HKCEE Macroeconomics

1. HKCEE Macroeconomics Chapter 7:International Trade CH7-International Trade-SV

2. Why do Countries Trade? self-sufficiency cannot be achieved • cheaper products could be enjoyed • raising standard of living by enjoying a larger variety of products CH7-International Trade-SV

3. The Model of Absolute Advantage Absolute Advantage (AA) • allows a country to produce more of a good with the same amount of resources • allows a country to produce the same amount of a good with less resource CH7-International Trade-SV

4. The Model of Absolute Advantage An Illustration • AA in producing good A: • AA in producing good B: Country X Country Y CH7-International Trade-SV

5. The Model of Absolute Advantage Task 1：Study the table below and find out which country has the AA in producing goods A and B. CH7-International Trade-SV

6. The Model of Absolute Advantage Task2：Study the table below and find out which country has the AA in producing goods A and B. CH7-International Trade-SV

7. The Model of Absolute Advantage The Principle of Absolute Advantage • It states that countries should specialize in producing goods with absolute advantage. • They would then gain if they follow the principle to trade with other countries • Limitation: Trade would not occur if countries enjoy NO absolute advantage in production. CH7-International Trade-SV

8. The Model of Comparative Advantage Comparative Advantage (CA) • A country is said to have a comparative advantage in producing a good over others if it can produce the good at a lower opportunity cost than other countries. CH7-International Trade-SV

9. The Model of Comparative Advantage An Illustration CH7-International Trade-SV

10. The Model of Comparative Advantage An Illustration CH7-International Trade-SV

11. The Model of Comparative Advantage Task3：Study the table below and find out which country has the CA in producing goods A and B. CH7-International Trade-SV

12. The Model of Comparative Advantage Task3：Study the table below and find out which country has the CA in producing goods A and B. Opportunity cost of producing 1 unit of … 1B/6 = 0.17B 2B/4 = 0.5B 6A/1 = 6A 4A/2 = 2A CH7-International Trade-SV

13. The Model of Comparative Advantage Task4：Study the table below and find out which country has the CA in producing goods A and B. CH7-International Trade-SV

14. The Model of Comparative Advantage Task4：Study the table below and find out which country has the CA in producing goods A and B. Opportunity cost of producing 1 unit of … 2/10B = 0.2B 3/9B = 0.3B 10/2A = 5A 9/3A = 3A CH7-International Trade-SV

15. The Model of Comparative Advantage The Law/Principle of Comparative Advantage • It states that countries should specialize in producing goods with comparative advantage. • Total output will be increased by engaging specialization in production. • They then would gain if they follow the principle to trade with other countries CH7-International Trade-SV

16. The Model of Comparative Advantage An Illustration There are two countries only Each country has 2 man-hours Each country produces 2 goods only No country could live on one good only Without international trade, each country is under self-sufficient CH7-International Trade-SV

17. The Model of Comparative Advantage Given: CH7-International Trade-SV

18. The Model of Comparative Advantage Under Self-sufficient Assume each country devotes equal amount of resources (i.e. 1 man-hour) to produce both goods. Total Output 11 AND 15 CH7-International Trade-SV

19. The Model of Comparative Advantage After Specialization Country X spends 0.5 man-hour in producing good A and 1.5 man-hours on good B. Country Y spends all 2 man-hours in producing good A. CH7-International Trade-SV

20. The Model of Comparative Advantage After Specialization 13 18 11 15 +2 +3 CH7-International Trade-SV

21. Terms of Trade and Gains from Trade Terms of Trade (TOT) • TOT refers to the amount of goods that a nation must export for one unit of a good that she imports. • TOT = ?X:1M • TOT should be mutually beneficial to trading partners. • TOT should be setin-betweenthe opportunity costs of trading partners. CH7-International Trade-SV

22. Find both countries’ O.C. in their productions from the table below. Terms of Trade and Gains from Trade CH7-International Trade-SV

23. Terms of Trade and Gains from Trade Finding the beneficial TOT: Opportunity Cost of producing 1 unit of … Good A Good B Country X (12B/6=)2B or (6A/12=)0.5A Country Y (3B/5=)0.6B or (5A/3=)1.67A • Mutually beneficial TOT: Good A: 0.6B-2B Good B: 0.5A-1.7A CH7-International Trade-SV

24. Terms of Trade and Gains from Trade Gains from Trade to Importing Country • Unit Gains from Trade = Domestic O. C. (saved) - TOT • Total Gains from Trade = Unit Gains x Amount Imported CH7-International Trade-SV

25. Terms of Trade and Gains from Trade Gains from Trade to Exporting Country • Units Gains from Trade = TOT - Domestic O. C. • Total Gains from Trade = Unit Gains x Amount Exported CH7-International Trade-SV

26. Terms of Trade and Gains from Trade Task 5a: Find the opportunity cost of both countries in producing goods A and B. Given: • Output/1 man-hour: Country X: 6A or 12B • Output/1 man-hour: Country Y: 5A or 3B • Each country has 2 man-hours only • Complete specialization • Country X exports 5B CH7-International Trade-SV

27. Terms of Trade and Gains from Trade The opportunity cost of both countries in producing goods A & B are below: Opportunity Cost of producing 1 unit of … Good A Good B Country X (12B/6=)2B or (6A/12=)0.5A Country Y (3B/5=)0.6B or (5A/3=)1.67A CH7-International Trade-SV

28. Terms of Trade and Gains from Trade • Task 5b: Find the gains from trade for both countries if the TOT is (a) 1A:1B (b) 1A:2B (c) 2A:1.2B CH7-International Trade-SV

29. Terms of Trade and Gains from Trade (a) When TOT = 1A:1B • Unit Gains from Trade to Importing country, Y = Domestic O. C. (saved) - TOT = 1.67A - 1A = 0.67A (saved) • Unit Gains from Trade to Exporting country, X = TOT - Domestic O. C. = 1A - 0.5A = 0.5A CH7-International Trade-SV

30. Terms of Trade and Gains from Trade (a) When TOT = 1A:1B • Total Gains from Trade to Importing country, Y = Unit Gains x Amount Imported = 0.67A(5) = 3.35A (saved) • Total Gains from Trade to Exporting country, X = Unit Gain x Amount Exported = 0.5A(5) = 2.5A CH7-International Trade-SV

31. Terms of Trade and Gains from Trade (b) When TOT = 1A:2B ( 1B = 0.5A) • Unit Gains from Trade to Importing country, Y = Domestic O. C. (saved) - TOT = 1.67A - 0.5A = 1.17A (saved) • Unit Gains from Trade to Exporting country, X = TOT - Domestic O. C. = 0.5A - 0.5A = 0A CH7-International Trade-SV

32. Terms of Trade and Gains from Trade (b) When TOT = 1A:2B( 1B = 0.5A) • Total Gains from Trade to Importing country, Y = Unit Gains x Amount Imported = 1.17A(5) = 5.85A (saved) • Total Gains from Trade to Exporting country, X = Unit Gain x Amount Exported = 0A(5) = 0A CH7-International Trade-SV

33. Terms of Trade and Gains from Trade (c) When TOT = 2A:1.2B( 1B =1.67A) • Unit Gains from Trade to Importing country, Y = Domestic O. C. (saved) - TOT = 1.67A - 1.67A = 0A (saved) • Unit Gains from Trade to Exporting country, X = TOT - Domestic O. C. = 1.67A - 0.5A = 1.17A CH7-International Trade-SV

34. Terms of Trade and Gains from Trade (c) When TOT = 2A:1.2B( 1B =1.67A) • Total Gains from Trade to Importing country, Y = Unit Gains x Amount Imported = 0A(5) = 0A (saved) • Total Gains from Trade to Exporting country, X = Unit Gain x Amount Exported = 1.17A(5) = 5.85A CH7-International Trade-SV

35. Terms of Trade and Gains from Trade Task 6 Referring to your findings in Task 5: • How is the TOT set to allow the importing country capture ALL the gains from trade? • How is the TOT set to allow the exporting country capture ALL the gains from trade? • Is it still beneficial for a country to trade if its gains from trade is zero? CH7-International Trade-SV

36. Terms of Trade and Gains from Trade The importing country will capture ALL the gains from trade if the TOT is set equal to the exporting country’s domestic opportunity cost. • The exporting country will capture ALL the gains from trade if the TOT is set equal to the importing country’s domestic opportunity cost. CH7-International Trade-SV

37. Terms of Trade and Gains from Trade Country with zero gains from trade will still trade for other benefits: • To enjoy goods that it cannot produce. • To enjoy higher standard of living. • To maintain better international relationship. • To improve skills and techniques of production by examining imports CH7-International Trade-SV

38. Terms of Trade and Gains from Trade Task 7 Given: • each country has its own comparative advantage in production • trading parties reach a mutually beneficial terms of trade Question: Must trade take place? Answer:NO CH7-International Trade-SV

39. Factors Affecting Trade Potential trade might be halted if: • the transportation cost outweighs the potential gains from trade. • the other costs of conducting trade (e.g. insurance cost) becomes prohibitively high when serious political problems occur, e.g. wars. CH7-International Trade-SV

40. Free Trade Benefits of Free Trade: • More output could be produced. • Better international relationship • Mass production allows firms to enjoy economies of scale. • Exchange of technology is allowed. • Standard of living is higher with a larger variety of cheaper imports. • More employment opportunities CH7-International Trade-SV

41. Free Trade • Promotion of Free Trade: • World Trade Organization, WTO: reducing trade barriers • Generalized Schemes of Preference, GSP: low/no tariffs to developing countries • Asia-Pacific Economic Cooperation, APEC: promoting free trade & economic cooperation • North America Free Trade Agreement, NAFTA: promoting tariff-free trade CH7-International Trade-SV

42. Trade Restrictions(1) • Tariffs • Tariffs are taxes on imports. • Tariffs can be per-unit tax or ad valorem tax (i.e. percentage tax). • Effects of Tariffs on Imports • Cost of production increases • Supply of imports decreases • Import price increases • Quantity imported/transacted falls CH7-International Trade-SV

43. P S2 S1 D tax P2 P1 Q 0 Q1 Q2 Trade Restrictions(1) • Effects of Tariffs on Imports CH7-International Trade-SV

44. Trade Restrictions(2) • Import Quota • Import quota fixes the maximum amount or value of imports during a given period. • Effects of Import Quotas on Imports • Supply of imports decreases • Quantity imported/transacted falls • Import price increases • Kinked Supply curve resulted CH7-International Trade-SV

45. Quota P S2 S1 D P2 P1 Q 0 Q1 Q2 Trade Restrictions(2) • Effects of Quota on Imports CH7-International Trade-SV

46. Trade Restrictions • Comparison Between Tariffs & Quota CH7-International Trade-SV

47. Trade Restrictions (3) • Subsidies to Local Goods • A sum of money provided by the government for local production • Effects: • Lower cost allows larger local supply • Local product prices fall leading to more local products demanded • Demand for imports falls and thus fewer products being imported CH7-International Trade-SV

48. Trade Restrictions (4) • Embargo • A ban on imports • Total embargo versus partial embargo • It is imposed for political reasons CH7-International Trade-SV

49. Trade Restrictions (5) • Exchange Control • A government control on the buying and selling of foreign currencies • Imports will be reduced by limiting the amount of foreign currencies available CH7-International Trade-SV

50. Trade Restrictions (6) • Voluntary Export Restriction • The exporting countries themselves restrict their exports to some other countries • Imports to Country A will then be reduced if Country B restricts her exports voluntarily. CH7-International Trade-SV