H3 Theme 31 Notes.docx

H3 Theme 31 Notes.docx

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H3Theme31Notes

Theme3:

RegionalandInternationalEconomics

Thisthemeprovidesanopportunityforcandidatestoexaminerecenttrends,relatedissuesanddevelopmentsinSingaporeaswellastheregionalandinternationaleconomy.Candidatesshouldbeabletoevaluatetradetheories,tradepolicies,economiceffectsofglobalization,regionalandinternationaleconomicco-operationandtheirimplicationsfornational,regionalandinternationalpolicies.

References:

InternationalEconomicsTheoryandPolicy（2003）,8thedition,PaulR.KrugmanandMauriceObstfeld

InternationalTradeTheoryandPolicy,SteveSuranovic,Availableat

InternationalEconomicsusesthesamefundamentalmethodsofanalysisasotherbranchesofeconomicsbecausethemotivesandbehavioursofindividualsarethesameindomesticandinternationaltransactions.However,therearenewanddifferentconcernsthatarisefrominternationaltradeandinvestmentbecausetheyoccurbetweenindependentnationsandsovereignstates.

Insection3.1,wefocusonthestudyofInternationalTradewhichistheexchangeofgoodsandservicesbetweenpeopleorfirmsindifferentcountries.InternationalTradehasgrownmuchfasterthantradewithincountriesinrecentyears.Onereasonisthatthecostoftransportationandcommunicationhasreduceddramatically.Asecondreasonisthatgovernmentrestrictionsontradebetweencountrieshavealsocomedown.

3.1TradeTheories

ContentScope

SyllabusRequirement

A.ComparativeAdvantage（Ricardo）

（CoveredinH2Syllabus）

HistoricalBackgroundofComparativeAdvantage

（AdaptedfromInternationalTradeTheoryandPolicybySteveSuranovic.

Readthewholearticleat

Theearlylogicthatfreetradecouldbeadvantageousforcountrieswasbasedontheconceptofabsoluteadvantagesinproduction.AdamSmithwroteinTheWealthofNations:

"Ifaforeigncountrycansupplyuswithacommoditycheaperthanweourselvescanmakeit,betterbuyitfromthemwithsomepartoftheproduceofourownindustry,employedinawayinwhichwehavesomeadvantage.”

Inotherwords,ifourcountrycanproducesomesetofgoodsatlowercostthanaforeigncountry,andiftheforeigncountrycanproducesomeothersetofgoodsatalowercostthanwecanproducethem,thenclearlyitwouldbebestforustotradeourrelativelycheapergoodsfortheirrelativelycheapergoods.Inthiswaybothcountriesmaygainfromtrade.

Theoriginalideaofcomparativeadvantagedatestotheearlypartofthe19thcentury.Althoughthemodeldescribingthetheoryiscommonlyreferredtoasthe"Ricardianmodel",theoriginaldescriptionoftheideacanbefoundinanEssayontheExternalCornTradebyRobertTorrensin1815.

DavidRicardoformalizedtheideausingacompelling,yetsimple,numericalexampleinhis1817booktitled,OnthePrinciplesofPoliticalEconomyandTaxationinwhichhewrote,“ToproducethewineinPortugal,mightrequireonlythelabourof80menforoneyear,andtoproducetheclothinthesamecountry,mightrequirethelabourof90menforthesametime.Itwouldthereforebeadvantageousforhertoexportwineinexchangeforcloth.Thisexchangemighteventakeplace,notwithstandingthatthecommodityimportedbyPortugalcouldbeproducedtherewithlesslabourthaninEngland.Thoughshecouldmaketheclothwiththelabourof90men,shewouldimportitfromacountrywhereitrequiredthelabourof100mentoproduceit,becauseitwouldbeadvantageoustoherrathertoemployhercapitalintheproductionofwine,forwhichshewouldobtainmoreclothfromEngland,thanshecouldproducebydivertingaportionofhercapitalfromthecultivationofvinestothemanufactureofcloth.”

TradebasedoncomparativeadvantagedoesnotcontradictAdamSmith'snotionofadvantageoustradebasedonabsoluteadvantage.Advantageoustradebasedoncomparativeadvantagecoversalargersetofcircumstanceswhilestillincludingthecaseofabsoluteadvantageandhenceisamoregeneraltheory.

AnintroductiontothenotionofComparativeAdvantage:

AbsoluteAdvantage

AcountryhasanabsoluteadvantageoveranothercountryintheproductionofgoodXifanequalquantityofresourcescanproducemoregoodXthanintheothercountry.

ComparativeAdvantage

AcountryhasacomparativeadvantageoveranothercountryintheproductionofgoodXifitcanproducegoodXataloweropportunitycost.

SupposeoneunitofresourcescanproducethefollowingquantitiesofgoodsinSingaporeandMalaysia:

Books

CDs

Singapore

10

10

Malaysia

5

2

SingaporehasanabsoluteadvantageintheproductionofbothbooksandCDs.

Calculatetheopportunitycostoftheproductionofeachgoodineachcountry.

Books

CDs

Singapore

Malaysia

SinceMalaysiaandSingaporehavecomparativeadvantageinbooksandCDsrespectively,theywillspecialiseinandexportbooksandCDsrespectively.

SupposeSingaporetransfers0.3unitsofresourcesfrombookstoCDsandMalaysiatransfers1unitofresourcesfromCDstobooks.Calculatethecountries’outputchange:

Books

CDs

Singapore

Malaysia

World

TheRicardianModel（Ageneralequilibriummodel）

Assumptions:

∙1factoreconomies（L）

∙2goods

∙Goodsarehomogeneousacrossfirmsandcountries

∙2countries（HomeandForeign）

∙Differencesintechnology（summarizedbylabourproductivityandexpressedintermsofunitlabourrequirement）

∙Constantopportunitycost

∙Labourishomogeneouswithinacountrybutheterogeneousacrosscountries

∙Laborismobilebetweenindustrieswithinacountrybutimmobilebetweencountries

∙Laborisalwaysfullyemployed

∙Laborandgoodsmarketsareassumedtobeperfectlycompetitive

∙Notransportcosts

Therearealwaystrade-offsinproduction.Toproducemoreofonegood,theeconomymustsacrificesomeproductionofanothergood.

Thesetrade-offsareillustratedgraphicallybyaPPF.

RecallfromH2:

WhatdoesthePPFofacountrywhichproducesonly2goods（wineandcheese）andusesonly1factorofproductionlooklike?

Whenonecountrycanproduceaunitofgoodwithlesslabourthananothercountry,wesaythatthefirstcountryhasanabsoluteadvantageinproducingthatgood.Butwecannotdeterminethepatternoftradefromabsoluteadvantagealone.Weneedtoconsidercomparativeadvantage.Whentwocountriesspecializeinproducingthegoodsinwhichtheyhaveacomparativeadvantagein,bothcountriesgainfromtrade.

ANumericalExample

UnitLabourRequirements

Cheese

Wine

Home

1hourperpound

2hourspergallon

Foreign

6hoursperpound

3hourspergallon

NoticeHomehaslowerunitlabourrequirementsi.e.higherlabourproductivityinbothindustries.（Ithasanabsoluteadvantageintheproductionofbothgoods）.

Whohasthecomparativeadvantageintheproductionofcheese/wine?

1.WhatdothePPFsofHomeandForeignlooklike?

2.WhathappenstothePPFsofHomeandForeigniftheybothspecializeandtrade?

HighlightsoftheRicardianModel

（ReadPg.40–41:

MisconceptionsaboutComparativeAdvantage,KrugmanandObstfeld）

1.Tradeoccursduetodifferencesinproductiontechnology.

TheRicardianmodelisconstructedsuchthattheonlydifferencebetweencountriesisintheirproductiontechnologies.Allotherfeaturesareassumedidenticalacrosscountries.Sincetradewouldoccurandbeadvantageous,themodelhighlightsoneonthemainreasonswhycountriestrade;namely,differencesintechnology.

2.Tradeisadvantageousforeveryoneinbothcountries.

Althoughmostmodelsoftradesuggestthatsomepeoplewouldbenefitandsomelosefromfreetrade,theRicardianmodelshowsthateveryonecouldbenefitfromtrade.However,oneofthereasonsforthisoutcomeisthesimplifyingassumptionthatthereisonlyonefactorofproduction（L）.

3.Evenatechnologicallyinferiorcountrycanbenefitfromfreetrade.

Thecompetitiveadvantageofanindustrydependsnotonlyonitsproductivityrelativetotheforeignindustrybutalsoonthedomesticwageraterelativetotheforeignwagerate.Acountry’swagerateinturn,dependsontherelativeproductivityinitsotherindustries.

4.Adevelopedcountrycancompeteagainstsomelowforeignwageindustries.（ArgumentagainstPauperLabourArgument）

TheRicardianmodelshowsthepossibilitythatanindustryinadevelopedcountrycouldcompeteagainstanindustryinalessdevelopedcountryeventhoughthelessdevelopedcountrypaysitsworkersmuchlowersinceeachcountryshouldproducegoodsthatithasacomparativeadvantagein.

LimitationsoftheRicardianmodel

1.Misleadingpredictionaboutcompletespecializationintherealworld.（TheRicardianmulti-goodmodelpredictsthattheproductionofatleastonegoodispartiallyspecializedbutthereiscompletespecializationintheproductionofallothergoods.）

Reasonsforpartialspecializationintherealworld

（i）Existenceofmorethanonefactorofproduction

ThestraightlinePPFsandconstantopportunitycostsresultincompletespecialization.Withmorethanonefactorofproduction,thereareincreasingcostsanddiminishingreturnsintherealworldasfactorsofproductionarenotperfectlysuitedfortheproductionofdifferentgoods.ThismakesthePPFsbowedout.Inotherwords,astheproductionofonegoodincreases,theopportunitycostofproducingitalsoincreases.Atsomepoint,theopportunitycostofproducingthisgoodwillequaltotheothercountry’sandfurtherspecializationwouldcease.

（ii）Protectionism

TheRicardianmodelassumesstaticcomparativeadvantagebuttheinfant-industryargumentisbasedonthecon