MACROECONOMICS
AND THE GLOBAL BUSINESS ENVIRONMENT
2nd edition
International Trade
1
8-2
Key Concepts
 Comparative Advantage


Terms of trade
Opportunity Cost
 New Trade Theory
8-3
Patterns of World Trade
Growth rate in world output and volume of world trade
14
12
10
Percent
8
6
4
2
-4
Source: IMF WEO
Gross domestic product, constant prices, annual percent change
World trade volume of goods and services, annual percent change
20
06
20
04
20
02
20
00
98
19
19
96
94
19
92
19
19
90
19
88
84
86
19
World GDP
19
82
19
19
80
78
19
19
7
4
19
7
2
19
7
70
19
-2
6
Trade Volume
0
8-4
Comparative Advantage
 Focus on activities in which disadvantage is least
 Produce good/service with lowest opportunity cost
 Trade for good with highest opportunity cost
 Trade benefits all countries
 Key assumptions
 Competitive markets
 Labor and capital can easily be reallocated
 Stable rate of unemployment
 Costless transportation
 China-U.S. example
8-5
Comparative Advantage
 ALL countries benefit from free trade
 However, not all countries will be equally well
off


Gains may not be equal between countries
Depends on terms of trade
 Not all citizens benefit

Country is richer as a whole, but some citizens
are worse off
 Should these problems stop trade?
8-6
Terms of Trade
 Ratio of the price of a country’s exports to the price of
a country’s imports
 Gains from trade rise with terms of trade

Example: oil-exporters have recently experienced a
strong increase in their terms of trade
 Application: Prebisch-Singer hypothesis
 Hypothesis that agricultural prices, fall in value over
time…
 Rising productivity in agriculture
 low elasticity of demand for agricultural products
fall in agricultural prices relative to overall prices and
decline in terms of trade
 Countries should promote non-agriculture sector or fall
behind
8-7
Factor Price Equalization
 Factor price equalization Theorem


As trade grows, input prices (wages and the
cost of capital) should converge
Both within and across countries
 Assumes identical inputs
 Productivity-adjusted wages different
8-8
Germany,
Norw ay
Denmark
Sw itzerland
Belgium
United States
Japan
Finland
Netherlands
Austria
Europe
Sw eden
Luxembourg
United
Canada
Israel
France
Italy
Australia
Ireland
Spain
Israel
Korea
Singapore
Asian
Taiw an
Hong Kong
Portugal
Mexico
Wages, US $, 2000
Source: BLS
0
5
10
15
20
25
30
8-9
National Competitiveness: Classical
Trade Theory
 Trade is not a zero-sum game
 Competitiveness concerns imply zero-sum game
 Focus on comparative advantage, not competitiveness
 Countries do not go bankrupt
 Instead of bankruptcy, a country undergoes
restructuring of economy
 Reallocate labor and capital to new industry
 Trade is not adversarial
 Caveat: shortrun vs. longrun
 Example: Mexico’s competitiveness concerns
8-10
International Trade Theory: New Trade
Theory
 Economies of scale are important to some industries
 Commercial airlines, auto dealers
 Economies of scale require large production run, and
in turn a large market to sell goods

If no large market, then…
 No production of certain goods
 Less variety
 What’s one way to increase market size for a good?
 International Trade
8-11
International Trade Theory: New Trade
Theory
 Example:



Suppose two countries with annual market for
1 million autos
Before trade: 1 million auto market
After trade: 2 million auto market

Produce more, at lower cost, and greater variety
8-12
International Trade Theory: New Trade
Theory
 First Mover Advantage
 If economies of scale is important (i.e. need a large
market) and there has been a first mover, then
subsequent competitors will face a barrier to entry
 Not enough market demand left for them to operate at
level of economy of scale => cost disadvantage
 Example: Airbus is spending $14 billion to develop 550
seat commercial plane
 Needs to sale 350 planes for venture to be profitable
 Demand over next 20 years is for 400 to 600 planes
 Room for only one profitable player
8-13
National Competitiveness: New Trade
Theory
 Don’t necessarily need productivity or factor
endowment advantage to benefit from trade…if you
are the first mover
 Comparative advantage can be created


Carpet industry, Dalton, Georgia
Silicon Valley, California
 Comparative advantage should not be accepted as is
 Countries should actively promote strategic trade
policies

Example: Aircraft industry
 Imperfect competition
 Increasing returns to scale
 U.S. vs. Europe: Boeing vs. Airbus
8-14
Strategic New Trade Theory
Airbus
Enter
Enter
Boeing
Don’t enter
Don’t Enter
-$100m -$100m $500m
0
$500m
0
•If both firms enter, neither reap lower costs from increasing
returns to scale (IRS)
•$500 million earning potential…if IRS fully used
•Best strategy is consider what the other firm is going to do
0
0
8-15
Strategic New Trade Theory
Airbus
Enter
Enter
Boeing
Don’t enter
Don’t Enter
$-100m $100m $500m
0
$700m
0
0
0
•Suppose European government promises $200 million subsidy if Airbus produces
planes
•Regardless of Boeing’s decision, Airbus will now produce…positive earning
regardless
•Boeing either looses $100 million or withdraws at no lost…easy choice
•$200 million subsidy gave Airbus monopoly profits of $500 million and will help
create an European comparative advantage
8-16
Strategic New Trade Theory
Airbus
Enter
Boeing
Enter
$100m
Don’t enter
0
Don’t Enter
$100m $500m
0
$500m
0
0
•If Europe and U.S. both subsidize $200 million, both firms will produce
•However, profit includes subsidy
•Europeans and Americans overpay for aircraft, foreigners benefit
•Solutions:
•Cartel: agree to set same prices
•Move toward niche products
•Raise the stakes: higher subsidies
8-17
Strategic Trade Theory
 Paul Krugman
 Strategic trade policy is tantamount to “beggar thy
neighbor” policy
 Boost national income at expense of other country
 Likely to provoke retaliation and trade ware
 Result could be a costly subsidy race between two
countries from which other countries benefit
 What to do if competitor is subsidizing competing
industry?
 Better to establish “rules of the game” than to retaliate
 WTO
 Often government intervention is based on special
interest rather than strategic trade theory (economies
of scale)
8-18
Arguments for Trade Restrictions
 Political Arguments





National Security
Protecting Jobs and Industries
Retaliation
Consumer Protection (health, safety)
Furthering Foreign Policy Objectives
 Economic Arguments


Infant Industry Protection
Strategic Trade Policy
8-19
Summary
 Trade is an increasing feature of the world
economy
 Comparative advantage and terms of trade
 New trade theory
 Arguments for Trade Restrictions