INTERNATIONAL TRADE

ECON 4Q

Why do countries trade?

Countries trade because it is beneficial. Economic theory tells us that whenever nations trade, economic gains are achieved.
The Basis for Trade
1. Specialization
devoting all resources for the production of the product where one has relative efficiency.
promotes the efficient use of resources like time and endowments.
2. Absolute Advantage (AA)
A country has absolute advantage in one commodity over another country if that country can produce the
commodity more efficiently (higher AP) than the other country.
E.g.
Q of corn and cars by a worker per day
corn
cars
Philippines
10
2
Japan
5
10
w/o trade: each country uses 10 units of labor (L) for each product (co=corn; ca=cars)
Lco
Qco
Lca
Qca
Philippines
10
100
10
20
Japan
10
50
10
100
w/ trade: each country decides to use all L in one product (specialization)
Lco
Qco
Lca
Qca
Philippines
20
200
0
0
Japan
0
0
20
200
gains w/ trade:
Qco for Philippines = 100 vs. 20 w/o trade
Qca for Japan = 100 vs. 50 w/o trade
3. Comparative Advantage (CA)
A country has comparative advantage in the production of a commodity if that country can produce that
commodity more efficiently (or at a lower opportunity cost) than another commodity compared to another
country.
Occurs when a country has absolute advantage on both goods.
E.g.
Q of corn and cars by a worker per day
corn
okra
Philippines
8
4
Japan
1
3

opp.cost
2
0.3

Philippines has AA on both goods.

Japan however has lower opportunity cost in producing okra (gives up only 1 corn to produce 3 more okra).
Philippines has CA on corn while Japan has CA on okra. The Philippines then exports corn and imports okra.
Law of Comparative Advantage countries specialize and export g/s where it has CA and import those
commodities where it does not have CA.

Multilateral Trade
many goods-many countries case (trading between one country and the rest of the world)
ranking goods from highest CA to lowest CA.
when demand is high & if country has CA in that good, country exports that good.
drawback: displacement of labor
FOREIGN EXCHANGE
Foreign Exchange Market market in w/c currencies of different countries are traded and foreign exchange rates are
determined. Foreign currencies are traded at the retail level in many banks and firms
specializing in that business.
Exchange rate price of a foreign currency in terms of a domestic currency. (e.g. P/$ rate, price of $ in P)
Types of Exchange Rates
1. Flexible Exchange Rate or floating exchange rate; completely flexible and moves purely under the influence of
supply and demand.
2. Fixed Exchange Rate governments specify the rate at which their currency will be converted into other
currencies.
Terminology for Exchange Rate Changes
1. Depreciation a fall in the price of one currency in terms of one or all other currencies.
2. Appreciation a rise in the price of a currency in terms of another currency.
3. Devaluation confined to situations in w/c a country has officially set or pegged its exchange rate relative to one
or more other currencies.
4. Revaluation occurs when the official price is raised.
(P per $ )
exchange
rate

- (refer to graph) A decrease in demand for dollars

leads to dollar depreciation, and of course, peso appreciation.

Do
D1
Foreign exchange (Q of $)
DEVELOPMENT ECONOMICS
What is Economic Development?
Economic development as defined by Myrdal (1968) is the upward movement of the entire social system. Or the
attainment of a number of ideals of modernization such as improved institutions and attitudes, a rise in productivity,
modern knowledge, and a system of policy measures that can remove the undesirable conditions in the system that have
perpetuated a state of underdevelopment (Black, 1966).
Simply, economic development is growth + change.
Measuring Economic Growth and Human Development
1. GNP/GDP or GNP per capita/GDP per capita used for international income and output comparisons
2. Income distribution in deciles/quintiles the share of total income received by the poorest 10% or 20% of the

population up to the richest 10% or 20% of the population.

i.e.

richest20%
--------------- ; if ratio/coefficient is closer to 1, there is a greater degree of equality
poorest 20%

e.g. Brazil had a coefficient of 32.1 in 1989 while the Philippines posted 7.4 in 1988.
3. Gini Coefficient another measure that attempts to capture the degree of income inequality basing on the Lorenz
curve, w/c is fitted to percentile shares.
Percent of
Income
E
L
Percent of income recipients
E is the line of equality, L, the observed Lorenz curve.
Area of concentration/inequality area bounded by L and E.
The Gini coefficient is the ratio of the concentration area to the total area under the line of equality. The
coefficient varies from 0 to 1. The closer to 1, the greater the degree of income inequality.
E.g. 1993 Gini coeff. : Brazil
0.63
Venezuela
0.44
4. Human Development Index (HDI) a composite index measuring average deprivation using longevity,
knowledge and income as the representative indicators of development.
Estimates often used are life expectancy, literacy rate, and an adjusted income
measure.
Value of HDI varies from 0 to 1, w/ an index closer to 1 indicating greater achievement and thus a higher
human development.
E.g 1995 HDIs: Philippines 0.677
Thailand
0.838
GDI (Gender-related development index) takes into account the differences in the level of
attainment of men and women, as separate groups, on the component of values of the HDI.
5. Kuznets Inverted U Hypothesis suggests that at low levels of income, economic growth tends to create more
income inequality as measured by the Gini coefficient. Upon reaching a critical
threshold level of income (pt. A), however, further economic growth tends to
reduce inequality.
Gini
1
Coefficient
A

Per capita income

6. Poverty Incidence percentage of the population that are impoverished or living below the poverty line.
THE DETERMINATION OF PRICES AND OUTPUT: THE AS-AD FRAMEWORK
Aggregate Demand Curve shows the relationship between the total amount of g/s demanded in the economy and the
general price level.
Like the ordinary demand curve, the downward sloping AD curve is explained primarily by the combined income and
substitution effects. Nevertheless, the macroeconomy offers some complications to further describe the downward sloping
nature of the AD curve. (note: P = general price level)
a. Price effects on real wealth (RW) - P RW purchasing power ( AD)
b. Effects on Real Interest Rates (i) - P i purchasing power ( AD)
c. Effectson Net Exports (NX) - P X ( M) AD
The above factors in turn imply that changes in the price level affect expenditures.
AE
AE
E
Y (aggregate output)
Yo
P
Po

E
AD
Y (aggregate output)
Yo

Movements/Shifts in the AD Curve

1. AD = f (P) : a decrease in the price level shifts AE curve upward at a new price level, and AD increases (downward
movement along AD curve)
2. AD = f (i, MS, FXr, G, Yfc) : shifts in AD (downward, upward) are caused by non-price factors (with fixed Price)
i - interest rate ( i AD)
MS money supply in circulation ( MS AD)
FXr foreign exchange rates ( FXr Price of exports, Price of imports AD)
G government spending ( G AD)
Yfc Income & other factors affecting demand in foreign countries ( Yfc AD)
Aggregate Supply Curve depicts the relationship between the price level and the aggregate output that firms in the
economy are willing to supply.
1. AS = f (P) : movement along the AS curve
P
2. AS = f (Pi, SSi, T) : shifts in AS curve (upward/ Y or downward/ Y)

AS

Pi price of inputs, factors of production ( Pi AS)

Ssi changes in the supply of inputs ( Ssi AS)
T changes in the level of technology ( T AS)
Y