Trade

1. Trade Comparative advantage and terms of trade

2. Observations: • World trade grows faster than world production • Real GDP (world) is about 7 times more now than in 1950 • Volume of trade (world) is about 30 times more now than in 1950 • Canada exports (on net) • Fish • Energy • Forestry products • Canada imports (on net) • Machinery and equipment • Automotive products • Canada is a small country, in terms of trade • Does not have much influence on world prices

3. Why trade? • Absolute advantage • Production per unit of time • Canada vs Niger • Comparative advantage • Cost of production • Production possibility frontiers • Canada vs Niger • While it is possible for a country/individual to have no absolute advantage, there is always comparative advantage in something • Comparative, not absolute, advantage determines the gains from trade • World output increases if countries specialize according to their comparative advantage

4. Comparative advantage comes from: • Different factor endowment • Heckscher-Ohlin theory • Countries have comparative advantage in in the production of goods that use intensively the factors of production with which they are abundantly endowed. • Variation: different climates • Variation: human capital • Variation: acquired factors • Acquiring factors that are likely to generate large comparative advantage is becoming a policy objective throughout the world

5. The patterns of trade: • A country will be an exporter if it has a comparative advantage • A small country is facing world prices for the goods/services • The law of one price: if a product is traded freely throughout the world, its prices in different countries must differ by no more than cost of transporting the product between those countries • Think “a single world price” • If a product’s world price exceed the autarky price, the country exports the product • But this means the cost of producing is low for the exporter • Or, in other words, the exported has comparative advantage in producing the product • If a product’s world price is below the autarky price, the country imports the product • But this means the cost of producing is high for the exporter • Or, in other words, the exported has comparative disadvantage in producing the product

6. The terms of trade: • Consider the production possibility frontier again • If a country is an exporter of the product, an increase in the relative price of that product expands consumption possibilities • So we would say that their terms of trade improve/rise • If a country is an importer of the product, an increase in the relative price of that product shrinks consumption possibilities • So we would say that their terms of trade worsen/fall • In practice, there are more than two goods, so we use a set of all exports/imports • Terms of trade = 100 (index of export prices) / (index of import prices)