HKCEE Macroeconomics
 Chapter
7:International
Trade
By Mr. LAU san-fat
CH7-International Trade-SV
1
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
By Mr. LAU san-fat
CH7-International Trade-SV
2
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
By Mr. LAU san-fat
CH7-International Trade-SV
3
The Model of Absolute
Advantage

An Illustration
Unit(s) of product being
produced with 1 unit of resource
Good A
Good B
Country X
3
or
1
Country Y
1
or
9

AA in producing good A: Country X
 AA in producing good B: Country Y
By Mr. LAU san-fat
CH7-International Trade-SV
4
The Model of Absolute
Advantage

Task 1：Study the table below and
find out which country has the AA in
producing goods A and B.
Unit(s) of product being
produced with 1 unit of resource
Good A
Good B
Country X
6
or
1
Country Y
4
or
2
By Mr. LAU san-fat
CH7-International Trade-SV
5
The Model of Absolute
Advantage

Task 2：Study the table below and
find out which country has the AA in
producing goods A and B.
Unit(s) of resources required for
producing 1 unit of…
Good A
Good B
Country X
2
10
Country Y
3
1
By Mr. LAU san-fat
CH7-International Trade-SV
6
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.
By Mr. LAU san-fat
CH7-International Trade-SV
7
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.
By Mr. LAU san-fat
CH7-International Trade-SV
8
The Model of Comparative
Advantage

An Illustration
Unit(s) of product being
produced with 1 unit of resource
Good A
Good B
Country X
6
or
12
Country Y
5
or
3
By Mr. LAU san-fat
CH7-International Trade-SV
9
The Model of Comparative
Advantage

An Illustration
Country X
Opportunity cost of producing
1 unit of …
Good A
Good B
12B/6 = 2B
or 6A/12 = 0.5A
Country Y 3B/5 = 0.6B
By Mr. LAU san-fat
or
CH7-International Trade-SV
5A/3 = 1.67A
10
The Model of Comparative
Advantage

Task 3：Study the table below and
find out which country has the CA in
producing goods A and B.
Unit(s) of product being
produced with 1 unit of resource
Good A
Good B
Country X
6
or
1
Country Y
4
or
2
By Mr. LAU san-fat
CH7-International Trade-SV
11
The Model of Comparative
Advantage

Task 3：Study the table below and
find out which country has the CA in
producing goods A and B.
Opportunity
of producing
Unit(s) of cost
product
being
1 unit
of …of resource
produced with
1 unit
Good A
Good B
Country X 1B/6 =60.17B or 6A/1 =16A
Country Y 2B/4 =40.5B
or 4A/2 =22A
By Mr. LAU san-fat
CH7-International Trade-SV
12
The Model of Comparative
Advantage

Task 4：Study the table below and
find out which country has the CA in
producing goods A and B.
Unit(s) of resources required for
producing 1 unit of…
Good A
Good B
Country X
2
10
Country Y
3
9
By Mr. LAU san-fat
CH7-International Trade-SV
13
The Model of Comparative
Advantage

Task 4：Study the table below and
find out which country has the CA in
producing goods A and B.
Opportunity
cost ofrequired
producing
Unit(s)
of resources
for
1 unit1ofunit
… of…
producing
Good A
Good B
Country X 2/10B 2
= 0.2B
10/2A10= 5A
9/3A =9 3A
Country Y 3/9B =30.3B
By Mr. LAU san-fat
CH7-International Trade-SV
14
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
By Mr. LAU san-fat
CH7-International Trade-SV
15
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
By Mr. LAU san-fat
CH7-International Trade-SV
16
The Model of Comparative
Advantage

Given:
Unit(s) of product being
produced with 1 unit of resource
Good A
Good B
Country X
6
or
12
Country Y
5
or
3
By Mr. LAU san-fat
CH7-International Trade-SV
17
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.
Country X
Country Y
Total Output
By Mr. LAU san-fat
Units of product produced
Good A
Good B
6
AND
12
5
AND
3
11
AND
15
CH7-International Trade-SV
18
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.
By Mr. LAU san-fat
CH7-International Trade-SV
19
The Model of Comparative
Advantage

After Specialization
Units of product produced
Good A
Good B
6(0.5) = 3 AND 12(1.5)=18
5(2)=10
AND
3(0)=0
Country X
Country Y
Total Output
Total Output under
Self-sufficient
Net Increase
By Mr. LAU san-fat
13
AND
18
11
+2
AND
AND
15
+3
CH7-International Trade-SV
20
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 = ?X:1M
• TOT should be mutually beneficial to
trading partners.
• TOT should be set in-between the
opportunity costs of trading partners.
By Mr. LAU san-fat
CH7-International Trade-SV
21
Terms of Trade and Gains
from Trade

Find both countries’ O.C. in their
productions from the table below.
Unit(s) of product being
produced with 1 unit of resource
Good A
Good B
Country X
6
or
12
Country Y
5
or
3
By Mr. LAU san-fat
CH7-International Trade-SV
22
Terms of Trade and Gains
from Trade

Finding the beneficial TOT:
Opportunity Cost of producing
1 unit of …
Good A
Good B
Country X (12B/6=)2B
or (6A/12=)0.5A
Country Y (3B/5=)0.6B
or
(5A/3=)1.67A
• Mutually beneficial TOT:
Good A: 0.6B-2B
Good B: 0.5A-1.7A
By Mr. LAU san-fat
CH7-International Trade-SV
23
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
By Mr. LAU san-fat
CH7-International Trade-SV
24
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
By Mr. LAU san-fat
CH7-International Trade-SV
25
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
By Mr. LAU san-fat
CH7-International Trade-SV
26
Terms of Trade and Gains
from Trade

The opportunity cost of both countries in
producing goods A & B are below:
Opportunity Cost of producing
1 unit of …
Good A
Good B
Country X (12B/6=)2B
or (6A/12=)0.5A
Country Y (3B/5=)0.6B
By Mr. LAU san-fat
or
CH7-International Trade-SV
(5A/3=)1.67A
27
Terms of Trade and Gains
from Trade

Task 5b: Find the gains from trade for
both countries if the TOT is
(a) 1A:1B
(b) 1A:2B
(c) 2A:1.2B
By Mr. LAU san-fat
CH7-International Trade-SV
28
Terms of Trade and Gains
from Trade

(a) When TOT = 1A:1B
• 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
By Mr. LAU san-fat
CH7-International Trade-SV
29
Terms of Trade and Gains
from Trade

(a) When TOT = 1A:1B
• 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
By Mr. LAU san-fat
CH7-International Trade-SV
30
Terms of Trade and Gains
from Trade

(b) When TOT = 1A:2B ( 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
By Mr. LAU san-fat
CH7-International Trade-SV
31
Terms of Trade and Gains
from Trade

(b) When TOT = 1A:2B( 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
By Mr. LAU san-fat
CH7-International Trade-SV
32
Terms of Trade and Gains
from Trade

(c) When TOT = 2A:1.2B( 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
By Mr. LAU san-fat
CH7-International Trade-SV
33
Terms of Trade and Gains
from Trade

(c) When TOT = 2A:1.2B( 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
By Mr. LAU san-fat
CH7-International Trade-SV
34
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?
By Mr. LAU san-fat
CH7-International Trade-SV
35
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 country’s
domestic opportunity cost.

The exporting country will capture
ALL the gains from trade if the TOT is
set equal to the importing country’s
domestic opportunity cost.
By Mr. LAU san-fat
CH7-International Trade-SV
36
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
By Mr. LAU san-fat
CH7-International Trade-SV
37
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
By Mr. LAU san-fat
CH7-International Trade-SV
38
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.
By Mr. LAU san-fat
CH7-International Trade-SV
39
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
By Mr. LAU san-fat
CH7-International Trade-SV
40
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
By Mr. LAU san-fat
CH7-International Trade-SV
41
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
By Mr. LAU san-fat
CH7-International Trade-SV
42
Trade Restrictions(1)

Effects of Tariffs on Imports
P
S2
S1
D
tax
P2
P1
0
By Mr. LAU san-fat
Q2
Q1
CH7-International Trade-SV
Q
43
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
By Mr. LAU san-fat
CH7-International Trade-SV
44
Trade Restrictions(2)

Effects of Quota on Imports
P
D
Quota
S2
S1
P2
P1
0
By Mr. LAU san-fat
Q2
Q1
CH7-International Trade-SV
Q
45
Trade Restrictions

Comparison Between Tariffs & Quota
Tariffs
Quota
Nature Import tax
Output limit
Effects ↑ P→Q↓
↓ Q→↑P
△Q depending on △Q is certain
Ed of M
Tariffs revenue
Quota revenue
only if by
auction
By Mr. LAU san-fat
CH7-International Trade-SV
46
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
By Mr. LAU san-fat
CH7-International Trade-SV
47
Trade Restrictions (4)

Embargo
• A ban on imports
• Total embargo versus partial embargo
• It is imposed for political reasons
By Mr. LAU san-fat
CH7-International Trade-SV
48
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
By Mr. LAU san-fat
CH7-International Trade-SV
49
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.
By Mr. LAU san-fat
CH7-International Trade-SV
50
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
By Mr. LAU san-fat
CH7-International Trade-SV
51