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Lecture International trade and investment (2/e): Chapter 3 - John Gionea

Chapter 3 - International trade theory. This chapter examines the development of international trade theory from the seventeenth century through the second half of the twentieth century. The main goals of this chapter are to: Outline and critically evaluate the major theories that attempt to explain why nations should engage in international trade and the patterns of international trade; show, via simple examples, the case for free trade and how all countries can benefit from free trade;. | Chapter 3 International trade theory 3– Lecture plan Mercantilism Absolute advantage Comparative advantage Comparative advantage versus competitive advantage Factor endowments The new trade theory Porter’s diamond 3– Mercantilism: mid-16th century A nation’s wealth depends on accumulation of precious metals (e.g. holdings of gold and silver). Theory says you should have a trade surplus – maximise exports through subsidies – minimise imports through tariffs and quotas. David Hume (1752): persistent trade surplus will affect money supply and in the long run close the trade surplus. Key problem: ‘zero-sum game’. 3– Theories of international trade: absolute advantage Exporting country holds superiority in availability of certain goods. Reasons: – climate, quality of land, and natural resources – differences in labour, capital, technology and – entrepreneurship Beef Computer Printers (tonnes) (units) Australia 800 200 Japan 400 500 • Australia has an absolute advantage in beef, while Japan has an absolute advantage in printers. 3– Theory of competitive advantage David Ricardo (1817) One country has a comparative advantage over another in the production of a certain commodity if its opportunity cost of producing that commodity is lower. 3– Alternative production possibilities from 100 units of resources Source: Table 3.2 3– Opportunity cost and comparative advantage Source: Table 3.3 3– Diversified production before trade production/consumption Source: adapted from Table 3.4 3– Theory of comparative advantage and the gains from trade Production and Consumption without Trade Cheese (tonnes) Cloth (bolts) Australia 125 60 UK 40 60 Total production 165 120 Production with Trade Specialisation Australia 200 - UK - 120 Total production 200 120 Consumption after UK trades 60 bolts of cloth for 60 tons of Australian cheese Australia 140 60 UK 60 60 Total consumption 200 120 Increase in consumption as a result of specialisation and trade . | Chapter 3 International trade theory 3– Lecture plan Mercantilism Absolute advantage Comparative advantage Comparative advantage versus competitive advantage Factor endowments The new trade theory Porter’s diamond 3– Mercantilism: mid-16th century A nation’s wealth depends on accumulation of precious metals (e.g. holdings of gold and silver). Theory says you should have a trade surplus – maximise exports through subsidies – minimise imports through tariffs and quotas. David Hume (1752): persistent trade surplus will affect money supply and in the long run close the trade surplus. Key problem: ‘zero-sum game’. 3– Theories of international trade: absolute advantage Exporting country holds superiority in availability of certain goods. Reasons: – climate, quality of land, and natural resources – differences in labour, capital, technology and – entrepreneurship Beef Computer Printers (tonnes) (units) Australia 800 200 Japan 400 500 • Australia has an absolute advantage in .