M03EFA: Economic
Environment of Business
Key Aspects of International Trade
This Lecture Aims to: a) Introduce concepts of absolute/
comparative advantage
b) Assess key arguments for free-trade
& protectionism
c) Considers the impact of tariffs
d) Evaluate key trade theories
• The gains From Trade:
A. The Law of Comparative Advantage
Production Hours
Opportunity Cost
U.S.A.
1 Car
1 Shirt
30
5
6 shirts
1/6 car
U.K.
1 Car
1 Shirt
60
6
10 shirts
1/10 car
 USA absolute advantage
 USA relative advantage in cars
Student Task 1:
Suppose the USA opts to make 10 more cars whilst the UK
opts to make 60 more shirts. What is the outcome &
what are the gains from trade between the USA & UK?
USA makes + 10 cars = - 60 shirts
 UK makes + 60 shirts = - 6 cars
 Globally cars = (+ 10 – 6 = + 4)
 Globally shirts = ( - 60 + 60= 0)
 Globally more cars/ no fewer shirts
 This is a Pareto efficient improvement
Comparative Advantage:
 The ability to produce a particular good or
service at a lower opportunity cost
Arguments for Protectionism:
 Prevent dumping (e.g. pharmaceuticals)
 Protecting ‘fledgling’ industry (innovation/ invention)
 Strategic industry (defence/ water/ farming)
 Protect employment (e.g. U.S. car industry; U.S. steel)
 Transition…..
“When particular manufacturers have been so far
extended as to employ a great multitude of hands,
humanity may require that the freedom of trade should
be restored only by slow graduations and with a good
deal of reserve” (Adam Smith, 1776)
Types of Protection:
Voluntary export restraints (VER)
 Quota (volume/ value)
 Tariff (essentially a tax on importers)
 Technology standard (e.g. cars)
 Subsidy (assume unit subsidy)
Effects of a Tariff on Trade:
a) Domestic supply rises
b) Domestic demand falls
c) Consumer faces higher prices
d) Govt. revenue rises
Infant Industry
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Rationale for protectionism:
IIs lack economies of scale
Industrialize behind tariff barriers
Only until II is internationally competitive
Hence, intended as a temporary measure
Historic use by industrialized counties, but
was that the reason for success?
Infant Industry II
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•
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Overall, poor track record
How to pick a ‘winner’?
Subject to lobbying and emotional pleas
Infants may never grow up
Infants may never catch up (perpetually
inefficient)
High costs to society & Retaliation
Trade Theories: Ricardian
Model I
• Labour is the only factor of production
• Countries will have a comparative advantage in
the good that their labour produces relatively
efficiently, i.e. the good that has a lower
domestic opportunity cost.
• Countries will export the good in which they
have comparative advantage while importing the
good that their labour produces relatively
inefficiently.
Trade Theories: Specific
Factors Model I
• Two fixed, specific factors and one mobile factor.
• Countries will have a comparative advantage in
the good that requires the specific factor in
relative abundance (defined by comparing ratios
of specific factors across countries).
• Countries will export the good in which they
have comparative advantage and import the
good that requires the specific factor that is
relatively scarce domestically.
Trade Theories: HeckscherOhlin model I
• Countries have a comparative advantage in the
good that uses intensively the factor a country
has in relative abundance.
• It will export the good in which it has
comparative advantage and import the good that
uses intensively the factor that is relatively
scarce domestically
• A country should specialize production and
export using the factors that are most abundant,
and thus the cheapest, not to produce the goods
it produces most efficiently.