 In the United Kingdom Pw / Pc = 2 Pw / Pc (U.S) < Pw / Pc(U.K.) it is a reflection of the United states’s comparative advantage in wheat. Similarly, Pc/Pw(U.K.) < Pc/Pw(U.S.) it is a reflection of the United Kingdom’s comparative advantage in cloth.

32. 2.5 The basis for and the gains from trade under constant costs 2.5.1 The basis for trade under constant costs The difference in relative commodity prices between the two nations is a reflection of their comparative advantage and provides the basis for mutually beneficial trade. constant opportunity costs a. The factors of production are perfect substitutes for each b. All units of a given factor are of the same quality

33. cloth cloth United States United Kingdom B’ 120 120 E 70 E’ 50 40 60 A B A’ 0 90 110 180 wheat 0 40 60 70 wheat 2.5.2 Illustration of the gains from trade specialization can result in production gain 180W + 120C > (90+40)W + (60+40)C if the U.S. exchanges 70w for 70c with the U.K, (trade) it ends up consuming at point E (110w + 70c) , gain 20W + 10 C U.K. ends up consuming at E’ and gains 30 W + 10 C So, trade can result in consumption gains for both countries.

34. 2.6 Comparative advantage with more than two commodities If the exchange rate between the dollar and the pound is ￡1 = $2 U.S will export commodities A and B; U.K. ----- E,D If ￡1 = $ 3 U.S. will export A.B.C; U.K. will export E,D

35. 2.7 Comparative advantage with more than two nations If the equilibrium Pw / Pc = 3 Nation A, B will export wheat to Nations and E in exchange for cloth. If a trade equilibrium Pw/Pc = 4, Nations A,B,C will export wheat to Nation E in exchange for cloth If the equilibrium Pw/Pc =2 with trade, ?

36. A B y Nation 1 y1 y2 - y y3 y4 x y5 x 0 10 30 50 70 90 110 130 Chapter 3 The Standard Theory of International Trade 3.1. The Production Frontier with Increasing Costs Increasing opportunity costs mean that the nation must give up more and more of one commodity to release just enough resources to produce each additional unit of another commodity. y1y2<y2y3<y3y4<y4y5

37. y Nation 2 140 B’ 120 X1x2<x2x3<x3x4 100 80 60 X4 X3 X2X1 A’ 40 20 x Production Frontiers of Nation 2 with increasing costs

38. c. The difference in the production frontiers of two nations is due to the fact that the two nations have different factor endowments or resources at their disposal and /or use different technologies in production. 3.1.2 Reasons for increasing opportunity costs and different Production frontiers a. Resources or factors of production are not homogeneous b. Resources or factors of production are not used in the same fixed proportion or intensity in the production of all commodities.

39. 100 80 60 40 20 0 10 30 50 70 90 3.2 Community Indifference Curves 3.2.1 Illustration of community indifference curves A community indifference curve shows the various combinations of two commodities that yield equal satisfaction to the community or nation. Y T E A III B H N II C D I Nation 1 X

40. 3.2.2 The marginal Rate of Substitution (MRS) MRS of X for Y in consumption refers to the amount of Y that a nation could give up for one extra unit of X and still remain on the same indifference curve. In Nation 1 ,the substitution of x for y ,MRS(N) > MRS(A) The decline in MRS or absolute slope of an indifference curve is a reflection or the fact that the more of X and the less of Y a nation consumes; The declining slope of the curve reflects the diminishing marginal rate of substitution (MRS) of X for Y in consumption.

41. A Nation 1 y B I 60 PA=1/4 x 0 10 30 50 70 90 110 130 3.3. Equilibrium in Isolation 3.3.1. Illustration of Equilibrium in Isolation

42. In the absence of trade (or autarky), a nation is in equilibrium when it reaches the highest indifference curve possible given its production frontier.

43. 3.3.2. Equilibrium Relative Commodity Prices and Comparative Advantage The equilibrium relative commodity price in isolation is given by the slope of the common tangent to the nation’s production frontier and indifference curve at the autarky point of production and consumption. PA = Px / Py=1/4 PA’ = Px / Py = 4 PA < PA’ So, Nation 1 has a comparative advantage in commodity X and Nation 2 in commodity Y.

44. 3.4. The basis for and the Gains from trade with increasing costs 3.4.1.Illustrations With trade, Nation 1 moves from point A to point B in production. By then exchanging 60X for 60Y with Nation 2 Nation 1 ends up consuming at point E(on indifference curve) Thus, Nation 1 gains 20X and 20Y from trade. A ---- E

45. A.  With trade, each nation specializes in producing the commodity of its comparative advantage and faces in creasing opportunity costs. B.  Specialization in production proceeds until relative commodity prices in the two nations are equalized at the level at which trade is in equilibrium.

46. 3.4.2. Equilibrium relative Commodity Prices with trade The process of specialization in production continues until relative commodity prices (the slope of the production frontiers) become equal in the two nations PB = PB’ The equilibrium relative commodity price with trade is the common relative price in both nations at which trade is balanced

47. 3.4.3. Incomplete Specialization Under constant costs, both nations specialize completely in production of the commodity of their comparative advantage Under increasing opportunity costs, there is incomplete specialization in production in both nations. The reason for this is that as Nation 1 specializes in the production of X, it incurs increasing opportunity costs in producing X.

48. 3.4.4. The gains from exchange and from specialization A nation’s gains from trade can be broken into two components: The gains from exchange The gains from specialization

49. 3.5. Trade based on differences in tastes with increasing costs, even if two nations have identical production possibility frontiers (which is unlikely), there will still be a basis for mutually beneficial trade if tastes, or demand preferences, in the two nations differ. The nation with the relatively smaller demand or preference for a commodity will have a lower autarky relative price for, and a comparative advantage in, that commodity.

50. Illustration A, A’ in isolation PA < PA’ Nation 1 has a comparative advantage in X and Nation 2 in Y. A(40,160)----B ---- C ---- E(60,180) gain 20 X + 20Y in Nation 1 A’(160,40)-----B’ ---- C’ ---- E’(180,60) gain 20X+20Y in Nation 2