Free Trade
A policy by which a government does not discriminate against imports or interfere with exports by applying tariffs (to imports) or subsidies (to exports).
- Government does not attempt to influence through quotas or duties what its citizens can buy from another country or what they can produce and sell to another country.
Trading Benefits
Some international trade is beneficial even for products a country can produce for itself.
- Allows specialization.
Limits on imports are often in the interests of domestic producers but not domestic consumers.
Ricardo’s Comparative Advantage Theory
A country should specialize in the production of those goods that it produces most efficiently and buy the goods that it produces less efficiently from other countries, even if it can produce those goods more efficiently itself.
-The ability of an economy to produce a given good or service in a more efficient and economically manner than its competitors.
- Ability to produce a particular good or service at a lower opportunity cost than its trading partners.
-Potential world production is greater with unrestricted free trade than it is with restricted trade.
- The theory of comparative advantage suggests that trade is a positive-sum game in which all countries that participate realize economic gains.
Heckscher-Ohlin Theory
States that countries export what they can most easily and abundantly produce.
Krugman’s New Trade Theory
New trade theory suggests that governments might have a role to play in promoting new industries and supporting the growth of key industries.
Adam Smith’s Absolute Advantage
Countries should specialize in the production of goods for which they have an absolute advantage and then trade these goods for goods produced by other countries.
- Both countries benefit from specialization and trade.
Mercantilism (mid 16th century)
An economic practice by which governments used their economies to augment state power at the expense of other countries.
It is in a country’s best interest to maintain a TRADE SURPLUS—to EXPORT MORE THAN IT IMPORTS.
- Advocates government intervention to achieve a surplus in the balance of trade.
- Mercantilism views trade as a zero-sum game—one in which a gain by one country results in a loss by another.
Why many economists believe that unrestricted free trade between nations will raise the economic welfare of countries that participate in a free trade system?
- Simple world with 2 countries and 2 goods
- No transportation costs
- No differences in price of resources
- Resources can move freely
- Constant returns to scale
- Each country has a fixed stock of resources and free trade does not change the efficiency with which a country uses its resources.
- No effects of trade on income distribution within a country.
Trade can result in dynamic changes
- Free trade might increase a country’s stock of resources as increased supplies of labor and capital from abroad become available for use within the country.
- Free trade might also increase the efficiency with which a country uses its resources.
- Dynamic gains in both the stock of a country’s resources and the efficiency with which resources are utilized will cause a country’s PPF to shift outward.
What happens when a rich country (U.S.) enters into a free trade agreement with a poor country (China) that rapidly improves its productivity after the introduction of a free trade regime?
-Lower prices may not make up for lower wages in the U.S.
-Historically, free trade has benefited wealthy countries.
-Protectionist measures may be harmful.
Evidence for the link between trade and growth.
Countries that adopt a more open stance towards international trade enjoy higher growth rates than those that close their economies to trade.
Factor Endowment
The amount of land, labor, capital, and entrepreneurship that a country possesses and can exploit for manufacturing.
- Countries with a large endowment of resources tend to be more prosperous than those with a small endowment.
- Comparative advantage arises from differences in national factor endowments.
- Countries will export those goods that make intensive use of factors that are locally abundant.
- Countries will also import goods that make intensive use of factors that are locally scarce.
Leontief Paradox
A country with a higher capital per worker has a lower capital/labor ratio in exports than in imports.
- Disputes Ohlin Theory
Product Life Cycle Theory
It is defined as 4 distinct stages:
- Product introduction
- Growth
- Maturity
- Decline
Economies of Scale
Cost advantages gathered by companies when production becomes efficient. Companies can achieve economies of scale by increasing production and lowering costs.
- Trade can increase the variety of goods available to consumers and decrease the average cost of those goods.
- In those industries in which the output required to attain economies of scale represents a significant proportion of total world demand, the global market may be able to support only a small number of enterprises.
World Without Trade
The variety of goods that a country can produce and the scale of production are limited by the size of the market.
World WIth Trade
- Individual national markets are combined into a larger world market.
- Each nation can increase the variety of goods available to its consumers and lower the costs of those goods.
First-mover advantages
Can gain a scale-based cost advantage that later entrants find almost impossible to match.
Implications of New Trade Theory
- Nations may benefit from trade even when they do not differ in resource endowments or technology.
- A country may predominate in the export of a good simply because it was lucky enough to have one or more firms among the first to produce that good.
- Luck, entrepreneurship, and innovation give a firm first-mover advantages.
4 broad attributes of a nation shape the environment in which local firms compete:
The determinants of national competitive advantage: Porter’s diamond:
- Factor endowments
- Demand conditions
- Related and supporting industries
- Firm strategy, structure, and rivalry
2 additional variables can influence the national diamond:
- Chance
-Government
Factor Endownments - Basic Factors
Natural resources, climate, location, demographics.
Factor Endownments - Advanced Factors
Communication infrastructure, sophisticated and skilled labor, research facilities, and technological know-how.
- Advanced factors are a product of investment by individuals, companies, and governments.
Demand Conditions
Firms gain competitive advantage if their domestic consumers are sophisticated and demanding.
