THEORIES OF
INTERNATIONAL TRADE
Group 8 - Topic 6
INTERNATIONAL
TRADE
is the exchange of goods and
services among countries.
INTERNATIONAL
TRADE
This exchange is vital for allowing countries to
access products that are not readily
available domestically or are too expensive
to produce themselves.
INTERNATIONAL
TRADE
International trade operates under the same
basic economic principles that govern local
market exchanges.
These are goods or
services that a
country sells to
other countries.
These are goods or
services that a
country buys from
other countries.
means "relative" or "in relation
to something else."
we're comparing the opportunity
cost of producing one good or
service instead of another
of Comparative Advantage in Trade
Specialization is the first major benefit. When countries or
firms specialize in the goods and services they produce
most efficiently, they can achieve greater productivity.
Rather than trying to produce everything, they can
concentrate on the areas where they have the greatest
comparative advantage.
This leads to increased production. Through
specialization, total output increases, which benefits the
entire economy. This is the key reason why trade works:
countries can trade what they produce efficiently for what
others produce more efficiently, leading to economic gains
for all parties involved.
Additionally, comparative advantage leads to lower prices
and better profit margins. By focusing on what they’re best
at, producers can offer goods at lower prices, which
increases their sales and strengthens their competitive
position in the global market.
of Comparative Advantage in Trade
Country A is good at producing computers and
textiles, but it’s more efficient at making
computers.
It takes 10 hours to produce 1 computer and
20 hours to produce 1 unit of textiles.
Country B is also good at producing
computers and textiles, but it’s more efficient
at making textiles.
It takes 15 hours to produce 1 computer and
10 hours to produce 1 unit of textiles.
of Comparative Advantage in Trade
Producing 1 computer costs it 10 hours of
labor.
In those 10 hours, it could have produced
0.5 units of textiles (since it takes 20 hours
to produce 1 textile).
So, the opportunity cost of 1 computer for
Country A is 0.5 units of textiles.
Producing 1 computer costs it 15 hours of
labor.
In those 15 hours, it could have produced
1.5 units of textiles (since it takes 10 hours
to produce 1 textile).
So, the opportunity cost of 1 computer for
Country B is 1.5 units of textiles.
Trade Benefits:
Country A should specialize in making computers
and export them to Country B.
Country B should specialize in making textiles and
export them to Country A.
By specializing in what each country is most
efficient at and trading, both countries can end up
with more goods than if they tried to make
everything themselves. This is the core idea of
comparative advantage in international trade.
ABSOLUTE
ADVANTAGE
A concept in economics that refers to
the ability of an individual, company,
or country to produce a good or
service more efficiently than others,
using fewer resources or in less time.
When an entity has an absolute
advantage in producing a particular
good, they can produce it at a lower
cost or with higher productivity
compared to competitors.
EXAMPLE OF
ABSOLUTE
ADVANTAGE
Electronics and Agriculture: Japan
VS. Argentina
- Japan has an absolute advantage
in producing high-tech electronics
due to its skilled labor force and
advanced technology. Argentina
has an absolute advantage in
producing beef due to its vast
pastures and favorable climate.
WHY ABSOLUTE
ADVANTAGE IS
USEFUL IN TRADE?
- Absolute advantage is useful in
trade because it highlights where
natural efficiencies exist, setting
the foundation for how countries
can optimize production. When
countries focus on producing
goods where they have an
absolute advantage, the total
global output increases, leading
to more goods and services
available to everyone.
THREE FAMOUS
INTERNATIONAL
TRADE THEORIES
Ricardian Model
- Developed by economist David
Ricardo, is an economic theory that
explains the benefits of international
trade through the concept of
comparative advantage.
-This model shows that even if a
country has an absolute disadvantage
in producing all goods, it can still benefit
from trade by focusing on producing
goods in which it has the lowest
opportunity cost relative to other goods
THREE FAMOUS
INTERNATIONAL
TRADE THEORIES
Heckscher-Ohlin Model
- Also known as the H-O Model,
developed by two Swedish economists
Eli Heckscher and his student Bertil
Ohlin is a theory in international trade
that explains how and why countries
trade based on their relative
abundance of production factors (such
as labor, capital, and land).
- This model emphasizes a country’s
factor endowments as the primary
determinant of trade patterns.
THREE FAMOUS
INTERNATIONAL
TRADE THEORIES
Gravity Model of Trade
- First developed by Jan Tinbergen, is
an economic model that predicts
bilateral trade flows between two
countries based on the idea that larger
economies and closer proximity lead to
more trade between them.
- This model is inspired by Newton’s law
of gravity. In the Gravity Model of Trade,
economic "mass" and distance play
similar roles in determining trade
volume.
TRADING FLOWS:
EXPORTS AND IMPORTS
IMPORTS EXPORTS
goods and services goods and services
produced by the produced by the
foreign sector and domestic economy and
purchase by the purchased by the
domestic economy. foreign sector.
TOP IMPORTERS OF GOODS IN 2023
The world's largest importers of commodities in 2023:
USA - 14.6% of the world imports ($3.16 trillion)
China - 11.8% ($2.55 trillion)
Germany - 6.81% ($1.46 trillion)
United Kingdom - 3.66% ($791 billion)
France - 3.6% ($777 billion)
https://trendeconomy.com/data/commodity_h2/TOTAL
WHAT IS NET EXPORTS?
are the difference between the goods flowing
out of the domestic economy and goods and
services flowing into the domestic economy.
BALANCE OF
TRADE
WHAT IS A BALANCE
OF TRADE?
the difference in value over
a period of time between a
country’s import and
exports of goods and
services
TRADE SURPLUS
is an economic measure of a positive balance
of trade, where a country's exports exceed its
imports.
TRADE DEFICIT
is an economic condition when a country imports
more goods than it exports.
DETERMINANTS
OF BALACE OF
TRADE
1 2 3
FOREIGN DOMESTIC FOREIGN
EXCHANGE AND FOREIGN PRICE
RATE INCOMES LEVEL
Foreign
exchange
rate
foreign exchange is the currency
and other financial instrument
used to conduct transaction and
make payments in the foreign
sector of a given country.
Factors Affecting Foreign
Exchange Rates:
01 02 03 04
Economics Political Market Cental Bank
Indicators Stability Sentiment Intervention
Why foreign Exchange Rates Matter?
International Trade: Businesses need to understand exchange
rates to price good and services in foreign markets and to convert
foreign earnings into their domestic currency.
Investing: Investors who invest in foreign market need to consider
exchange rate fluctuations, as they can impact the value of their
investment.
Travel: Tourists need to exchange their currency to the local
currency of the country they are visting.
Domestic
and Foreign
Incomes
Domestic Income and Foreign
Income refer to the sources of
earnings or revenue.
Domestic Income: 1. Income earned within a
country's borders.
Foreign Income: 1. Income earned outside a
country's borders.
Impact of domestic income
Contributes to the country’s GDP (Gross Domestic Product)
Fuels domestic economic growth and development
Funds government revenue through taxes
Impact foreign income
Contributes to the country’s GNI (Gross National Income)
Can boost a country’s exchange reserves
Can influence a country’s balance payments
Foreign
price level
The foreign price level refers to the
general level of prices in a foreign
country. It's a measure of the cost
of goods and services in a specific
economy, relative to a domestic
economy.
1.) International Trade
2.) Exchange Rate
Purchasing power
Parity (PPP) Determination
Price Inflation
Competitiveness Differential
3.) Investment 4.) Consumer
Decisions Behavior
Profitability Purchasing
Power
Why is it important to
understand the foreign price
level?
How is it measured?
The foreign price level is often measured
using a price index, such as the Consumer
Price Index (CPI) or the Producer Price Index
(PPI).
MANAGED
FLEXIBLE FIXED
FLEXIBLE
EXCHANGE EXCHANGE
EXCHANGE
RATE RATE RATE
Flexible
Exchange Rate
A flexible exchange rate, also termed floating
exchange rate, is an exchange rate
determined through the unrestricted
interaction of supply and demand in the
foreign exchange market.
1 Market-determined
KEY
2
CHARACTERISTICS Fluctuating exchange
OF A FLEXIBLE
EXCHANGE RATE rates
SYSTEM
3 No government
intervention
Advantages
1.) Automatic adjustment
2.) Monetary policy
independence
3.) Reduced vulnerability to
external shocks
Disadvantages
1.) Exchange rate volatility
2.) Increased risk for
exporters and importers
3.) Potential for speculative
attacks
Fixed Exchange
Rate
a fixed exchange rate is an
exchange rate that is established at
a specific level and maintained
through goverment action (usually
through monetary policy action of a
central bank.)
Advantages
1 2 3
Stability Reduced Attracting
inflation foreign
investment
Disadvantages
1 2 3
Loss of
Vulnerability Potential for
monetary
to external currency
policy shocks crises.
independence
Managed
Flexible
Exchange Rate
A managed flexible exchange rate, what is
also termed a managed float, is a
exchanged rate that is generally allowed to
adjust due to the interaction of supply and
demand in the foreign exchange market
but it occasional intervention by goverment.
1 Market-determined
KEY
2
CHARACTERISTICS
OF A MANAGED Central bank intervention
FLEXIBLE
EXCHANGE RATE
SYSTEM
3 Limited flexibility
Flexibility Stability
Advantages
Monetary policy
independence
Risk of
Uncertainty inconsistent
policy
Disadvantages Transparency
BALANCE OF
PAYMENTS (BOP)
A comprehensive set of accounts that
track all sorts of payments coming in to
and going out of a nation for a wide variety
of reasons.
Difference between all payments coming
into a nation and those going out of a
nation.
BOP
COMPONENTS
Current Account (CA) Capital Account (KA) Financial Account (FA)
Trade in goods Direct Investment Direct Investment abroad
Trade in services Portfolio Investment Portfolio Investment abroad
Income Other investment Other investment abroad
A country’s BOP is in equilibrium
when : CA + KA + FA = 0
SURPLUS: CA + KA + FA > 0
DEFICIT : CA + KA + FA < 0
MEASURING a summary of all the international
transactions of a country and its citizens
OF BALANCE during a specified period of time.
OF PAYMENTS
Harvey and Johnson states that BOP records all
economic transactions between residents of a
country and the rest of the world.
The balance of payments of a country may be
expressed through the following relation:
B=R–P
where:
B - balance of payment
R - receipts
P - payments
IS BALANCE OF
PAYMENTS ALWAYS IN
BALANCE?
In the accounting sense, the BOP remains always in a state of balance. This can be shown on
the assumption that an economic system is in a state of equilibrium and the aggregate
income (Y) is exactly equal to the aggregate expenditure. Alternatively, it may be assumed
that the total injections are exactly equal to total withdrawals in the system.
Total injections : Total withdrawals:
Investment (I) Savings (S)
Government expenditure (G) Taxes (T)
Exports of goods, services and capital (X) Imports of goods, services and capital (M)
I+G+X=S+T+M
(X – M) = (S -I) + (T – G)
INTERNATIONAL
TRADE HAS BOTH
WINNERS LOSERS
CONSUMERS IN THE PRODUCERS IN THE
BUYING (IMPORTING) BUYING (IMPORTING)
NATION NATION
PRODUCERS IN THE CONSUMERS IN THE
SELLING(EXPORTING) SELLING(EXPORTING)
NATION NATION
THANKYOU
