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Theories of Trade
Trade is BIG Business in Canada
Canadian Exports account for over 40% of our GDP - $423 billion dollars
Approximately 1 in 4 jobs are directly dependent on exports in Canada
Exports only account for about 10% of the GDP in the U.S
Canada’s Big Five
Top 5 Exports Petroleum - $63.7 billion Passenger cars - $36.6 billion Car parts and accessories - $15.6 Aluminum products - $8 billion Lumber - $7 billion
The Key Question in this Chapter
Why get someone else to do it when you can do it yourself?
Why can one country produce products at a lower price?
Differences in Resource Endowment– Land, labour and capital
Differences in Technology– Techniques to turn resources into products
Existence of Economies of scale– The more you produce the cheaper it is
Government policies– Taxes breaks and subsidies to certain industries
Decisions Decisions
A country has limited resources. Therefore must CHOSE what products it
produces and which it trades How does it choose?
What’s Opportunity Cost Again?
Opportunity Cost
What must be given up for making one choice over another
– DVD vs. Subway all week– Driver’s Ed vs. more expensive insurance– Art Gallery vs. Casino– Rent vs. Own
Every decision has consequences– What do you gain?– What do you loose?
Opportunity Cost
What would you do with $2000– What are your priorities?– List the at least three alternatives?
Spring Break Trip to Cancun Investment Save for college or university
Opportunity Cost
NOTE: Opportunity cost of a decision is only the next best option not all of them
Ex If you choose to spend $2000 on a trip the opportunity cost of the $2000 is either
– enjoyment of the Blu-Ray system OR – the savings for school (+ interest)– Why? You only have $2000
Opportunity Cost Production Possibility Curve
Imagine a country that can… Only produce two goods,
1. Computers (Consumer Good)
2. Tractor (Capital Good)
Opportunity Cost Production Possibility Curve Country A
Production Possibility Tractors Computers
OC (Computers)
OC (Tractors)
A 0 1000
B 100 800
C 200 600
D 300 400
E 400 200
F 500 0
Opportunity Cost Production Possibility Curve Country A
Production Possibility Tractors Computers
OC (Computers)
OC (Tractors)
A 0 1000 100
B 100 800 200 100
C 200 600 200 100
D 300 400 200 100
E 400 200 200 100
F 500 0 200
Opportunity Cost Production Possibility Curve Country A
Opportunity Cost
0
100
200
300
400
500
600
700
800
900
1000
0 100 200 300 400 500 600 700 800 900 1000
Tractors
Co
mp
ute
rs
Production Possibility Curve (PPC)
PPC represents all of the consumption possibilities in country A
What is the maximum number of tractors that can be built?– 500
What is the maximum number of Computers that can be built?– 1000
Opportunity Cost Country A
The Opportunity cost is expressed in the good given up (i.e. 100 tractors) not dollars
What is the opportunity cost of increasing the production of tractors from 0 to 300?– 600 Computers
What is the opportunity cost of increasing the production of Computers from 0 to 600?– 300 Tractors
Opportunity Cost Country A
The opportunity cost of one tractor is:
– 2 Computers
The opportunity cost of one Computer is:
– 0.5 Tractors
Opportunity Cost Production Possibility Curve Country B
Production Possibility Tractors Computers
OC (Computers)
OC (Tractors)
A 0 500
B 200 400
C 400 300
D 600 200
E 800 100
F 1000 0
Opportunity Cost Production Possibility Curve Country B
Production Possibility Tractors Computers
OC (Computers)
OC (Tractors)
A 0 500 200
B 200 400 100 200
C 400 300 100 200
D 600 200 100 200
E 800 100 100 200
F 1000 0 100
Opportunity Cost Production Possibility Curve Country B
Opportunity Cost
0
100
200
300
400
500
600
700
800
900
1000
0 100 200 300 400 500 600 700 800 900 1000
Tractors
Co
mp
ute
rs
Production Possibility Curve (PPC) B
PPC represents all of the consumption possibilities in country A
What is the maximum number of tractors that can be built?– 1000
What is the maximum number of Computers that can be built?– 500
Opportunity Cost Country B
The Opportunity cost is expressed in the good given up (i.e. 100 tractors) not dollars
What is the opportunity cost of increasing the production of tractors from 0 to 400?– 200 Computers
What is the opportunity cost of increasing the production of Computers from 0 to 300?– 600 Tractors
Opportunity Cost Country B
The opportunity cost of one tractor is:
– 0.5 Computers
The opportunity cost of one Computer is:
– 2 Tractors
Comparative advantage
Comparative Advantage:A person, corporation or country has a comparative advantage when they perform an activity at a lower opportunity cost than anyone else
Which country has a comparative advantage in the production of tractors?
Which country has a comparative advantage in the production of computers?
Comparative advantage
Country A The opportunity cost of
one Computer is:– 0.5 Tractors
The opportunity cost of one tractor is:
– 2 Computers
Comparative advantage in the production of Computers
Country B The opportunity cost of
one Computer is:– 2 Tractors
The opportunity cost of one tractor is:
– 0.5 Computers
Comparative advantage in the production of Tractors
Scenario 1 No Trade
Country A Maximum Consumption
– Computers: 1000
OR– Tractors: 500
Country B Maximum Consumption
– Computers: 500OR– Tractors: 1000
Scenario 2 Specialization and Trade
Country A
What should country A specialise in?
What do they have a lower opportunity cost
Country BWhat should country B
specialise in? What do they have a
lower opportunity cost
Scenario 2 Specialization and Trade
Opportunity Cost Tractor
Opportunity Cost Computers
Country A 2 Computers 0.5 Tractors
Country B 0.5 Computers 2 Tractors
Scenario 2 Specialization and Trade
Country A
Specialization Computers– 1000 Computers– 0 Tractors
Country B Specialization Tractors
– 0 Computers– 1000 Tractors
Opportunity Cost Production Possibility Curve Country B
Opportunity Cost
0
100
200
300
400
500
600
700
800
900
1000
0 100 200 300 400 500 600 700 800 900 1000
Tractors
Co
mp
ute
rs
Country A
Country B
Consumption Possibilities for both
A and B
Conclusion
Countries should produce goods that they have a comparative or absolute advantage in .
Specializing and trading will allow for greater world wide consumption possibilities
Build what you do best and trade the rest
What happens when country A specializes in Computers and B in Tractors?
Opportunity Cost
0
100
200
300
400
500
600
700
800
900
1000
0 100 200 300 400 500 600 700 800 900 1000
Tractors
Co
mp
ute
rs
Country A
Country B
Consumption Possibilities for both
A and B
Absolute Advantage
Absolute Advantage refers to the ability of a party (an individual, firm, or country) to produce more of a good or service than competitors, using the same amount of resources
CHEAPER THAN EVERYBODY
Comparative and Absolute Advantage In Trade Clip
Quick Review of Theories of Trade
1. Absolute Advantage:1. Based on the Theories of Adam Smith
2. Countries should specialise in the products that they produce most EFFICIENTLY (lower input cost)
Review Theories of Trade
2. Comparative Advantage:1. Based on the Theories of David Ricardo
2. Countries should specialise in the products that they produce RELATIVELY EFFICIENTLY (lower opportunity cost – comparative advantage)
3. Comparative advantage is based on how productively it uses it’s resources1. Especially Labour productivity
Gains from trade
Specialization and Trade results in a greater variety and quantity of goods that can be consumed without increasing inputs
WTO – World Trade Organization
Is the main organization promoting trade among nations
Trade liberalization:– Production is allocated based on comparative
advantage– Tariffs are decreased– Protectionism is discouraged
Non-Tariff Barriers Dumping Subsidies
All members have Most Favoured Nation (MFN) status - Reciprocal
WTO – World Trade Organization
Progress at the WTO has slowed Groups around the world have developed
their own trade agreements Multilateral – More than two nations Bilateral – Two Nations Agreements have varied in terms of
economic integration
What is WTO?
Trade Liberalization vs Protectionism
Trade Liberalization: Government policies that aim to facilitate trade
Protectionism: Government policies that aim to protect local industry by limiting trade
Non Tariff Barriers
Quotas: Only a certain quantity of a product can be imported into the country tariff free (or at all)– Example Milk in Canada
Tariff bellow quota: 3% Tariff above quota: 274.5%
Import Licensing Requirements: Permission to import into a country– Example Weapons
Non Tariff Barriers
Local Content Requirements: Multinational is required to use a certain proportion of locally made parts and components, employment
Embargoes: prohibition of commerce and trade with a particular country, in order to isolate it
http://www.cbc.ca/video/#/Shows/The_National/World/ID=1503300323
Non Tariff Barriers
Documentation Requirements: Bureaucratic red tape that increases the cost and slows down the import process
Standards: Government standards regarding safety, packaging and labelling
Barriers to Trade
Tariffs Currency Fluctuations Investment Regulations Environmental Restrictions
Tariffs
From the Arabic تعرفة, translit. T’ariffa: "fee to be paid“
Tariffs are form of PROTECTIONISM– Almost always applied to imported goods– Restrict imports of products that could compete
with local manufacturers (protects jobs and domestic business…sometimes).
– Tariffs are a tax on the value of imported goods– Different ways of calculating
No Tariffs
Canadian Shirt Cost for Retailer: $50 Price for consumer:
$100
Indonesian Shirt Cost for Retailer: $40 Shipping costs: $5 Price for consumer: $90
Tariffs
Canadian Shirt Cost for Retailer: $50 Price for consumer:
$100
Indonesian Shirt Cost for Retailer: $40 Tariff (22%): $8.80 Shipping costs: $5 Price for consumer:
$108
Heckscher-Ohlin Theory
Built on Ricardo’s idea of Comparative advantage
Argued that country’s comparative advantage was due to resource endowment– Land– Labour– Capital
Countries will export goods that make use of those factors that are locally abundant
Import goods that make use of factors that are locally scarce
Heckscher-Ohlin Theory
Example– Textiles require extensive use of labour Canada
imports textiles– Aluminium requires extensive use of Capital
(electricity) and Land (Ore) Canada exports aluminium
New Trade Theory
Built on Heckscher-Ohlin idea of Comparative advantage Proposed by Paul Krugman A country can achieve a comparative advantage by:
– Economies of scale (building a lot)– First Mover advantage (being the first to develop a product)– Building a strong brand
Explains why countries with similar factor endowments trade with each other
– Ex France and Germany
Advantages
Absolute Advantage: Producing at a lower cost than everyone else– Country A produce T-Shirt for $0.25– Country B produce T-Shirt for $0.50
Comparative Advantage: Producing at a lower opportunity cost than anyone else
Competitive Advantage: Producing better than everyone else
Competitive advantage
Being better than the competition– Better Pricing
Manufacturing of clothing in Vietnam– Superior Products
Televisions from Japan– Better service
Air travel with UAE– Higher quality
Belgian Chocolate– Uniqueness
Canadian Polar Bear Diamonds
– BRAND Loyalty through Advertising and Brand Experience
Competitive advantage
What factors are important in a country to produce companies that can compete internationally?
Competitive advantage
Both countries and companies strive to achieve a competitive advantage
Countries measure how successful they are with GDP: Gross Domestic Product– The total value of all goods and services
produced in a time period
Companies measure how successful they are with profit
Achieving Competitive Advantage
Quality and quantity of natural resource– Oil, gas, water
Strength of country’s currency and its exchange rate– Currencies that are relatively weak help exports– Currencies that are relatively strong help imports
Infrastructure– Quality of roads, IT networks, bridges, ports– Ability to get goods to Market
Research and development (R&D)– Investing in R&D allows for the development of new products
and innovations– Ex Canada has the NRC National Research Council
Achieving Competitive Advantage
Workforce characteristics– Number of workers, education of workers, level of unionization– Acceptable wages
Social characteristics (Ethics)– Work ethic, social ethics (rule of law), health care standard of living
Entrepreneurship– Willingness of people to take risk to start venture– Presence of Venture Capital (VC)
Government involvement– Corporate tax rates– Free trade agreements– Political stability– Investment in strategic industries– Business friendly laws
Productivity
Factors of production– Land– Labour
Physical Labour Mental/Knowledge Labour Entrepreneurship
– Capital Money Capital Capital Equipment / Technology
Productivity
The amount of work that is accomplished in a unit of time using the factors of production
Ex – Both Bob and Bill drive a similar snow plows
Amount of labour is the same Amount of Capital is the same
– In one hour Bob can clear 10 drive ways– In one hour Bill can clear 8 drive ways – BOB IS MORE PRODUCTIVE
Productivity in business
Goal of business– To be profitable
Productivity is key to profitability Assessing productivity and setting
productivity goals will help a business measure the relationship between– Inputs (People, Machines, Parts, Supplies, Raw
materials etc)– Outputs (Products or services)
Factors Influence a Countries Productivity
1. Efficient use of human resources
2. Costs associated with labour1. Wages/Salaries
2. Benefits
3. Insurance and worker’s safety costs
3. Accessibility of natural resources
4. Quality and availability of technology
5. Quality and availability of government services1. Education
2. Healthcare
3. Business support
4. Amount of bureaucracy (red tape)
Factors Influence a Countries Productivity
6. Quality of business leadership1. Quality business schools
2. Ability to attract world class talent
7. General work ethic and lifestyle1. Work life balance important for long term productivity
2. Sleep
8. Efficiency of organizational structures1. Are plants well organized
2. Are businesses designed properly
9. Size of markets for countries goods1. Larger the market = economies of scale
10. Support given to R&D
