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LECTURE 7

International Trade and Development

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The Basis for Trade• International trade is the exchange of goods and services

between countries.• International trade greatly enhances living standards for all

parties involved because: (a) every country lacks some vital resources that it can get only by trading with others. (b) each country’s climate, labor force, and other

endowments make it a relatively efficient producer of some goods

and an inefficient producer of other goods. (c) specialization permits larger outputs and can therefore offer economies of large-scale production.

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Specialization

• Specialization means that a country devotes its energies and resources to only a small proportion of the world’s productive activities.

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Theory of Comparative Advantage

• According to the law of comparative advantage, each country should specialize in producing the good with the lower opportunity cost.

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Example

• Assume that there are only 2 countries: (a) Malaysia with a labor force of 100 million workers and (b) Japan with a labor force of 200 million workers.• Assuming at a given technology and that labor is

fully and efficiently employed; (a) each worker in Malaysia can produce either 6 units of food or 3 units of clothing per day; where else (b) each worker in Japan can produce only 1 unit of

food or 2 units of clothing per day.

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• From the example above, since each Malaysian worker can produce both more food and clothing per day than each Japanese worker, Malaysian workers have an absolute advantage in the production of both goods.

• However, this does not mean that Malaysian workers have a comparative advantage in the production of both goods too.

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• If all 200 million Japanese workers specialize in food, they can produce million units of food per day.

• On the other hand, if they were to specialize in clothing, total output is million.

• This means that the opportunity cost of 1 more unit of food is units of clothing.

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• How about the opportunity cost of producing 1 more unit of food for a Malaysian worker?

• Which country has a comparative advantage in the production of food?

• Which country has a comparative advantage in the production of clothing?

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Trade Restrictions

• Trade restrictions are barriers to impede or block free trade among nations. They usually benefit domestic producers but harm domestic consumers.

• Consumer surplus – the difference between the maximum sum of money that consumers are willing to pay and how much they actually pay for the good / service.

• Producer surplus – the difference between the actual sum of money producers receive and the minimum sum they would accept for the quantity sold.

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Tariff Import Export quota

subsidy

Types of Trade Restrictions

Low-interest loans Domestic content

to domestic buyers requirements

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Tariffs

Tax on Imports2 types:

Specific tariff Ad valorem * Tariff based on the * A percentage

of the number of goods price of

imports at imported. the port of

entry.

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• Import Quotas Legal limits on the quantity of a particular

commodity that can be imported.

• Export Subsidy Subsidies given to firms to encourage them to

export.

• Low-interest Loans Loans given out to foreign buyers to promote

exports of large capital goods.

• Domestic Content Requirements A certain percentage of a final good’s value must

be produced domestically.

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Why Protectionism?

• Military Self-Sufficiency• Increased Domestic Employment• Diversification for Stability• Infant Industry• Protection against Dumping• Cheap Foreign Labor

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Free Trade

• Through free trade based on the principle of comparative advantage, the world economy can achieve a more efficient allocation of resources and a higher level of material well-being than it can without free trade.

• Benefits of free trade:• Promotes competition and deters

monopoly.• It links national interests and breaks down

national animosities.

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Examples• Japan-Malaysia Economic Partnership Agreement

(JMEPA): (a) Malaysia’s main exports – palm oil, polymer of ethylene, plywood, lauric and strearic acids. (b) Japan’s main products – CKD parts, car parts, excavators, televisions. (c) Exports to Japan, approved investments from Japan

have increased

• Malaysia-Pakistan Free Trade Agreement (MPFTA)

• ASEAN – China Free Trade Agreement (ACFTA)