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Lec 1: Introduction

Lec 1: Introduction. Subject Outline. Trade Theory. International Economics. Trade Policy. Finance. Heckscher-Ohlin. Stolper-Samuelson. Factor Price Equalisation. Comparative Advantage. Trade Theory. Trade Theory Study Guide 1. Rybzcynski. Absolute Advantage.

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Lec 1: Introduction

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  1. Lec 1: Introduction

  2. Subject Outline Trade Theory International Economics Trade Policy Finance

  3. Heckscher-Ohlin Stolper-Samuelson Factor Price Equalisation Comparative Advantage Trade Theory Trade Theory Study Guide 1 Rybzcynski Absolute Advantage Immiserising Growth Mercantilism

  4. Trade Theory • Theory used to explain and predict. • What is International Trade? • Why do nations trade? • What are the gains from trade? • Who gains from trade?

  5. Other Trade Policies Regional Trade Agreements Trade Policy Tariffs International Resource Movements Tools of the Trade Policy Analysis

  6. Exchange Rates Current Account Deficit Finance Study Guide 3 Weeks 9-12 Exchange rate theorems Interest Arbitrage

  7. Heckscher-Ohlin Stolper-Samuelson Factor Price Equalisation Comparative Advantage Trade Theory Trade Theory Study Guide 1 Rybzcynski Absolute Advantage Week 1 Immiserising Growth Mercantilism

  8. Trade Theory Why do Nations Trade? • Mercantilism - zero sum game - one nation gains at the expense of the other. • Adam Smith - both nations can gain from trade. • Absolute Advantage - each nation should specialise in production of the good which it is most efficient at producing.

  9. Trade Theory Assumptions Why do Nations Trade? • Perfect Competition in Product and Factor Markets (P=MC) • Each Country has a fixed endowment of resources that are fully used and are homogeneous • Technology is Unchanging • No Transportation Costs or barriers to trade • Factors of Production are perfectly mobile between industries but are immobile between countries • 2x2x1

  10. Trade Theory Why do Nations Trade? Mercantilism Thomas Munn (1571-1641) The way for a nation to become rich and powerful is to export more than to import

  11. Trade Theory Why do Nations Trade? Mercantilism ENGLAND FRANCE Imports Imports Exports Exports

  12. Introduction Adam Smith (1723-1790)

  13. Introduction David Ricardo (1772-1823)

  14. International EconomicsBy Robert J. Carbaugh7th Edition Chapter 2: Foundations of modern trade theory

  15. Historical development of trade theory Foundations of trade theory • Mercantilism • positive trade balance • Absolute advantage (Adam Smith) • Countries benefit from exporting what they make cheaper than anyone else • Comparative advantage (David Ricardo) • Nations can gain from specialization, even if they lack an absolute advantage Carbaugh, Chap. 2

  16. International Trade Theories: Mercantilism (1500 – 1750): 1. International trade is a zero-sum game: Static view of world resources: One’s gains = Other’s losses 2. Wealth: Acquisition of precious metals—gold or silver Well-being = Accumulating gold 3. Economic growth =Enhancement of power with strong army, strong navy and merchant marine, and enlargement of foreign colonies.

  17. 4. Productive = maintaining and increasing the power 5. Regulations or restrictions on importable activities 6. Favorable positive trade balance: Exports > Imports  Inflows of specie (gold)  Money supply increases  Stimulates output and employment  Economic growth

  18. Mercantilism : Role of the government and domestic economic policy • Control the use and exchange of precious metals (Bullionism) • High tariffs, quotas on imports of consumption goods • Tax exemptions and subsidies to exports • Allows trade monopolies and monopsonies • Pursues low wage policies • Encourage large family, providing financial incentives for marriage and stimulate population growth • Emphasis the important of the merchant class

  19. David Hume (1752): Price-Specie-Flow Mechanism Accumulate specie with internal automatic repercussions. Assumptions: 1. Link between money and price: MV = PV; Full employment; Fixed velocity of money 2. Demand for trade goods is price elastic: Stable equilibrium in trade sector. 3. Perfect competition: product and factor markets Link between prices and wages (W). 4. Gold standard exists: Gold is directly linked to money and specie.

  20. Price-Specie-flow Mechanism: Trade surplus vis-à-vis Trade Deficit Country A Country B

  21. Adam Smith (1723 – 1790) Laissez faire and free trade is a positive-sum game: Nation’s wealth  production capacity not holdings of gold Economic growth  free environment and self-interest and competition Productivity gains  division of labor and specialization of labor Mutual beneficial  exchange and free trade

  22. 2 Foundations of modern trade theory

  23. Historical development of trade theory Foundations of trade theory • Mercantilism • positive trade balance • Absolute advantage (Adam Smith) • Countries benefit from exporting what they make cheaper than anyone else • Comparative advantage (David Ricardo) • Nations can gain from specialization, even if they lack an absolute advantage Carbaugh, Chap. 2

  24. Comparative advantage Absolute & Comparative Advantage Absolute advantage: each nation is more efficient in producing one good Output per labor hour Nation WineCloth United States 5 bottles 20 yards United Kingdom 15 bottles 8 yards Comparative advantage: the US has an absolute advantage in both goods Output per labor hour Nation WineCloth United States 40 bottles 40 yards United Kingdom 20 bottles 10 yards Carbaugh, Chap. 2

  25. Comparative advantage Ricardo’s Comparative Advantage in money prices Cloth (yards) Wine (bottles) Nation LaborWage Quant. Price Quant. Price US 1 hr $20/hr 40 $0.50 40 $0.50 UK 1 hr £5/hr 10 £0.50 20 £0.25 UK 1 hr $8 10 $0.80 20 $0.40 (at $1.6 = £1) Carbaugh, Chap. 2

  26. Transformation schedules Comparative advantage • Generalizes theory to include all factors, not just labor • Shows combinations of products that can be made if all factors are used efficiently • Slope, or marginal rate of transformation, shows the opportunity cost of making more of one good (how much of one good must be given up to make more of another) Carbaugh, Chap. 2

  27. Comparative advantage Marginal Rate of Transformation A Slope = MRT = 0.5 B Wheat C Carbaugh, Chap. 2

  28. Comparative advantage Transformation schedules: constant opportunity costs Slope = 2.0 = MRT Wheat Wheat Slope = 0.5 = MRT Carbaugh, Chap. 2

  29. Comparative advantage Supply schedules: constant opportunity costs SCanada SUS SUS Bushels of wheat per auto Autos per bushel of wheat SCanada Carbaugh, Chap. 2

  30. Comparative advantage Trading under constant opportunity costs Trading possibilities line (terms of trade 1:1) B’ Trading possibilities line (terms of trade 1:1) D’ C’ E Wheat Wheat A’ C A F B D Carbaugh, Chap. 2

  31. Comparative advantage Production gains from specialization: constant opportunity costs Before After Net Gain Specialization Specialization (Loss) AutosWheat AutosWheatAutosWheat US 40 40 120 0 80 -40 Canada 40 80 0 160 -40 80 World 80 120 120 160 40 40 Carbaugh, Chap. 2

  32. Comparative advantage Consumption gains from trade: constant opportunity costs Before After Net Gain Specialization Specialization (Loss) AutosWheat AutosWheatAutosWheat US 40 40 60 60 20 20 Canada 40 80 60 100 20 20 World 80 120 120 160 40 40 Carbaugh, Chap. 2

  33. Comparative advantage Complete specialization under constant opportunity costs SCanada SUS Aw Aa’ SUS Bushels of wheat per auto Autos per bushel of wheat SCanada Aw’ Aa Carbaugh, Chap. 2

  34. Comparative advantage Changing comparative advantage MRT = 0.67 Autos Autos MRT = 0.5 Carbaugh, Chap. 2

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