Ch.5 : International Trade Theory
An Overview of Trade Theory:
* The Benefits of Trade – Some international trade is beneficial, exchange products you can produce at a low cost for some products you cannot produce at all * Free Trade – The absence of government barriers to the free flow of goods and services between countries. * International trade allows a country to specialize in the manufacture and export of products it can produce most efficiently while importing products that can be produced more efficiently in other countries. * Climate and natural resources explain why Ghana exports cocoa, and Saudi Arabia exports oil * Product Life-Cycle Theory – Early in their life cycles, most new products are produced in and exported from the country in which they were developed. As the product becomes accepted internationally, production begins to start in other countries. Thus suggesting that the product may ultimately be exported back to the country of its original innovation. * New Trade Theory – Theory that sometimes countries specialize in the production and export of particular products not because of underlying differences in factor endowments, but because in certain industries the world market can support only a limited number of firms. Mercantilism:
* Mercantilism – Originated in England, An economic philosophy advocating that countries should simultaneously encourage exports and discourage imports. It was in the countries best interest to maintain a trade surplus, to export more than it imported. Also advocated government intervention to achieve a surplus in the balance of trade. * Zero-Sum Game – A situation in which an economic gain by one country results in an economic loss by another. The flaw with Mercantilism is that it is viewed as a Zero-Sum Game. * Critics think China is pursuing a neo-mercantilist society, deliberately keeping its currency value low against the U.S. dollar in order to sell more goods to the U.S., thus creating a surplus and foreign exchange reserves. Absolute Advantage:
* Absolute Advantage – A country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it. * According to Smith countries should specialize in the production of goods for which they have an absolute advantage and then trade these for goods produced by other countries. (Countries should never produce goods at home that it can buy at a lower cost from other countries. Comparative Advantage:
* Comparative Advantage – It makes sense for a country to specialize in the production of those goods that it produces most efficiently and to buy the goods that it produces less efficiently from other countries, even if this means buying goods from other countries that it could produce more efficiently itself. * Basic Message of Comparative Trade – Potential world production is greater with unrestricted free trade than it is with restricted free trade. * Immobile Resources – Resources do not always shift easily from on activity to another, some friction is involved. Belief that a country will produce less of some goods but more of others, however not everyone has the skills and knowledge to produce the greater good, thus some people may lose their jobs. * Diminishing Returns – When more units of a resource are required to produce each additional unit. First not all resources are of the same quality, and different goods use resources in different proportions. * Constant Returns to Specialization – The units of resources required to produce a good are assumed to remain constant no matter where one is on a country’s production possibility frontier. * Dynamic Effects and Economic Growth – Opening an economy to trade, might increase a countries stock of resources as increased suppliers of labor and capital from abroad become available for use within the country, and free trade might...