HKCEE Macroeconomics

1
HKCEE Macroeconomics

• Chapter 7International Trade

2
Why do Countries Trade?

• self-sufficiency cannot be achieved

• cheaper products could be enjoyed

• raising standard of living by enjoying
• a larger variety of products

3
The Model of Absolute Advantage

• Absolute Advantage (AA)

• allows a country to produce more of a good with
  the same amount of resources

• allows a country to produce the same amount of a
  good with less resource

4
The Model of Absolute Advantage

• An Illustration

• AA in producing good A
• AA in producing good B

Country X Country Y
5
The Model of Absolute Advantage

• Task 1Study the table below and find out which
  country has the AA in producing goods A and B.

6
The Model of Absolute Advantage

• Task 2Study the table below and find out which
  country has the AA in producing goods A and B.

7
The Model of Absolute Advantage

• The Principle of Absolute Advantage

• It states that countries should specialize in
  producing goods with absolute advantage.

• They would then gain if they follow the principle
  to trade with other countries

• Limitation Trade would not occur if countries
  enjoy NO absolute advantage in production.

8
The Model of Comparative Advantage

• Comparative Advantage (CA)

• A country is said to have a comparative advantage
  in producing a good over others if it can produce
  the good at a lower opportunity cost than other
  countries.

9
The Model of Comparative Advantage

• An Illustration

10
The Model of Comparative Advantage

• An Illustration

11
The Model of Comparative Advantage

• Task 3Study the table below and find out which
  country has the CA in producing goods A and B.

12
The Model of Comparative Advantage

• Task 3Study the table below and find out which
  country has the CA in producing goods A and B.

Opportunity cost of producing 1 unit of
1B/6 0.17B 2B/4 0.5B
6A/1 6A 4A/2 2A
13
The Model of Comparative Advantage

• Task 4Study the table below and find out which
  country has the CA in producing goods A and B.

14
The Model of Comparative Advantage

• Task 4Study the table below and find out which
  country has the CA in producing goods A and B.

Opportunity cost of producing 1 unit of
2/10B 0.2B 3/9B 0.3B
10/2A 5A 9/3A 3A
15
The Model of Comparative Advantage

• The Law/Principle of Comparative Advantage

• It states that countries should specialize in
  producing goods with comparative advantage.

• Total output will be increased by engaging
  specialization in production.

• They then would gain if they follow the principle
  to trade with other countries

16
The Model of Comparative Advantage

• An Illustration
• There are two countries only
• Each country has 2 man-hours
• Each country produces 2 goods only
• No country could live on one good only
• Without international trade, each country is
  under self-sufficient

17
The Model of Comparative Advantage

• Given

18
The Model of Comparative Advantage

• Under Self-sufficient
• Assume each country devotes equal amount of
  resources (i.e. 1 man-hour) to produce both goods.

Total Output 11 AND 15
19
The Model of Comparative Advantage

• After Specialization
• Country X spends 0.5 man-hour in producing good A
  and 1.5 man-hours on good B.
• Country Y spends all 2 man-hours in producing
  good A.

20
The Model of Comparative Advantage

• After Specialization

13 18
11 15
2 3
21
Terms of Trade and Gains from Trade

• Terms of Trade (TOT)

• TOT refers to the amount of goods that a nation
  must export for one unit of a good that she
  imports.

• TOT ?X1M

• TOT should be mutually beneficial to trading
  partners.

• TOT should be set in-between the opportunity
  costs of trading partners.

22
Terms of Trade and Gains from Trade

• Find both countries O.C. in their productions
  from the table below.

23
Terms of Trade and Gains from Trade

• Finding the beneficial TOT

• Mutually beneficial TOT

Good A 0.6B-2B
Good B
0.5A-1.7A
24
Terms of Trade and Gains from Trade

• Gains from Trade to Importing Country

• Unit Gains from Trade
• Domestic O. C. (saved) - TOT

• Total Gains from Trade
• Unit Gains x Amount Imported

25
Terms of Trade and Gains from Trade

• Gains from Trade to Exporting Country

• Units Gains from Trade
• TOT - Domestic O. C.

• Total Gains from Trade
• Unit Gains x Amount Exported

26
Terms of Trade and Gains from Trade

• Task 5a Find the opportunity cost of both
  countries in producing goods A and B.

• Given
• Output/1 man-hour Country X 6A or 12B
• Output/1 man-hour Country Y 5A or 3B
• Each country has 2 man-hours only
• Complete specialization
• Country X exports 5B

27
Terms of Trade and Gains from Trade

• The opportunity cost of both countries in
  producing goods A B are below

28
Terms of Trade and Gains from Trade

• Task 5b Find the gains from trade for both
  countries if the TOT is
• (a) 1A1B
• (b) 1A2B
• (c) 2A1.2B

29
Terms of Trade and Gains from Trade

• (a) When TOT 1A1B

• Unit Gains from Trade to Importing country, Y
• Domestic O. C. (saved) - TOT
• 1.67A - 1A 0.67A (saved)

• Unit Gains from Trade to Exporting country, X
• TOT - Domestic O. C.
• 1A - 0.5A 0.5A

30
Terms of Trade and Gains from Trade

• (a) When TOT 1A1B

• Total Gains from Trade to Importing country, Y
• Unit Gains x Amount Imported
• 0.67A(5) 3.35A (saved)

• Total Gains from Trade to Exporting country, X
• Unit Gain x Amount Exported
• 0.5A(5) 2.5A

31
Terms of Trade and Gains from Trade

• (b) When TOT 1A2B (? 1B 0.5A)

• Unit Gains from Trade to Importing country, Y
• Domestic O. C. (saved) - TOT
• 1.67A - 0.5A 1.17A (saved)

• Unit Gains from Trade to Exporting country, X
• TOT - Domestic O. C.
• 0.5A - 0.5A 0A

32
Terms of Trade and Gains from Trade

• (b) When TOT 1A2B(? 1B 0.5A)

• Total Gains from Trade to Importing country, Y
• Unit Gains x Amount Imported
• 1.17A(5) 5.85A (saved)

• Total Gains from Trade to Exporting country, X
• Unit Gain x Amount Exported
• 0A(5) 0A

33
Terms of Trade and Gains from Trade

• (c) When TOT 2A1.2B(? 1B 1.67A)

• Unit Gains from Trade to Importing country, Y
• Domestic O. C. (saved) - TOT
• 1.67A - 1.67A 0A (saved)

• Unit Gains from Trade to Exporting country, X
• TOT - Domestic O. C.
• 1.67A - 0.5A 1.17A

34
Terms of Trade and Gains from Trade

• (c) When TOT 2A1.2B(? 1B 1.67A)

• Total Gains from Trade to Importing country, Y
• Unit Gains x Amount Imported
• 0A(5) 0A (saved)

• Total Gains from Trade to Exporting country, X
• Unit Gain x Amount Exported
• 1.17A(5) 5.85A

35
Terms of Trade and Gains from Trade

• Task 6

• Referring to your findings in Task 5
• How is the TOT set to allow the importing country
  capture ALL the gains from trade?
• How is the TOT set to allow the exporting country
  capture ALL the gains from
• trade?
• Is it still beneficial for a country to trade if
  its gains from trade is zero?

36
Terms of Trade and Gains from Trade

• The importing country will capture ALL the gains
  from trade if the TOT is set equal to the
  exporting countrys domestic opportunity cost.

• The exporting country will capture ALL the gains
  from trade if the TOT is set equal to the
  importing countrys domestic opportunity cost.

37
Terms of Trade and Gains from Trade

• Country with zero gains from trade will still
  trade for other benefits

• To enjoy goods that it cannot produce.

• To enjoy higher standard of living.

• To maintain better international relationship.

• To improve skills and techniques of production by
  examining imports

38
Terms of Trade and Gains from Trade

• Task 7

• Given
• each country has its own comparative advantage in
  production
• trading parties reach a mutually beneficial terms
  of trade

Question Must trade take place?
Answer NO
39
Factors Affecting Trade

• Potential trade might be halted if

• the transportation cost outweighs the potential
  gains from trade.

• the other costs of conducting trade (e.g.
  insurance cost) becomes prohibitively high when
  serious political problems occur, e.g. wars.

40
Free Trade

• Benefits of Free Trade

• More output could be produced.

• Better international relationship

• Mass production allows firms to enjoy economies
  of scale.

• Exchange of technology is allowed.

• Standard of living is higher with a larger
  variety of cheaper imports.

• More employment opportunities

41
Free Trade

• Promotion of Free Trade

• World Trade Organization, WTO reducing trade
  barriers
• Generalized Schemes of Preference, GSP low/no
  tariffs to developing countries
• Asia-Pacific Economic Cooperation, APEC
  promoting free trade economic cooperation
• North America Free Trade Agreement, NAFTA
  promoting tariff-free trade

42
Trade Restrictions(1)

• Tariffs

• Tariffs are taxes on imports.

• Tariffs can be per-unit tax or ad valorem tax
  (i.e. percentage tax).

• Effects of Tariffs on Imports

• Cost of production increases

• Supply of imports decreases

• Import price increases

• Quantity imported/transacted falls

43
Trade Restrictions(1)

• Effects of Tariffs on Imports

44
Trade Restrictions(2)

• Import Quota

• Import quota fixes the maximum amount
• or value of imports during a given period.

• Effects of Import Quotas on Imports

• Supply of imports decreases

• Quantity imported/transacted falls

• Import price increases

• Kinked Supply curve resulted

45
Trade Restrictions(2)

• Effects of Quota on Imports

46
Trade Restrictions

• Comparison Between Tariffs Quota

47
Trade Restrictions (3)

• Subsidies to Local Goods

• A sum of money provided by the government for
  local production

• Effects

• Lower cost allows larger local supply

• Local product prices fall leading to more local
  products demanded

• Demand for imports falls and thus fewer products
  being imported

48
Trade Restrictions (4)

• Embargo

• A ban on imports

• Total embargo versus partial embargo

• It is imposed for political reasons

49
Trade Restrictions (5)

• Exchange Control

• A government control on the buying and selling of
  foreign currencies

• Imports will be reduced by limiting the amount of
  foreign currencies available

50
Trade Restrictions (6)

• Voluntary Export Restriction

• The exporting countries themselves restrict their
  exports to some other countries

• Imports to Country A will then be reduced if
  Country B restricts her exports voluntarily.

51
Reasons for Trade Restrictions

• To protect local industries

• To enhance employment opportunity

• To raise tariff revenue

• To reduce balance of payments deficit

• To undergo industrial diversification

• For political reasons