Extension of Trade Theory Chapter 1 Extension of Trade Theory

Extension of Trade Theory Comparative advantage & its relationship with globalization Production possibilities frontier & trade theory

1.1 Production possibilities frontier & trade theory A. Production possibilities frontier (PPF) B. Trade theory

A. Production possibilities frontier To learn about the PPF To understand the slope of the PPF reflects opportunity cost To analyze how changes in the quantity of resources & production technology affect the PPF To explain why the PPF is concave to the origin

What is a production possibilities frontier? Shows the locus of the maximum output combinations of two goods given the existing resources endowment & technological level.

The opportunity cost of production Marginal cost of the good on the x-axis = Slope of the PPF Assumption: Marginal cost is constant. PPF is a downward sloping line. Production point Good X (units) Good Y (units) A 6 B 1 4 C 2 D 3 The slope of the PPF is the marginal cost of the good on the x-axis. The maximum output combinations of goods that are attainable.

Changes in the PPF Change in resources in resources  Parallel outward shift of PPF

Changes in the PPF Advancement in technology Advancement in technology  Intercept of the PPF 

PPF is concave to the origin Diminishing marginal returns = The marginal cost will finally rise  PPF is generally concave to the origin

B. Trade theory To understand the consumption choice under autarky To learn about the trade line To examine how international trade expands consumption possibilities To explain comparative costs & gains from trade with the PPF

Trade theory Consumption choice in an autarky economy The consumption possibilities frontier shows the locus of the maximum combinations of consumption of an economy.

Trade theory Trade line Trade line: A straight line passing through the production point, which shows the consumption opportunities brought by trade. Slope of trade line = Terms of trade = Relative price of Good X Blue area: The increased consumption possibilities with trade.

Trade theory Changes in consumption possibilities Specialization and trade according to the principle of comparative advantage further expand consumption possibilities. Blue area: The increased consumption possibilities. Trade line = Consumption possibilities frontier

Two-country model Comparative cost Country A: Comparative advantage & specialization in producing Y. Country B: Comparative advantage & specialization in producing X.

Two-country model Gains from trade Assumptions: (1) specialization according to comparative advantage; (2) there is trade; (3) terms of trade: 1X = 1Y Consumption possibilities  Total gains from trade: 2X & 2Y Country A Country B

1.2 Comparative advantage & its relationship with globalization A. What is economic globalization? B. The effects of globalization

A. What is economic globalization? To understand the concept of economic globalization To analyze comparative advantage & its relationship with globalization To examine the controversies over economic globalization

What is economic globalization? The process of which international trade and production activities across countries or regions become more frequent.

Integration of worldwide markets Goods markets (1) International trade  (3) Firms: competition  (2) Trade barriers  (4) Consumers: choice 

Integration of worldwide markets Financial & investment markets (1) Capital flow across countries  (2) Global expansion of financial markets  (3) Foreign direct investment (FDI) 

Integration of worldwide markets Labour market (1) Immigrants & imported labour 

Integration of worldwide markets Labour market (2) Outsourcing / relocation of tasks 

Integration of worldwide markets Labour market (3) Networked labour market  Firms: Production costs  Workers: Job opportunities  Competition 

Globalization of production activities Changes in the nature of international division of labour The specialization of the part of a good which a country or region has a comparative advantage in the global production chain.

Globalization of production activities Dynamic comparative advantage The comparative advantage in a good or component part will shift from one region to another along with changes in economic development.

Globalization of production activities The expansion of the organization & scale of enterprises Through foreign direct investments, the scope of expansion of large enterprises is extended from developed countries to emerging markets.

Globalization of production activities The increasingly networked business models Online trading Online Bookshop Online Shopping Online auction Online Payment

International economic cooperation (1) International organizations that promote global trade and economic cooperations. (2) Arrangements that facilitate regional economic cooperation. (3) The formulation & implementation of international standards.

B. The effects of globalization To learn about the gains from trade brought by globalization To analyze the effects of globalization on labour, income distribution & capital flow across countries To analyze the effects of globalization on multinational enterprises, small enterprises & consumers

The effects of globalization Gains from trade Consumers: Choice  World output  Average production cost  Prices  Globalization: (1) Enhances economic growth. (2) Gives consumer more choices.

The effects of globalization Employment opportunities & income  A change in income distribution (1) Economic restructuring (2) Labour demand & supply  (3) Differences in the mobility of production resources

The effects of globalization Effects of capital flow across countries (1) Enhancing global economic growth (2) Financial risks  Market competition  Environmental conservation 

End of Chapter 1