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Summary Macro Economics: International Trade (CH24)
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Chapter 24: International Trade. 24.1-24.3
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Chapter 24: International TradeT HE GROWT H O F WO RL D T RADE
World trade has grown rapidly over the past 60 years and at consistently higher rates than world GDP.
Developed economies have dominated world trade. Many of the countries with the most rapid growth in
exports can be found in the developing world. The growth in exports from the group of developing
nations collectively known as the BRICS (Brazil, Russia, India, China and South Africa) has been especially
rapid.
S PEC IAL I SAT ION AS THE B AS IS FO R T RADE
The reasons for international trade are really only an extension of the reasons for trade within a nation.
Rather than people trying to be self-sufficient and do every- thing for themselves, it makes sense to
specialise.
Firms specialise in producing certain goods. This allows them to gain economies of scale and to exploit
their entrepreneurial and management skills and the skills of their labour force. It also allows them to
benefit from their particular location and from the ownership of any particular capital equipment or
other assets they might possess. With
the revenues firms earn, they buy in the inputs they need from other firms and the labour they require.
Firms thus trade with each other.
Countries also specialise. They produce more than they need of certain goods. What is not consumed
domestically is exported. The revenues earned from the exports are used to import goods that are not
produced in sufficient amounts at home.
It should specialise in those goods in which it has a comparative advantage.
T HE L AW O F COM PARAT I V E ADVANT AGE
Countries have different endowments of factors of production. They differ in population density, labour
skills, climate, raw materials, capital equipment, etc. These differences tend to persist because factors
are relatively immobile between countries. Obviously land and climate are totally immobile, but even
with labour and capital there are more restrictions on their international movement than on their
movement within countries. Thus the ability to supply goods differs between countries.
What this means is that the relative cost of producing goods varies from country to country.
We need to distinguish between absolute advantage and comparative advantage.
Absolute advantage
Absolute advantage = A country has an absolute advantage over another in the production of a good if it
can produce it with less resources than the other country.
Comparative advantage
The above seems obvious, but trade between two countries can still be beneficial even if one country
could produce all goods with less resources than the other, providing the relative efficiency with which
goods can be produced differs between the two countries.
Comparative advantage = A country has a comparative advantage over another in the production of a
good if it can produce it at a lower opportunity cost: i.e. if it has to forgo less of other goods in order to
produce it.
, Countries have a comparative advantage in those goods that can be produced at a lower opportunity cost
than in other countries.
If countries are to gain from trade, they should export those goods in which they have a comparative
advantage and import those goods in which they have a comparative disadvantage.
Law of comparative advantage = Trade can benefit all countries if they specialise in the goods in which
they have a comparative advantage.
T HE GAI NS F ROM T RADE B ASED O N COMPA RAT I VE ADVANT AGE
Before trade, unless markets are very imperfect, the prices of the two goods are likely to reflect their
opportunity costs.
The actual exchange ratios will depend on the relative prices of wheat and cloth after trade takes place.
These prices will depend on total demand for and supply of the two goods. It may be that the trade
exchange ratio is nearer to the pre-trade exchange ratio of one country than the other. Thus the gains to
the two countries need not be equal.
Simple graphical analysis of comparative advantage and the gains from trade: constant
opportunity cost
The gains from trade can be shown graphically using production possibility curves.
The blue lines illustrate the various total combinations of the two goods that can be produced and hence
consumed.
An exchange ratio of 1:1 means that the two countries can now consume along the red lines.
See page 712 for example.
Before trade, the countries could only consume along their production possibility curves (the blue lines);
after trade, they can consume along the higher red lines.
Note that in this simple two-country model total production and consumption of the two countries for
each of the two goods must be the same, since one country’s exports are the other’s imports.
I NT ERNAT IO NAL T RADE AN D I T S EF F ECT ON F A C TO R PRI C ES
Countries tend to have a comparative advantage in goods that are intensive in their abundant factor.
South Asian countries have abundant supplies of labour with low wage rates, and hence specialise in
clothing and other labour-intensive goods. Europe, Japan and the USA have relatively abundant and
cheap capital, and hence specialise in capital-intensive manufactured goods.
Trade between such countries will tend to lead to greater equality in factor price.
I NCREASIN G O PPO RTUN I T Y COS TS AND T HE LI MI T S TO SPEC IAL I SATI ON AND T RADE
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