CHAPTER I INTRODUCTION TO INTERNATIONAL TRADE

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CHAPTER I INTRODUCTION TO INTERNATIONAL TRADE

• Classical Theories of International Trade
• Mercantilism
• Absolute Advantage
• Comparative Advantage
• Interactions Between an Exporter and an Importer

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Mercantilism

• 16th to 18th centuries in Europe
• More exports than imports
• Trade surplus------gt More gold and silver
• Protectionism------gt Reduced international
  trade

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Absolute Advantage

• Adam Smith 1776
• An Inquiry into the Nature and Causes of the
  Wealth of Nations
• Goods and services available to citizens rather
  than gold and silver.
• Should not produce all items a country needs
• Should produce export goods at an absolute
  advantage and import goods not at an absolute
  advantage

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Absolute Advantage

• Free Trade---gt International division of labor
  ---gtMore output to all trading partners
• Natural Advantage Climate and natural resources
• Acquired Advantage Product and process technology

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Absolute Advantage
Two countries Mexico USA
Resources available 100 100
To produce 1 ton of tomatoes 4 10
To produce 1 ton of beans 20 2
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Absolute Advantage When each country uses a
half of its resources,50, per product
Two Countries Mexico USA Total
Tomato production 12.50 5.00 17.50 M/T
Bean production 2.50 25.00 27.50 M/T
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Absolute Advantage

• When each country uses all resources,100, only
  for a product at an absolute advantage

Two Countries Mexico USA Total
Tomato production 25.00 0.00 25.00 M/T
Bean production 0.00 50.00 50.00 M/T
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Absolute Advantage
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Comparative Advantage

• David Ricardo 1817
• On the Principles of Political Economy
  Taxation
• When a country does have or does not have an
  absolute advantage on two products,
• Produce and export one product at a comparative
  advantage, relatively greater advantage than
  other product.
• Import the other product not at a comparative
  advantage.
• Gives up less efficient production allocates
  more resources to more efficient production due
  to limited resources
• Basis for economic development of less developed
  countries

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Comparative Advantage

• Productivity comparison between two countries

Two countries Mexico USA
Resources available 100 100
To produce 1 ton of tomatoes 2 10
To produce 1 ton of beans 4 8
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Comparative Advantage

• When each country uses a half of its
  resources,50, per product without trade

Two Countries Mexico USA Total
Tomato production 25.00 5.00 30.00 M/T
Bean production 12.50 6.25 18.75 M/T
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Comparative Advantage

• When Mexico produces only tomatoes and USA
  produces only beans and trade

Two Countries Mexico USA Total
Tomato production 50.00 0.00 50.00 M/T
Bean production 0.00 12.50 12.50 M/T
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Comparative Advantage

• To make a comparison easier, if Mexico produces
  30 tons of tomatoes by using 60 resources

Two countries Mexico USA Total
Tomato production 30.00 0.00 30.00 M/T
Bean production 10.00 12.50 22.50 M/T
Increased production 3.75 (22.50-18.75) M/T of bean Increased production 3.75 (22.50-18.75) M/T of bean Increased production 3.75 (22.50-18.75) M/T of bean Increased production 3.75 (22.50-18.75) M/T of bean
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Comparative Advantage

• If Mexico produces 6.25 tons of beans by using 25
  resources to make the total production of beans
  18.75 tons

Two countries Mexico USA Total
Tomato production 37.50 0.00 37.50 M/T
Bean production 6.25 12.50 18.75 M/T
Increased production 7.5(37.50-30.00) M/T of tomato Increased production 7.5(37.50-30.00) M/T of tomato Increased production 7.5(37.50-30.00) M/T of tomato Increased production 7.5(37.50-30.00) M/T of tomato
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Assumptions Absolute and Comparative Advantage

• Limited resources
• No transportation costs
• No mobility of resources between countries

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Interactions Between Exporter Importer
Exporter Overseas Importer U.S.A.
Inquiry lt-----------------------------------------------
Offer(Quotation) ----------------------------------------------gt
Acceptance lt-----------------------------------------------
Order lt-----------------------------------------------
Letter of Credit lt-----------------------------------------------
Shipping Docs -----------------------------------------------gt
Payment lt-----------------------------------------------
Customs Clearance X
Distribution X