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International Economics Faculty: Prof. Sunitha Raju Session 1: Introduction and International Trade Theory Session Date: 06.07.13.

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Presentation on theme: "International Economics Faculty: Prof. Sunitha Raju Session 1: Introduction and International Trade Theory Session Date: 06.07.13."— Presentation transcript:

1 International Economics Faculty: Prof. Sunitha Raju Session 1: Introduction and International Trade Theory Session Date:

2 MBA(PT) International Economics/ Session: 1 Globalization - Meaning Integration of national Economies into an international economy Integration through trade investment, capital flows, technology and migration

3 MBA(PT) International Economics/ Session: 1 Globalisation Trends Promotion of Free Trade Elimination of tariffs subsidies Elimination of capital controls Reduction in transportation costs Integration of production activities Wider choice of goods & services Creates competition for local firms & keeps costs low Promotes specialisation Can lead to economic problem of unemployment & deindustrialisation

4 MBA(PT) International Economics/ Session: 1 Review of Trends in Global Trade

5 MBA(PT) International Economics/ Session: 1 Trade to GDP Ratios Source: UNCTAD Handbook of Statistics

6 MBA(PT) International Economics/ Session: 1 Composition of Exports By Regions Year World Developing Economies Transition Economies Developed Economies

7 MBA(PT) International Economics/ Session: 1 Total Merchandise Exports, Reporter Name Partner Name Value ($ billions) Share in WLD to WLD (%) Value ($ billions) Share in WLD to WLD (%) Value ($ billions) Share in WLD to WLD (%) World 5, , , Developing economies World1, , Developing economies , Source: UNCTADs South-South Trade Information System

8 MBA(PT) International Economics/ Session: 1 Composition of Exports of Developing Countries- Regional Groups

9 MBA(PT) International Economics/ Session: 1 Export Structure by Product Group: World All Food Items Agriculture Raw Material Ores & Metals FuelsManufacturing Goods Total

10 MBA(PT) International Economics/ Session: 1 Export Structure of Commodities by Regions Developed EconomiesDeveloping EconomiesTransition Economies Item All Products All Food Items Agriculture Raw Material Ores & Metals Fuels Manufacturing Goods

11 MBA(PT) International Economics/ Session: 1 Top 10 Economies in South-South Trade, 2003 (Percentage shares of total South-South Trade)

12 MBA(PT) International Economics/ Session: 1 Applied Tariffs in Developed and Developing Countries by Selected Product Group, 1994 and 2005 (percent) Products and Markets

13 MBA(PT) International Economics/ Session: 1 Trade and Investment Trends Exports of Goods & Services (i) World (100.0) (100.0) (100.0) (100.0) (ii) Advanced Economies (63.692) (60.709) (59.528) (58.430) (iii) Newly Industrialised Asia (9.745) (9.567) (10.023) (10.294) (US $ billions)

14 MBA(PT) International Economics/ Session: 1 World Trade Trends a)Why do some countries trade more than others b)Why is there a significant increase in the trade in manufactures compared to primary commodities c)Why is there a growing importance of developing countries in world trade d)Why is there a significant increase in south- trade e)What role do national trade policies have in defining the trade pattern

15 MBA(PT) International Economics/ Session: 1 Framework for International Trade

16 MBA(PT) International Economics/ Session: 1 Preview Questions 1.What is the basis for trade between countries? 2.How are gains from trade defined/ measured? 3.What determines the structure/pattern of trade flows?

17 MBA(PT) International Economics/ Session: 1 Basis for Trade 1. Mercantilism 2. Standard Trade Model Absolute Advantage Comparative Advantage Heckscher-Ohlin Theorem

18 MBA(PT) International Economics/ Session: 1 Absolute Advantage: Illustration US will export wheat and import cloth from UK UK will export cloth and import wheat Absolute cost differences between countries lead to trade USUK Wheat (bushels/man-hour)61 Cloth (Yards/man-hour)45

19 MBA(PT) International Economics/ Session: 1 Comparative Advantage: Illustration USUK Wheat (bushels/man-hour)61 Cloth (Yards/man-hour)42 US has absolute advantage in both wheat & cloth UK has absolute disadvantage in both wheat & cloth Can trade take place?

20 MBA(PT) International Economics/ Session: 1 Principle of Comparative Advantage (Ricardo) Comparison of relative advantage or disadvantage between countries US has 6 to 1 advantage in wheat and 2 to 1 advantage in textiles (over UK) UK has greater disadvantage in wheat than in cloth. Wheat: 1 to 6 Cloth: 1 to 2

21 MBA(PT) International Economics/ Session: 1 Comparative Advantage: Resource Cost US Domestically, 6W can be produced if 4C is given up (opportunity cost) 1C costs 1½ W and 1W costs W UK 2C can be produced if 1W is given up 1C costs ½ W and 1W costs 2C Therefore, cloth is relatively cheaper in UK and wheat in USA

22 MBA(PT) International Economics/ Session: 1 Comparative Advantage: Gains from Trade 1 US (Cloth) Import of cloth takes place if 6W can be exchanged for greater than 4C if 1C is less than 1½ W UK (Cloth) Export of cloth takes place if 2C can be exchanged for greater than 1W If 1C is greater than ½ W Both US & UK gain if the price of cloth (in terms of wheat) is 1W

23 MBA(PT) International Economics/ Session: 1 Comparative Advantage: Gains from Trade 2 Countries can gain from trade even when one of the countries has absolute disadvantage (cost) in both products Relative Advantage / Disadvantage will define the implicit resource cost for production of goods Relative prices determine the direction and volume of trade

24 MBA(PT) International Economics/ Session: 1 Comparative Advantage: Gains from Trade 3 Benefits from trade can be assessed when compared to a situation without trade (Autarky) In Autarky, resource allocation decision is based on production and consumption decisions of a country Possible production trade-offs between goods X and Y given the available resources and technology (production possibility curve for a country) Trade-offs between consumption of goods X and Y subject to consumer preferences (consumer indifference curve for a country)

25 MBA(PT) International Economics/ Session: 1 Comparative Advantage and Trade: Production Possibility Schedule (PPS) PPS shows various combinations of 2 goods that a country can produce when all inputs (land, labour capital & Entrepreneurship) are used most efficiently. Under constant cost conditions, relative cost of producing one good in terms of other remains same MRT =

26 MBA(PT) International Economics/ Session: 1 Production Possibility Frontier Production Possibility Schedules for Wheat and Cloth in the United States and the United Kingdom United StatesUnited Kingdom WheatClothWheatCloth

27 MBA(PT) International Economics/ Session: 1 Consumption/Demand Issues Consumer demand is underlined by tastes/ preferences or utility How much of the goods produced will be consumed depends on consumer preferences Consumer Indifference Curve Slope of the Indifference Curve represents consumers trade off between two goods, i.e. Marginal Rate of Substitution

28 MBA(PT) International Economics/ Session: 1 Slope = Y/ X = MRS A U A 2 A U A 1 U 0 Y A 0 X A Indifference Curves

29 MBA(PT) International Economics/ Session: 1 Equilibrium in Autarky Consumption utility maximized subject to the constraints of Production Possibility Frontier Slope = -(b LX /b LY ) = MRT B Slope = MRS B YBYB YBYB XBXB 0 XBXB U B B 2 U B 1 U B 0 L B/ b LY

30 MBA(PT) International Economics/ Session: A Cloth Cloth 40 United StatesUnited Kingdom Wheat 0 0 A Production Possibility Frontier: Equilibrium under Autarky

31 MBA(PT) International Economics/ Session: 1 Equilibrium in Open Economy E Cloth United StatesUnited Kingdom Wheat 0 A B E Cloth Wheat 0 B A

32 MBA(PT) International Economics/ Session: 1 Equilibrium-Relative Prices with Trade With specialisation in production & trade, each nation can consume outside its production frontier. The relative prices that balances trade (i.e. export of 1 country = import by another country)

33 MBA(PT) International Economics/ Session: 1 Exports Imports E*E* S D E A B P3P3 P2P2 P1P1 SXSX International Trade in Commodity X Nation 1s Market for Commodity X Nation 2s Market for Commodity X SXSX A E B A DXDX P3P3 B* A* XXOOO The Equilibrium-Relative Commodity Price Panel APanel B Panel C DxDx

34 MBA(PT) International Economics/ Session: 1 Trading under Constant Costs Basis for Trade Slopes of the production possibilities schedules give the relative cost of one product in terms of other Differences in relative costs provide the basis for mutually favourable trade Production gains from Specialisation A country will specialise in the production of the good in which it has comparative advantage A country will trade part of this production for the good in which it has comparative disadvantage (a) (b) Contd..

35 MBA(PT) International Economics/ Session: 1 Consumption gains from Trade Consumption alternatives limited by the domestic production possibilities schedules The exact consumption will be determined by the tastes & preferences Specialization & free trade care achieve post-trade consumption outside domestic production possibilities schedules trade results in consumption gains for both countries Terms of Trade Domestic terms of trade represents the relative prices at which goods are exchanged at home A country will exports/import goods internationally if the terms of trade are more favourable than domestic terms of trade (d) (c) Trading under Constant Costs

36 MBA(PT) International Economics/ Session: 1 Production Possibility Schedule under Increasing Costs (i)Increasing opportunity costs mean that more of one commodity is to be given up (to release resources) for additional production of another commodity (ii)Increasing costs result when inputs are not perfect substitutes

37 MBA(PT) International Economics/ Session: Nation 1Nation 2 Production Frontiers of Nation 1 and Nation 2 with Increasing Costs X -Y-Y A B X Y Y -X-X A B Y Slope of the PPS (or MRT) varies at different points on the schedule

38 MBA(PT) International Economics/ Session: Nation 1 Nation A B X Y A B Y I I 85 P A =4 Trade Under Increasing Cost

39 MBA(PT) International Economics/ Session: Nation 1Nation A B X Y A B Y I I III E 150 P B =1 C III E C P B =1 Trade Equilibrium Under Increasing Costs

40 MBA(PT) International Economics/ Session: 1 Trading under Increasing Costs Supply factors and Demand factors together determine the point at which a country chooses to consume along the PPS. In Autarky, a country is in equilibrium which the PPS is tangent to the highest indifference curve This tangency determines the equilibrium relative prices of commodities in each country.

41 MBA(PT) International Economics/ Session: 1 Determining Relative Prices (i)Terms of Trade (Net barter terms of trade) Ratio of price of export commodity to the price of import commodity Assume 2 countries : –Home Exports Food terms of trade –Foreign exports manufactures terms of trade

42 MBA(PT) International Economics/ Session: 1 Sources of Comparative Advantage a)Factor Endowments b)Technology c)Consumer Tastes (Demand Issues)


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