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1. INTRODUCTION
International trade enhances economic growth by
increasing the efficiency of the allocation of resources,
providing larger capital and product markets,
assisting specialization based on comparative advantages, and
increasing the efficiency of the flow of capital among countries.
2. INTERNATIONAL TRADE
We can measure aggregate output of a country by using the gross national
product (GNP) or the gross domestic product (GDP), which differ with
respect to goods and services produced by foreigners and by its citizens
abroad:
Gross national product (GNP)
Add
Subtract
Equals
TERMINOLOGY
Imports are goods and services that a domestic economy purchases from other
countries.
Exports are goods and services that a domestic economy sells to other countries.
The terms of trade is the ratio of the price of exports to the price of imports.
- Increasing terms of trade indicate improvement.
- Decreasing terms of trade indicate deterioration.
Net exports = Exports Imports
- If positive, there is a trade surplus.
- If negative, there is a trade deficit.
A country that does not trade with other countries is referred to as a closed
economy or being in autarky; the price of goods and services is the autarkic price.
An economy that is not closed is an open economy.
- If there are no restrictions to trade, the price of goods and services is the world
price.
Copyright 2014 CFA Institute
TERMINOLOGY
Free trade is the case in which there are no restrictions on a countrys trade
with other countries.
- Trade protections are restrictions on trade that prevent pricing based on
supply and demand.
- Capital restrictions are limits on the flow of funds into or out of a country.
Measure of international trade:
- Trade as a percentage of GDP
- Foreign direct investment (FDI): the amount of the investment by a firm in
one country in the assets in another country.
A multinational corporation (MNC) is a company that operates in more than
one country.
A foreign portfolio investment (FPI) is a short-term investment in foreign
financial instruments.
COSTS
Increased competition
COMPARATIVE ADVANTAGE
An absolute advantage exists if the country is able to produce a good at a
lower cost or use fewer resources.
A comparative advantage exists if the countrys opportunity cost of producing
a good is less than its trading partner.
It is possible to have a comparative advantage while not having an absolute
advantage in producing a good.
The greater the difference between the world price of a good and its autarkic
price, the more potential to gain from trade.
A countrys comparative advantage can change over time.
Comparative
advantage
Absolute
advantage
ADVANTAGES: EXAMPLE
COUNTRY A
COUNTRY B
Assume identical feed and labor supply.
Can produce 5 cows or 25 hogs
Can produce 5 cows or 12 hogs
Relative price for a cow: 5 hogs
Relative price for cow: 2.4 hogs
Relative price for a hog: 0.20 cow
Relative price for a hog: 0.42 cow
Comparative advantage in hogs
Comparative advantage in cows
Absolute advantage in hogs
Specialize in hogs
Specialize in cows
60
Country A
Country B
40
Hogs
20
0
5
Cows
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HECKSCHEROHLIN
Comparative advantages arise from
different endowments of capital and
labor.
Capital and labor are variable factors
of productivity.
Countries trade because of different
relative amounts of capital and labor.
- Efficiency of production matters.
This model allows for income
redistribution between owners and
capital and labor through trade.
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SUMMARY OF EFFECTS
Impact on
Producer surplus
Consumer surplus
Government revenue
Tariff
Import Quota
Export
Subsidy
Importing
country
Importing
country
Exporting
country
Voluntary
Export
Restraint
(VER)
Importing
country
Mixed
+
+
+
+
National welfare
Small country
Large country
Price
Domestic consumption
Domestic production
Trade
Imports
Exports
Copyright 2014 CFA Institute
+
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TRADING BLOCS
A trading bloc is an agreement among countries to work toward eliminating
trade barriers. Trading blocs may be regional (e.g., NAFTA, EU), yet there are
different degrees of integration possible.
Economic union
Coordination of economic
policies among members
Common market
Customs union
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4. BALANCE OF PAYMENTS
The balance of payments is the accounting of the flow of funds into and out of a
country.
DEBITS
Increase in Assets,
Decrease in Liabilities
CREDITS
Decrease in Assets,
Increase in Liabilities
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5. TRADE ORGANIZATIONS
As a result of countries building barriers to international trade in the 1930s and
1940s, international trade fell, along with the standard of living in many
countries.
International trade organizations were created to encourage international trade
and development.
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