H3 Theme 31 Notes.docx

1、H3 Theme 31 NotesTheme 3: Regional and International EconomicsThis theme provides an opportunity for candidates to examine recent trends, related issues and developments in Singapore as well as the regional and international economy. Candidates should be able to evaluate trade theories, trade polici

2、es, economic effects of globalization, regional and international economic co-operation and their implications for national, regional and international policies.References:International Economics Theory and Policy (2003), 8th edition, Paul R. Krugman and Maurice ObstfeldInternational Trade Theory an

3、d Policy, Steve Suranovic, Available at International Economics uses the same fundamental methods of analysis as other branches of economics because the motives and behaviours of individuals are the same in domestic and international transactions. However, there are new and different concerns that a

4、rise from international trade and investment because they occur between independent nations and sovereign states.In section 3.1, we focus on the study of International Trade which is the exchange of goods and services between people or firms in different countries. International Trade has grown much

5、 faster than trade within countries in recent years. One reason is that the cost of transportation and communication has reduced dramatically. A second reason is that government restrictions on trade between countries have also come down.3.1 Trade TheoriesContent ScopeSyllabus RequirementA. Comparat

6、ive Advantage (Ricardo)(Covered in H2 Syllabus)Historical Background of Comparative Advantage(Adapted from International Trade Theory and Policy by Steve Suranovic. Read the whole article at The early logic that free trade could be advantageous for countries was based on the concept of absolute adva

7、ntages in production. Adam Smith wrote in The Wealth of Nations: If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it from them with some part of the produce of our own industry, employed in a way in which we have some advantage.” In other words, i

8、f our country can produce some set of goods at lower cost than a foreign country, and if the foreign country can produce some other set of goods at a lower cost than we can produce them, then clearly it would be best for us to trade our relatively cheaper goods for their relatively cheaper goods. In

9、 this way both countries may gain from trade. The original idea of comparative advantage dates to the early part of the 19th century. Although the model describing the theory is commonly referred to as the Ricardian model, the original description of the idea can be found in an Essay on the External

10、 Corn Trade by Robert Torrens in 1815.David Ricardo formalized the idea using a compelling, yet simple, numerical example in his 1817 book titled, On the Principles of Political Economy and Taxation in which he wrote, “To produce the wine in Portugal, might require only the labour of 80 men for one

11、year, and to produce the cloth in the same country, might require the labour of 90 men for the same time. It would therefore be advantageous for her to export wine in exchange for cloth. This exchange might even take place, notwithstanding that the commodity imported by Portugal could be produced th

12、ere with less labour than in England. Though she could make the cloth with the labour of 90 men, she would import it from a country where it required the labour of 100 men to produce it, because it would be advantageous to her rather to employ her capital in the production of wine, for which she wou

13、ld obtain more cloth from England, than she could produce by diverting a portion of her capital from the cultivation of vines to the manufacture of cloth.”Trade based on comparative advantage does not contradict Adam Smiths notion of advantageous trade based on absolute advantage. Advantageous trade

14、 based on comparative advantage covers a larger set of circumstances while still including the case of absolute advantage and hence is a more general theory. An introduction to the notion of Comparative Advantage:Absolute AdvantageA country has an absolute advantage over another country in the produ

15、ction of good X if an equal quantity of resources can produce more good X than in the other country.Comparative AdvantageA country has a comparative advantage over another country in the production of good X if it can produce good X at a lower opportunity cost.Suppose one unit of resources can produ

16、ce the following quantities of goods in Singapore and Malaysia:BooksCDsSingapore1010Malaysia52Singapore has an absolute advantage in the production of both books and CDs.Calculate the opportunity cost of the production of each good in each country. BooksCDsSingaporeMalaysiaSince Malaysia and Singapo

17、re have comparative advantage in books and CDs respectively, they will specialise in and export books and CDs respectively. Suppose Singapore transfers 0.3 units of resources from books to CDs and Malaysia transfers 1 unit of resources from CDs to books. Calculate the countries output change:BooksCD

18、sSingaporeMalaysiaWorldThe Ricardian Model (A general equilibrium model)Assumptions: 1 factor economies (L) 2 goods Goods are homogeneous across firms and countries 2 countries (Home and Foreign) Differences in technology (summarized by labour productivity and expressed in terms of unit labour requi

19、rement) Constant opportunity cost Labour is homogeneous within a country but heterogeneous across countries Labor is mobile between industries within a country but immobile between countries Labor is always fully employed Labor and goods markets are assumed to be perfectly competitive No transport c

20、ostsThere are always trade-offs in production. To produce more of one good, the economy must sacrifice some production of another good.These trade-offs are illustrated graphically by a PPF.Recall from H2:What does the PPF of a country which produces only 2 goods (wine and cheese) and uses only 1 fac

21、tor of production look like?When one country can produce a unit of good with less labour than another country, we say that the first country has an absolute advantage in producing that good. But we cannot determine the pattern of trade from absolute advantage alone. We need to consider comparative a

22、dvantage. When two countries specialize in producing the goods in which they have a comparative advantage in, both countries gain from trade.A Numerical Example Unit Labour RequirementsCheese WineHome 1 hour per pound2 hours per gallonForeign6 hours per pound3 hours per gallonNotice Home has lower u

23、nit labour requirements i.e. higher labour productivity in both industries. (It has an absolute advantage in the production of both goods).Who has the comparative advantage in the production of cheese/wine?1. What do the PPFs of Home and Foreign look like?2. What happens to the PPFs of Home and Fore

24、ign if they both specialize and trade?Highlights of the Ricardian Model (Read Pg. 40 41: Misconceptions about Comparative Advantage, Krugman and Obstfeld) 1. Trade occurs due to differences in production technology.The Ricardian model is constructed such that the only difference between countries is

25、 in their production technologies. All other features are assumed identical across countries. Since trade would occur and be advantageous, the model highlights one on the main reasons why countries trade; namely, differences in technology. 2. Trade is advantageous for everyone in both countries. Alt

26、hough most models of trade suggest that some people would benefit and some lose from free trade, the Ricardian model shows that everyone could benefit from trade. However, one of the reasons for this outcome is the simplifying assumption that there is only one factor of production (L).3. Even a tech

27、nologically inferior country can benefit from free trade.The competitive advantage of an industry depends not only on its productivity relative to the foreign industry but also on the domestic wage rate relative to the foreign wage rate. A countrys wage rate in turn, depends on the relative producti

28、vity in its other industries.4. A developed country can compete against some low foreign wage industries. (Argument against Pauper Labour Argument)The Ricardian model shows the possibility that an industry in a developed country could compete against an industry in a less developed country even thou

29、gh the less developed country pays its workers much lower since each country should produce goods that it has a comparative advantage in. Limitations of the Ricardian model1. Misleading prediction about complete specialization in the real world. (The Ricardian multi-good model predicts that the prod

30、uction of at least one good is partially specialized but there is complete specialization in the production of all other goods.)Reasons for partial specialization in the real world(i) Existence of more than one factor of productionThe straight line PPFs and constant opportunity costs result in compl

31、ete specialization. With more than one factor of production, there are increasing costs and diminishing returns in the real world as factors of production are not perfectly suited for the production of different goods. This makes the PPFs bowed out. In other words, as the production of one good incr

32、eases, the opportunity cost of producing it also increases. At some point, the opportunity cost of producing this good will equal to the other countrys and further specialization would cease.(ii) ProtectionismThe Ricardian model assumes static comparative advantage but the infant-industry argument is based on the con