TOPIC 7 International Trade

1. TOPIC 7 International Trade

2. Definitions: • Trade or trading: refers to the transactions or the exchanges of ownership of goods and services.

3. and, • Domestic Trade: • refers tothe transactions made domestically among the domestic traders in a country only.

4. while, • International Trade (IT): • refers totransactions made • among different countries • in the world, whereby • involves export and import.

5. Why do countries tend to trade with the rest of the world? • Why don’t they become self-sufficient?

6. Indeed,large countrieslikeChina and America would also like to trade with other nations in the global economy. – they do not want to becomeself-sufficient: i.e. to produce all goods they consume and restrict foreign goods into their country. • While Chinanow tend to become an “open economy” i.e. widely open to their trading partners – allowing exports and imports activities. this explains how important is the International Trade.

7. International Trade can also be referred as: INTERNATIONAL SPECIALISATION - Specialisation is said as the basis for trade. - The benefit receives from specialisation is that it may improves economic growth.

8. M’sia Real GNP with Net Exports • Real GNP (RM Billion) 101.7 179.8 190.3 192.8 200.6 212.2 • Net Merchandise Exports (RM Billion) 0.5 73.1 92.6 53.7 51.1 53.1 (source: Malaysia key economic indicators: Malaysian Export Directory of Manufacturers) 1999 2000 2001 2002 2003 2004*

10. Growth rates and export performance of selected secondary outward-looking countries

11. Growth in real GDP and in real exports of goodsand services: total OECD countries

12. Growth in real GDP and in real exports of goodsand services: total OECD countries Growth in GDP

13. Growth in real GDP and in real exports of goodsand services: total OECD countries Growth in GDP

14. Growth in real GDP and in real exports of goodsand services: total OECD countries Growth in exports of goods and services Growth in GDP

15. Growth in real GDP and in real exports of goodsand services: total OECD countries Growth in exports of goods and services Growth in GDP

16. - one country will specialise in a good that she is best at and will trade among them. Specialisation means

17. WHAT ARE THE REASONSorFACTORS FOR COUNTRIES TO TRADE INTERNATIONALLY ORTO DO SPECIALISATION?

18. The factors that may lead these countries to involve in international trading are:

19. The reasons for IT to occur: i. Different factor endowments: raw materials, climate, specialist labour, capital or technology that may caused to produce different types of goods.

20. The reasons for IT to occur: i. Different factor endowments: raw materials, climate, specialist labour, capital or technology that may caused to different types of goods produced. ii. Limited mobility of factors: human capital usually are non-mobile: higher cost of production – costly to produce, so import goods from cheap countries.

21. The reasons for IT to occur: iii. To obtain the benefit from Specialisation: Thetheories of specialisationproves that countries which trade internationally (after specialisation) mayincrease theirproduction,consumptionand thusstandard of living. 2 types of specialisation to be gained either: i) absolute advantage or ii) comparative advantage. Specialisationimproves the volume of production and lower the cost and benefit countries that involves in trading. - This proves that self-sufficientis inefficient.

22. The reasons for IT to occur: iv. Wider consumer choice – varieties of goods to choose: may enjoy different types of goods. Differences in taste across countries prompt the global trading and large demand.

23. The reasons for IT to occur: • To expand the market and may benefits from Economies of Scale – decreasing cost: countries can gain from huge demand of global market by lowering its long run average cost; which declines as the rate of production increases. vi. Increases national income: specialisation helps to increase the volume of exports and raises GDP.

24. The reasons for IT to occur: vii. Increases Competition –the benefits from large competition may result to greater efficiency and better quality of goods: Competition among domestic traders is relatively small. Large competition may arise in global trading among countries in the world which may results to perfect competitive market, and thus, might benefit them in terms of both the productive and allocative efficiency. viii.Non-economic advantages – improves relationship and promote political links. ix. Exchanging knowledge and technological advancement.

25. The differences between International and Domestic Trade: • Size of market and volume of transactions. • Greater specialisation in countries which involves in international trade. • Involves the use of different units of currency. • Different nations produce varieties of goods as world production. • Large competition between nations may lead to better quality of goods. • Higher cost of transportation – involves longer distance of journey. • Subject to government policy and controls.

26. The benefits from Specialisation in INTERNATIONAL TRADE: • will specialise in its own best production of goods. TWO TYPES OF SPECIALISATION in international trade: - may gain either through the: • Absolute advantage or • Comparative advantage.

27. 1. ABSOLUTE ADVANTAGE • is the benefit received when one countryis relatively more efficientthan the other country in a production process: i)either in terms of the ability to producethe same amountof goods is relatively less costly(or using fewer resources) than the other country; ii)orwith the same resources,it is beneficial and efficient if one country might beable to produce more goodsthan the other country.

28. Scarcity of resources relative to material human wants • permits the use of resources efficiently with larger production. • Specialisation able to increase efficiency and volume of production. • One country may specialise in production of goods that has relatively lower cost or greater efficiency with higher output.

29. Mutual Benefit from Absolute Advantage: • After specialisation, each of them can benefit from absolute advantage in the production that they are relatively more efficient, then is said to gain from absolute advantage.

30. to understand the theory of specialisation, it is assumes that: i. only two (2) countries trading in the world market. ii. produces two (2) goods only. iii. constant cost of production (resulting to linear production possibility curves) iv. fixed resources v. no transportation cost or trading barriers.

31. Production possibilities for two countries For Example: Production Before Specialisation

32. The Opportunity Cost or Relative Price of furniture versus computers: In Malaysia; 1 unit of furniture = 2500/1800 = 1.4 units of computers (has to be forgone) In Japan; 1 unit of furniture = 3000/1500 = 2 units of computers. In this case, Malaysia has a lower opportunity cost for the production of furniture than Japan. Therefore, Malaysia will specialize in the production of furniture.

33. The Opportunity Cost or Relative Priceof computers versus furniture : In Malaysia; 1 unit of computer = 1800/2500 = 0.7 units of furniture. (has to be forgone) In Japan; 1 unit of computer = 1500/3000 = 0.5 units of furniture. In this case, Japan has a lower opportunity cost for the production of computers, therefore Japan will specialize in the production of computers.

34. The Relative Prices can be scheduled as: The Opportunity Cost

35. PRODUCTION AFTER SPECIALISATION After specialization, total production of both goods in the world increases. World production before: furniture= 3300, computers= 5500. World production after : furniture= 3600, computers= 6000.

36. PRODUCTION AFTER SPECIALISATION After specialization, total production of both goods in the world increases. World production before: furniture= 3300, computers= 5500. World production after : furniture= 3600, computers= 6000.

37. Terms of Trade refers to: the ratio of exchange between two commodities traded.

38. Terms of Trade • can be stated by looking at the opportunity cost of two countries; In Malaysia; 1 unit of furniture = 1.33 units of computers. In Japan; 1 unit of furniture = 2 units of computers. So, Terms of Trade agreed can be: 1 unit of furniture : 1.5 unit of computers OR1 unit of furniture : 0.8 units of computers OR 1 unit of furniture : 1.33 < computers < 2 OR1 unit of furniture: 1.33 + 2 = 1.67 computers. 2

39. CONSUMPTION AFTER SPECIALISATION With Terms of Trade (TOT); 1 FURNITURE : 1.5 COMPUTERS

40. Can these countries trade, if only onecountry has the absolute advantage in producing both goods?

41. still they can benefit from specialisation through comparative advantage. • If absolute advantage does not exist for both countries that trade still they can have the mutual benefit from trading.

42. 2. COMPARATIVE ADVANTAGE The law of or benefit from comparative advantage: • is the ability of a country to specialise and produce goodsat a relatively less opportunity costthan another country, even though only one country has the absolute advantage in all goods.

43. Instead, • when only one countrywas more efficient at producingboth goods, specialization still may gain both countries; (provided that one country has a greater comparative advantage of one good.) - thus, one countrywill specializein the good that she hasrelatively greater comparative advantage.

44. So … what’s the difference between Absolute and Comparative Advantages. • Absolute Adv: is the benefit enjoyed in the production process when one country can produce more than the other country with the same resources used. • Comparative Adv: is the benefit enjoyed in the production process when one country can produce at a lower opportunity cost in terms of the other goods than the other country.

45. Production possibilities for two countries Example of Comparative Advantage: Production Before Specialisation

46. The Opportunity Cost or Relative Price of vegetables versus fish: In Indonesia; 1 unit of vegetable = 150/200 = 0.75 units of fish (has to be forgone) In Thailand; 1 unit of vegetable = 400/300 = 1.33 units of fish. In this case, Indonesia has a lower opportunity cost for the production of vegetable than Thailand. Therefore, Indonesia will specialize in the production of vegetable.

47. The Opportunity Cost or Relative Price of fish versus vegetables : In Indonesia; 1 unit of fish = 200/150 = 1.33 units of vegetable. (has to be forgone) In Thailand; 1 unit of fish = 300/400 = 0.75 units of vegetable. In this case, Thailand has a lower opportunity cost for the production of fish, therefore Thailand will specialize in the production of fish.

48. The Relative Prices can be scheduled as: The Opportunity Cost

49. PRODUCTION AFTER SPECIALISATION After specialization, total production of goods in the world increases. World production before: vegetable= 500, fish = 550. World production after : vegetable= 400, fish = 800.

50. Terms of Trade • looking at the opportunity cost of two countries. In Indonesia; 1 unit of fish = 1.33 units of vegetable. In Thailand; 1 unit of fish = 0.75 units of vegetable. So, Terms of Trade agreed can be: 1 unit of fish : 1 unit of vegetable.OR 1 unit of fish : 0.8 units of vegetable OR 1 unit of fish : 1.33 > vegetable > 0.75