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Economics

Economics. Chapter 8 International trade. International trade. Trade: Exchange of goods and services International trade: Exchange of goods and services between countries or regions. Example 1. USA and China USA sells computer to China China sells garment to USA 2. HK and other regions

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Economics

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  1. Economics Chapter 8 International trade

  2. International trade Trade: • Exchange of goods and services International trade: • Exchange of goods and services between countries or regions. • Example 1. USA and China • USA sells computer to China • China sells garment to USA 2. HK and other regions • exports electronics goods • Imports rice and cars

  3. International trade Terms of trade: • International price • The quantity of imported goods that can be exchanged for one unit of exported goods. • Terms of trade = • Terms of trade index =

  4. International trade Terms of trade: • Given that: • Country A exports rice ($10 per unit) to Country B. • Country A imports garments ($5 per unit) from Country B. • Terms of trade = = = 2 • Meaning that for Country A, sales of 1 unit of rice can be used to buy 2 units of garments • Note that form Country B, terms of trade is the reciprocal of that fro Country A, i.e.

  5. International trade Assume trading among 2 countries only, calculate terms of trade in the following cases 1. A exports watches ($180 each) to B B exports T-shirts ($60 each) to A (i.e. A imports) Terms of trade for A = = 3 2. C exports seafood ($135 each) to D D exports camera ($1080 each) to C Terms of trade for C = = = 0.125 3.E exports TV ($1500 each) to F F exports furniture ($1500 each) to E Terms of trade for E= = 1

  6. Mutual benefits Why trading? • Mutual benefits • Free trade benefits both buyers and sellers. • Exporting country will gain from Px> Production cost, PX > PL • Importing country will gain from PM < Production cost, PM < PL

  7. Absolute advantage Definition • Adam Smith • If acountry can produce more Good X than other countries by using the same amount of resources, then this country has an absolute advantage in producing Good X. • Given the same input of resources: •  China has an absolute advantage in producing Good X • Conversely, USAhas an absolute disadvantage.

  8. Absolute advantage • Comparison of same goods among countries. • Determined by productivity. • Technologically advanced  higher productivity in all good  absolute advantage • Conversely, low level technology  low productivity  absolute disadvantage

  9. Absolute advantage Each unit of resources can produce: ∵ Compare the same goods among countries

  10. Case study: Absolute advantage Suppose Japan and USA both have 2,000 units of resources. They use half of their resource (1,000 units) to produce food and clothes on their own.

  11. Case study: Absolute advantage Each unit of resources can produce: For each unit of resources • USA produce more food than Japan  USA has absolute advantage on food  Japan has absolute disadvantage on food • Japan produce more clothes than USA Japan has absolute advantage on clothes  USA has absolute disadvantage on clothes

  12. Case study: Absolute advantage Suppose Japan and USA specialize on producing goodswith absolute advantages, i.e. USA uses all the resources to produce food. Japan uses all the resources to produce clothes. Total output of food and clothes 

  13. Case study: Absolute advantage Suppose USA exchanges 4,500 units of food for 7,000 units of clothes with Japan. After international trade: Compare with the output before trade:

  14. Case study: Absolute advantage Assume that • Free trade • No transaction cost Through international trade • USA gains Japan gains • 500 units of food  500 units of food • 1,000 units of clothes  1,000 units of clothes • Total output •  1,000 units of food •  2,000 units of clothes Conclusion • Specialize in production of goods with absolute advantage • Through international trade • Mutual benefits

  15. Comparative advantage Definition • David Ricardo • Acountry can produce Good X at a lower opportunity cost than other countries. Limitation of the principle of absolute advantage • A technologically advanced country  Absolute advantage in all goods  Why import??? • E.g. • Japan has high level of technology • Absolute advantage in all goods, but still imports from other countries

  16. Comparative advantage Each unit of resources can produce: Country A has absolute advantage in both Good X and Y.

  17. Comparative advantage With same unit of resources Looking at the opportunity cost in Country A: • To produce 50 units of Good X  give up producing 25 units of Good Y • Opportunity cost of producing 1X = Y = 0.5Y • To produce 25 units of Good Y  give up producing 50 units of Good X • Opportunity cost of producing 1Y = X = 2X

  18. Comparative advantage Convert the table to show the opportunity cost:

  19. Comparative advantage • Country A has a lower opportunity cost in producing Good Y. Country A has comparative advantage in Good Y. • Country B has lower opportunity cost in producing Good X. Country B has comparative advantage in Good X. • No country can have a comparative advantage in all goods. • Low opportunity cost in Good X  High opportunity cost in Good Y

  20. Comparative advantage Textbook p.36 Each unit of resources can produce:

  21. Comparative advantage Each unit of resources can produce: ∵ Compare the same goods among countries

  22. Absolute advantage & Comparative advantage • Absolute advantage: • A country with high productivity (usu.  technology) • Can be all types of goods • Comparative advantage • A country with lower costs in producing a certain kind of goods • Comparatively a certain kinds of goods only

  23. Principle of comparative advantage • If a country • specializes in and exports goods in which it has a comparative advantage, and • imports goods in which it has comparative disadvantage, the world’s total output will increase and both countries will benefit.

  24. Principle of comparative advantage • Assumptions • Only 2 countries, Country A and Country B • Only 2 types of goods, Goods X and Goods Y • Amount of goods produced by each unit of resources is fixed • Barter system (exchange of goods) • No transaction cost

  25. Comparative advantage Lower costB should produce Good X Lower costA should produce Good Y

  26. Principle of comparative advantage • Therefore, after specialization:

  27. Comparative advantage After specialization (Good X)

  28. Comparative advantage After specialization (Good Y)

  29. Potential gain from trade Potential gain (highest possible gain) • Gain before deducting the cost (transaction cost) of trade, such as transportation costs • If transaction cost is involved, Actual gain < Potential gain

  30. Potential gain from trade After specialization (Good X) • Cost saved by Country A = 0.5Y • Cost paid by Country B = 0.2Y • World Total cost saving = 0.3Y • Total increase in output = World total cost saving = 0.3Y

  31. Potential gain from trade From the example: • Countries specialize in producing goods with lower opportunity cost • International trade is mutually beneficial to 2 countries • Potential gain form trade = Cost difference between 2 countries = 0.3Y • Next questions: • Which country gains more? • Is the gain evenly distributed among 2 countries?

  32. Terms of trade determine the distribution of gains Before trade: Suppose the terms of trade: 1X = 0.4Y Trade. Total gain is shared by Country A (0.1Y) & B (0.2Y)

  33. Terms of trade determine the distribution of gains Before trade: Suppose the terms of trade: 1X = 0.3Y Trade. Total gain is shared by Country A (0.2Y) & B (0.1Y)

  34. Terms of trade determine the distribution of gains Before trade: Suppose the terms of trade: 1X = 0.1Y No trade. Country B will lose if trading.

  35. Case study (textbook p.39) Given the domestic costs: • Country A: 1Y = 2X and Country B: 1Y = 5X • Country A exports Good Y, because opportunity cost is lower. • Conversely, Country B exports Good X. Mutual benefits

  36. Case study (textbook p.39) Conclusion • Mutual benefits • Cost of importers > Terms of trade > Cost of exporters • If term of trade = Cost of importer • Importer’s gain = 0 • Exporter’s gain = max. (i.e. potential gain) • If term of trade = Cost of exporter • Importer’s gain = max. (i.e. potential gain) • Exporter’s gain = 0 • If term of trade > cost of importer or term of trade < cost of exporter • No trade • Determination of term of trade • Depends on the bargaining power of the countries • E.g. Bilateral trade negotiations bet. USA and China

  37. Conditions for mutually beneficial trade • Each party has a comparative advantage • Different opportunity costs in producing different goods • Mutual beneficial terms of trade • Terms of trade lies between domestic costs of both parties • Cost of importer > Terms of trade > Cost of exporter • Reasonable cost of trade • Low transaction cost • Transportation • Negotiation • Trade protection policies

  38. Advantages of international trade Social development • Exchange of products • Native products • E.g. teapots, art-crafts • Cultural interflow • Cultural exchange during communication and negotiation • E.g. Western businessmen learn Chinese culture

  39. Advantages of international trade Economical aspect • Comparative advantage • Lower cost • Specialization • More experience and knowledge • Better use of technology • Economies of scales • Specialization allows increasing scale of production • Thus, lower average cost • Technological interflow • Trade enhance technological interflow • Higher productivity • Enhancement of competition • Higher quality of domestic products • Lower cost to produce domestic products with advanced technology

  40. The effects of exchange rate on international trade Think about this: A Japanese car costs ¥1,500,000 Assume the exchange rate is HKD1 = JPY10 How much should a HK citizen pay for this car in terms of HKD? • HK$ 1 can be converted into JP¥ 10 •  The car costs HK$1,500,000 / 10 = HK$150,000 If HKD depreciates against JPY, what do you think about the price of the car in terms of HKD? • If the exchange rate is now HKD1=JPY9, • The car costs HK$1,500,000 / 9 = HK$166,666.67 The same car, but the price . • HK people suffer.

  41. The effects of exchange rate on international trade Think about this: Assume you have no special preference towards rice from different countries. If • HKD depreciates against AUD, and • HKD appreciates against THB (Thai Baht). Which one will you choose? Why?

  42. Depreciation and exports Suppose garments are exported to Europe. Price of garment made in HK = HK$100 Exchange rate: HK$100 = €11 Export price = €11 HKD depreciation: Exchange rate: HK$100 = €10 Local price = HK$100 Export price = €10 Price   Qd(Law of demand) That is, quantity demanded of HK garment export increases. P(€) HK garments 11 10 Export volume 0 Q1 Q2

  43. Appreciation and exports Suppose garments are exported to Europe. Price of garment made in HK = HK$100 Exchange rate: HK$100 = €11 Export price = €11 HKD appreciation: Exchange rate: HK$100 = €12 Local price = HK$100 Export price = $100 = €12 Price  Qd(Law of demand) That is, quantity demanded of HK garment export decreases. P(€) HK garments 12 11 Export volume 0 Q2 Q1

  44. Depreciation and imports Suppose watches are imported from Europe. Price of European watch = €110 Exchange rate: HK$100 = €11 Import price = HK$1000 HKD depreciation: Exchange rate: HK$100 = €10 Import price = $110 x (100/10) = HK$1100 Price   Qd(Law of demand) That is, quantity demanded of European watches import decreases. P($) European watches 1100 1000 Import volume 0 Q2 Q1

  45. Appreciation and imports Suppose watches are imported from Europe. Price of European watch = €110 Exchange rate: HK$100 = €11 Import price = HK$1000 HKD appreciation: Exchange rate: HK$100 = €12 Import price = $110 x (100/12) = HK$916.7 Price  Qd(Law of demand) That is, quantity demanded of European watches import increases. P($) European watches 1000 916.7 Import volume 0 Q1 Q2

  46. The effects of exchange rate on international trade Summary Case study in textbook p.46: Change in revenue which is brought be depreciation or appreciation depends on the price elasticity of demand. Try yourself!!!

  47. Trade in Hong Kong Merchandise trade (Goods) • Exports • Garments • Electronic products • Toys • Jewellery (accounted for more than 60% of total domestic exports in 2008)

  48. Trade in Hong Kong Merchandise trade (Goods) • Retained imports • Raw materials (e.g. gold, silver) • Semi-finished goods (e.g. LCD display, plastic button) • Capital goods (e.g. truck, machine) • Consumption goods (e.g. clothes, TV) • Fuel • Food (accounted for more than 99% of total retained imports in 2008)

  49. Trade in Hong Kong Trade in services • Exports of services (Exports have higher value than imports) • Financial consultation • Commerce • Accounting • Transportation • Entertainment • Imports of services (Imports have higher value than exports) • Tourism • Insurance

  50. Trade in Hong Kong Major trading partners Value of goods High Low

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