International Business Environment
Summary
Chapter 2-12, 14
Demand and supply
Demand
- Consumers want to get as much utility as possible by spending its limited income.
- Taste, preferences, opinions, price, income.
- Elasticity: measure of responsiveness.
- Price elasticity of demand: percent change in quantity demanded resulting from a 1%
change in price.
Consumer surplus
- Consumer surplus: the difference between the value that consumers place on the product
and the payment that they must make to buy the product.
Supply
- A firm supplies the product because it is trying to earn a profit on its activities.
- Price, cost of production and selling.
- The cost of producing another input depends on the resources or inputs needed to produce
the extra unit and the prices that have to be paid for these inputs.
- Price elasticity of supply: percent change in quantity supplied resulting from a 1% change in
market price.
Producer surplus
- Opportunity cost: the value of other goods and services that are not produced because
resources are instead used to produce this product.
- Producer surplus: difference between revenues received and costs incurred.
A national market with no trade
- If there is no trade, equilibrium occurs at the price at which the market clears domestically,
with national quantity demanded equal to national quantity supplied.
Two national markets and the opening of trade
- Arbitrage: buying something in one market and reselling the same thing in another market
to profit from a price difference.
Free-trade equilibrium
- International / world price: free-trade equilibrium.
- Demand for imports: excess demand within the national market.
- Supply of exports: excess supply.
Effects in the importing country
- Effects on consumers and producers:
o For the importing country, the shift to free trade lowers the market price.
- Net national gains:
o We cannot compare the welfare effects on different groups without imposing our
subjective weights to the economic stakes of each group.
o One-dollar, one-vote metric: each dollar of gain or loss is valued equally, regardless
of who experiences it.
1
, o Net national gains from trade: difference between what one group gains and what
the other group loses.
Effects in the exporting country
- For the exporting country, the shift to free trade increases the market price.
Which country gains more?
- The gains from opening trade are divided in direct proportion to the price changes that trade
brings to the two sides. If a nation’s price changes x percent and the price in the rest of the
natio n' s gain x
world changes y percent, then = .
rest of worl d s gain y
'
- The side with the less elastic (steeper) trade curve gains more.
Answers to the four trade questions
1. Why do countries trade?
- Trade begins as someone conducts arbitrage to earn profits from the price difference
between previously separated markets. A product will be exported from countries where its
price was lower to countries where its price was higher.
2. How does trade affect production and consumption in each country?
- Product price is changed from its no-trade value to the free-trade equilibrium international
price or world price. The price change in each country results in changes in quantities
consumed and produced. In the country importing the product, trade raises the quantity
consumed and lowers the quantity produced of that product. In the exporting country, trade
raises the quantity produced and lowers the quantity consumed of the product.
3. Which country gains from trade?
- If we use the one-dollar, one-vote metric, they both do. Each country’s net national gains
from trade are proportional to the change in its price that occurs in the shift from no trade
to free trade. Country whose prices are disrupted more, gains more.
4. Within each country, who are the gainers and losers from opening trade?
- The gainers are the consumers of imported products and the producers of exported
products. The losers are the products of import-competing products and the consumers of
exported products.
Chapter 3
Adam Smith’s theory of absolute advantage
- Labor productivity: the number of units of output that a worker can produce in one hour.
- Absolute advantage: being more productive in producing a product.
Ricardo’s theory of comparative advantage
- Opportunity cost of producing more of a product: the amount of production of the other
product that is given up.
- Principle of comparative advantage: a country will export the goods and services that it
would otherwise produce at a high opportunity cost.
- Relative price: the ratio of one product price to another product price.
- How do absolute and comparative advantage relate to each other?
o Smith’s example of each country having an absolute advantage in one product is
also a case of comparative advantage.
o Comparative advantage is more general and powerful.
- Having an absolute advantage in all products means that the country is less productive than
other countries; low real wages, poor countries.
2
, Ricardo’s constant costs and the production-possibility curve
- Production-possibility curve (ppc): shows all combinations of amounts of different products
that an economy can produce with full employment of its resources and maximum feasible
productivity of these resources.
Chapter 4
Production with increasing marginal costs
- Increasing marginal costs: as one industry expands at the expense of others, increasing
amounts of the other product must be given up to get each extra unit of the expanding
industry’s product.
- The ppc is bowed out with increasing marginal costs.
What’s behind the bowed-out production-possibility curve?
- There are several kinds of factor inputs, and different products use factor inputs in different
proportions.
- Law of diminishing returns: adding so much labor to slowly changing amounts of land causes
the gains in wheat production to decline as more and more resources are released from
cloth production.
What production combination is actually chosen?
- If the opportunity cost of producing another unit of cloth is less than the 2W/C that you can
sell it for, then try to make more cloth.
- If the opportunity cost of producing another unit of cloth is more than the 2W/C that you
can sell it for, then make less cloth.
- If the opportunity cost of producing another unit of cloth is equal to the 2W/C that you can
sell it for, then you are producing the right amount.
Community indifference curves
- Indifference curve: shows the various combinations of consumption quantities that lead to
the same level of well-being or happiness.
- The actual consumption point chosen by the individual depends on the budget constraint
facing the person: Y = (PW)(QW) + (PC)(QC).
- Community indifference curves: show how the economic well-being of a whole group
depends on the whole group’s consumption of products.
- Economic theory raises difficult questions about community indifference curves:
o Shapes of individual indifference curves differ from person to person.
o Concept of national well-being or welfare is not well defined.
Production and consumption together
Without trade
- With no trade, a country must be self-sufficient and must find the combination of
domestically produced wheat and cloth that will maximize community well-being.
With trade
- The export-import quantities in each country can be summarized by the trade triangles that
show these quantities.
Demand and supply curves again
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