International trade - theory and challenges

Question 1

when free trade occurs ?

Answer 1

Free Trade occurs when a government does not attempt to influence, through tariffs, quotas, or other means,
what citizens can buy from other countries or
produce and sell to other countries

Question 2

What is the benefits of trade ?

Answer 2

The Benefits of Trade allow countries to be richer by specializing in products they can produce most efficiently

Question 3

Trade Theory problem

Answer 3

There are a lots of problems with trade :
there may be some ways that some governments can make things better by intervening (that is, by not practicing free trade)
But government intervening in free trade can be problematic
Restrictions on trade have
kept some countries very poor
contributed to huge depressions

Question 4

Mercantilism trade theories

Answer 4

Mercantilism (pre-16th century)
Takes an us-versus-them view of trade
Other country’s gain is our country’s loss

Question 5

Classical trade theories

Answer 5

-Absolute Advantage (Adam Smith, 1776)
-Comparative Advantage (David Ricardo, 1817)
-Specialization of production and free flow of goods benefit all trading partners’ economies

Question 6

free trade refined theory

Answer 6

Factor-proportions (Heckscher-Ohlin, 1919)
International product life cycle (Ray Vernon, 1966)

Question 7

What the new trade theory consist in ?

Answer 7

As output expands with specialization, an industry’s ability to realize economies of scale increases and unit costs decrease
Because of scale economies, world demand supports only a few firms in such industries (e.g., commercial aircraft, automobiles)
Countries that had an early entrant to such an industry have an advantage:
Fist-mover advantage
Barrier to entry

Question 8

mercantilism main points

Answer 8

A nation’s wealth depends on accumulated “treasure”
Gold and silver are the currency of trade
Mercantilists sought what we now call ‘development’
They argued their countries should run a trade surplus
Maximize export through subsidies
Minimize imports through tariffs and quotas

Flaw: “zero-sum game”
Mercantilists neglected to see the benefits of trade

Question 9

What noemercantilism/ mercantilism consist in ?

Answer 9

Prevailed in 1500 - 1800
Export more to “strangers” than we import to amass treasure, expand kingdom
Zero-sum vs positive-sum game view of trade
Government intervenes to achieve a surplus in exports
King, exporters, domestic producers: happy
Subjects: unhappy because domestic goods stay expensive and of limited variety
Today neo-mercantilists = protectionists: some segments of society shielded short term

Question 10

What is the flaw in the mercantilist’s argument ?

Answer 10

They assumed that trade was a zero-sum game »»» It ain’t!!
As England, France, Spain, Portugal and the Netherlands competed with each other, many thought only about advantage for their country

Question 11

What is Absolute advantage ?

Answer 11

Adam Smith: The Wealth of Nations, 1776
Mercantilism weakens country in long run; enriches only a few
A country 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 than another country in producing a particular product

Question 12

Definition of absolute advantage according to Adam Smith

Answer 12

Adam Smith argued (Wealth of Nations, 1776): Capability of one country to produce more of a product with the same amount of input can vary.
A country should produce only goods where it is most efficient, and trade for those goods where it is not efficient

Trade between countries is, therefore, beneficial »» “positive sum game”!
Example: Ghana/cocoa vs.South Korea/rice

Question 13

Suppose one country is more efficient than another in everything?

Answer 13

There are still global gains to be made if a country specializes in products it produces relatively more efficiently than other products.

Question 14

What is the Comparative advantage according to David Ricardo ?

Answer 14

David Ricardo: Principles of Political Economy, 1817
Country should specialize in the production of those goods in which it is relatively more productive… even if it has absolute advantage in all goods it produces
Absolute Advantage is a special case of Comparative Advantage

Question 15

What is the definition of comprative advantage ?

Answer 15

David Ricardo (Principles of Political Economy, 1817):
A country should import products for which it is relatively inefficient even if the country is more efficient in the product’s production than country from which it is buying
Trade is a positive-sum game

Question 16

What is the relation between the opportunity cost and the comparative advantage ?

Answer 16

Countries have comparative advantage in goods for which the opportunity cost of production is relatively low
That is, those that can be produced by giving up relatively little in production of other goods
Meaning : your country has comparative advantage in the product or service where the ratio : (Resources required in your country/ Resources required in the other country)
is low.

Question 17

Example of how comprarative advanatge works.

Answer 17

Ghana has absolute advantage in both cocoa and rice, but its comparative advantage is in cocoa. Korea has comparative advantage in rice .
Let Korea specialize in rice – Ghana expands cocoa production to replace all Korean cocoa production lost.
Then Ghana can replace all Korean cocoa production and the countries have more of both goods.

Question 18

What is the meaning of free competition ?

Answer 18

They believed that if people were left to trade on their own, they would naturally trade the goods in which their countries had comparative advantage
“Every individual seeks the most advantageous employment for his capital….
“Study of his own advantage necessarily leads him to prefer that employment most advantageous to society” - Adam Smith, 1776

Question 19

Assumptions about comparative advantage

Answer 19

This is a very simple case, but the basic conclusions are generally valid
We’re assuming no transportation costs
We’re simplifying by not talking about currencies
We’re assuming constant returns to scale
We’re assuming resources can move freely from production of one good to another
We’re not thinking about effects on income distribution

Question 20

Is free trade advantageous for country less efficient ?

Answer 20

IN one hand, under free trade, the country that is less efficient will have low wages
It will be able to sell the products where it has comparative advantage without any special tariff or subsidy protection.
In other hand, the country less efficient in everything will be poor but it will be even poorer if it did not trade.

Question 21

Def of infrastructure

Answer 21

the basic equipment and structures (such as roads, bridges) that are needed for a country, region, etc. to function properly.

Question 22

Why it may need to work on infrastructure ?

Answer 22

China, India both sell cheap manufactured goods
China sells more because it has better transportation infrastructure and government that supports manufactured exports

Question 23

Why it will need education and institutions for its people ?

Answer 23

Banks, government agencies who can
process exports
work with foreigners
Honest banks and agencies

Question 24

what immobile resources consist in ?

Answer 24

Resources do not always move easily from one economic activity to another.
So some rice farms will persist in Ghana no matter what.
(Rice farmers will be losers as cheap rice comes from Korea)

Question 25

What diminishing returns consist in ?

Answer 25

Diminishing returns to specialization suggests that after some point, the more units of a good the country produces, the greater the additional resources required to produce an additional unit
So comparative advantage will vary with production

Question 26

What is Heckscher and Ohlin thoery depending on ?

Answer 26

Differences in factor endowments not on differences in productivity determine patterns of trade
Absolute amounts of factor endowments matter

Question 27

What is the leontief paradox and its explanation ?

Answer 27

Leontief paradox:
US has relatively more abundant capital yet imports goods more capital intensive than those it exports
Explanation(?):
US has special advantage on producing new products made with innovative technologies
These may be less capital intensive till they reach mass-production state

Question 28

Theory of relative factor endowments

Answer 28

Factor endowments vary among countries.
Products differ according to the types of factors that they need as inputs?
A country has a comparative advantage in producing products that intensively use factors of production (resources) it has in abundance.
Factors of production: labor, capital, land, human resources, technology.

Question 29

Two factors of production

Answer 29

labor and capital

Question 30

Factor proportion trade theory

Answer 30

A country that is relatively labor abundant (or capital abundant) should specialize in the production and export of that product which is relatively labor intensive (or capital intensive).

Question 31

What the international product life - cycle (vernon) consist in ?

Answer 31

Most new products conceived / produced in the US in 20th century
US firms kept production close to their market initially
Aid decisions; minimize risk of new product introductions
Demand not based on price; low product cost not an issue
Limited initial demand in other advanced countries initially
Exports more attractive than overseas production
When demand increases in advanced countries, production follows
With demand expansion in secondary markets
Product becomes standardized
production moves to low production cost areas
Product now imported to US and to advanced countries

Question 32

What product cycle theory according to vernon is based on ?

Answer 32

Focus on the product, not its factor proportions

Two technology-based premises

Question 33

What are the two Vernon’s premises ?

Answer 33

Technical innovations leading to new and profitable products require large quantities of capital and skilled labor

The product and the methods for manufacture go through three stages of maturation

Question 34

Stages of the product cycle

Answer 34

1. The new product
2. The maturing product
3. The standardized product

Question 35

The Product Cycle and Trade Implications

Answer 35

Increased emphasis on technology’s impact on product cost

Explained international investment

Limitations
Most appropriate for technology-based products
Some products not easily characterized by stages of maturity
Most relevant to products produced through mass production

Question 36

Classic theory conclusion

Answer 36

Free trade expands the world “pie” for goods/ services

Question 37

Theory limitations

Answer 37

Simple world (two countries, two products)
no transportation costs
no price differences in resources
resources immobile across countries
constant returns to scale
each country has a fixed stock of resources and no efficiency gains in resource use from trade
full employment