International Trade Theory Flashcards
NAFTA
North American Free Trade Agreement
TPP
Trans Pacific Partnership
FDI
Foreign Direct Investment
Absolute Advantage
a country has absolute advantage in the production of a product when it is
more efficient than any other country at producing it. If another country have absolute advantage in
a another product- the countries could really benefit for trading with each other.
Explain Smiths theory of absolute advantage
- He argued that the invisible hand of the market mechanism should determine what a
country exports and imports- not the government. - Mercantilism weakens country in long run; enriches only a few
A country should: - Should specialize in production of and export products for which it has absolute
advantage; import other products - Has absolute advantage when it is more productive (produces at lower cost) than
another country in producing a particular product
Free trade
refers to a situation where the government does not attempt to influence trade, what a
citizen can buy from another country or produce and sell to another country.
Comparative advantage
Comparative advantage is an economy’s ability to produce a particular good or service at a lower opportunity cost than its trading partners.
makes sense for a country to specialize in producing those goods that it can produce most efficiently, while buying goods that it can produce relatively less efficiently from other countries.
opening a country to free trade stimulates economic growth, which creates dynamic gains from trade. Empirical evidence seems to be consistent with this claim.
unrestricted free trade bring about increased world production-that is, that trade is a positive sum-game.
Read more in notes
Opportunity cost
The opportunity cost of good A in terms of good B is the number of unit of good B
that could be produced with the same resources used to produce a given number of
units of good A.
• Opportunity costs is the largest sacrifice made to produce a given good
Constant returns to specialization
the units of resources required to produce a good, are assumed
to remain constant no matter where one is on a country’s production possibility frontier (PPF).
PPF - Product possibility frontier
shows the maximum possible output combinations of two
goods or services an economy can achieve when all resources are fully and efficiently employed.
Diminishing returns
when more units of resources are required to produce each additional unit.
Diminishing returns shows that it is not feasible for a country to specialize to the degree
suggested by the simple Ricardian model.
Dynamic gain from free trade
- Gain in the stock of a county’s resources
- The county can produce more of both goods
- Opening an economy for free trade results in dynamic gain but stimulate economic growth.
What did Samuelson argue?
that in some circumstances- dynamic gains can lead to an outcome that is not
beneficial. Fx USA buying from poorer China- Wallmart can sell cheaper- but that doesn’t mean
they will give a crap about the wage of the people working in Wallmart.
What is the Hecscher-Ohlin theory?
They put forward a different explanation of comparative advantage- that arises from differences in
national factor endowments (explained futher up).
Nations have varying factor endowments and different factor endowments explain differences in
factor costs. The larger/abundant (bigger potion) a factor the lower the cost.
They predict countries
- With will export good that make intensive use of factor that are locally abundant- USA a
long substantial exporter of agricultural goods
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- While importing goods that make intensive use of factor that are locally scarce- importing
goods produced in China, that have relative abundance of low-cost labor in manufacturing
industries.
- Argues free trade is beneficial
- International trade is determined by differences in factor endowments, and not differences in
productivity
What is the Leontief paradox
Leontief said- because the United States was relativey abundant in capital compared to other
nations, the USA would be an exporter of capital-intensive goods and importer of labor-intensive
goods.- though he was wrong and its called a paradox
The product life-cycle theory
suggests that early the life cycle, most new products are produced
in and exported from the country in which they were developed- so as a new product becomes more
internationally accepted- the production starts in other countries. The theory suggests the products
may in the end be exported back to the country of its origin.
Rayon Vernon
• He argued the size and wealth of the U.S market have U.S firms an incentive to developed
new consumer products.
• Also that high laborcost gave the U.S firms an incentive to develop cost-saving process
innovations.
• U.S switches from being an exporter of the product to an importer of the product as
production becomes concentrated in lower-cost foreign locations.
Product life-cycle theory in the twenty first century
- Vernon’s argument that most new products are developed and introduced in the U.S is
outdated. Might have been true in the 1945-1975 - Many new products are now first introduced in Japan (video consoles) or South Korea
(smartphones) . - Many new products are simultaneously introduced in the United states and Europa and Asia
What are some new trade theories?
Economics of scale
Diseconomics of scale
Constant returns to scale
Economics of scale
unit cost reductions associated with large scale output.
• the best way to achieve high efficiency and low unit cost, is through the mass production of
a standardized output.
Diseconomics of scale
(referred also as decreasing returns) refer to the property whereby long-run
average total cost rises as the quantity of output increases.
• An alternative definition would be output increasing at a slower rate than the rate of
increase in inputs
Constant returns to scale
refers to the property whereby long-run average total cost stays the same
as the quantity of output increases
• An alternative definition would be output increasing at the same rate as the rate of
increase in inputs
What are some types of competition?
Perfect competition Imperfect competition - Monopoly - Oligopoly - Monopolistic competition - Monopsony - Oligopsony
Perfect competition
an economic model that describes a hypothetical market form in which no
producer or consumer has the market power to influence prices, ie., all act as price takers. The
analysis of perfectly competitive markets provides the foundation of the theory of supply and
demand.
Imperfect competition
the competitive situation in any market where the conditions necessary
for perfect competition are not satisfied.
Monopoly
only one seller of a good.
Oligopoly
small number of sellers
Monopolistic competition
there are many sellers producing highly differentiated
goods, but each has some power to influence prices.
Monopsony
only one buyer of a good.
Oligopsony
Small number of buyers
Explain the new trade theory
Paul Krugman, in some cases, countries specialize in the production and
export of particular products, not because of differences in factor endowments, but because in
certain industries the world market can support only limited number of firms fx commercial aircraft
industry- so the first firms to enter are able to build a very competitive advantage.
Factor endowments
commonly understood as the amount of land, labor, capital,
and entrepreneurship that a country possesses and can exploit for manufacturing.
What does the new trade theory say about increasing product variety and reducing cost?
- New trade theory get a market to have variety and reducing cost of making the good
- In a world with international trade, the producing of a good is limited to the national market
and economies of scale couldn’t happen, making prices higher and reducing the variety of
products.
What are some implications of the new trade theory?
- The theory suggests nations may benefit from trade even when they do not differ in resource
endowments or technology
29 - Trade allows a nation to specialize in the production of certain products
- Attaining svale economies
- Lowering the cost og production
- Buying specialized products from other nations
- So the variety of products increases and the average costs should fall- freeing resources to
produce other goods/service - First mover advantage is good – the first ot become specialized
- Quite use in explaining trade patterns
Explain Porters Diamond
The determinants of national competitive advantage
- Factor endowments
• land, labor, capital, workforce, infrastructure
(some factors can be created…) - Demand conditions
• large, sophisticated domestic consumer base; offers an innovation friendly
environment and a testing ground - Related and supporting industries
• local suppliers cluster around producers and add to innovation - Firm strategy, structure, rivalry
• competition good, national government
Balance-of-payment accounts
National accounts that track both payments to and receipts from foreigners. Is divided into three main sections:
- Current account
- The capital account
- Financial account
Current account
records transactions involving the export or import of goods and services.
A current account deficit
the current account of the balance of payments is in deficit when a
country imports more goods, service and income than it exports.
The capital account
records one-time changes in the stock of assets – capital transfer, such as debt
forgiveness and migrants’ transfers
The financial account
transaction that involve the purchase and sale og assets- fx when a German
firm purchases stock in a U.S company or buys a U.S bond- the transaction enters the U.S balance
of payments as a credit on the financial account.
What did Mercantilists argue?
that it was in a country’s best interest to run a balance-of-trade surplus. They viewed trade as a zero-sum game, in which one country’s gains cause losses for other countries.
What has some new trade theorists promoted about the idea of strategic trade policy?
The argument is that government, by the sophisticated and judicious use of subsidies, might be able to increase the chances of domestic firms becoming first movers in new industries.
Why are theories of international trade important to businesses?
primarily because they can help the firm decide where to locate its various production activities
What can firms involved in international trade influence?
Firms involved in international trade can and do exert a strong influence on government policy toward trade. By lobbying government, business firms can promote free trade or trade restrictions.
