International Trade

Opportunity cost
Opportunity cost = the benefits you don’t enjoy from the next best choice you didn’t choose
Full cost = direct (out of pocket) cost + indirect (opportunity) cost

Absolute Advantage and Comparative Advantage

Absolute advantage: an ability to produce a greater quantity of a good, product, or service
than competitors, using the same amount of resources
Comparative advantage: the one has a lower opportunity cost of producing than another
=> Lower Opportunity Cost = Comparative Advantage
Ex: There is an example for the above definition:
A can produce a backpack in 20 hours and a pencil in 1 hour
B can produce a backpack in 50 hours and a pencil in 2 hours
=> A has absolute advantages in producing backpack and pencil

From the above information, we have:

If A produces a backpack, he sacrifices 20 pencils => 1 backpack = 20 pencils
If B produces a backpack, he sacrifices 15 pencils => 1 backpack = 25 pencils
=> A has a comparative advantage in producing backpacks because 20/1 < 25/1
=> B has a comparative advantage in producing pencils because 1/25 < 1/20

Production Possibilities Frontier

Trade-offs: a situation of losing one benefit to gain another OR a situation in which you
accept something bad in order to have sth good
Ex: going to a party before the midterm leaves less time to study
Scarcity => Trade-offs: Limited resources mean we can't do everything, buy everything and
make everything so we need to know how to choose

PFF or Productive Possibilities Frontier: a line or a graph which shows combinations of

two products the economy can produce with its productive resources and technology
Understanding the PPF curve:
- PPF curve shows how much an economy can produce of these two goods and the
tradeoff between them
- Limited productive resources can be used in the production of both goods
- Productively inefficient = resources are not being used to their full potential
- Economy can not produce beyond the curve
Points of PFF:

=> In the picture, we can see that, if the computer decreases from 500 to 400, the wheat
increase from 0 to 1000.
Point F: 100 computer and 3000 tons of wheat => Point F require 40,000 hours of labor.
Possible but not efficient, could get more of either product and not sacrifice the other. => all
the point below the curve is Productive Inefficient - points under the PPF
Point E: 300 computers and 2000 tons of wheat => This point is perfect, possible but also
efficient => Productive efficient - points on the PPF
Point G: 300 computers and 3500 tons of wheat => Point G require 65000 hours of labor.
Not possible because the economy only has 50000 hours => all the point above the curve is
Productive Impossible - points above the PPF

Methods to shift the curve to the right: If you want to shift the curve to the right:
- Improvement of technology
- More physical capital: machines, tools, and factories
- Increase in human capital: more workers, more experiences

PFF: Opportunity cost

Recall: the benefits you lose from the next best choice you didn’t choose
The slope of a line equals the “rise over the run”
PPF slope = opportunity cost of one good in terms of the other.

International Trade
International Trade: the exchange of capital, goods, and services between countries.
Terms of trade: comparative advantage and opportunity cost determine the terms of trade
for exchange under which mutually beneficial trade can occur.
Ex:
A: 15 cars cost 5 planes => 1 car costs ⅓ plane => should specialize in cars
1 plane costs 3 cars
B: 16 cars cost 16 planes => 1 car costs 1 plane => should specialize in planes
1 plane costs 1 car
=> A only trade if they can get 1 plane for less than three cars
B only trade if they can B accept 1 plane for more than 1 car
So the acceptable terms for both people are 1 plane for 2 cars

Trade Barriers
A tariff: a tax on imports.
=> A tariff creates revenue for the government.

An import quota: is a quantitative limit on imports of a good.

- Mostly has the same effects as a tariff
- Raises price, reduces the number of imports.
- Reduces buyers’ welfare.
- Increases sellers’ welfare.
=> A quota creates profits for the foreign producers of the imported goods, who can sell
them at a higher price. (Or, governments could auction licenses to import to capture this
profit as revenue but usually, it does not.)
Voluntary export restraints (or VERs): the foreign government “volunteers” to restrict its
own exports into our market.

Health and safety regulations: rules designed to keep people safe and secure.

Foreign Exchange
Foreign exchange = Foreign money

Foreign exchange market: a market where those who want to buy the currency, and those
who supply it.

There are three major reasons for people want to purchase foreign exchange:
- Travel and tourism
- Buy foreign goods and services
- Investment purposes: financial investment (purchase of foreign-denominated
financial assets) or real investment (building factories overseas)

The equilibrium price in this market is called the exchange rate.

An appreciation: is an increase in the value of a currency
A depreciation: is a decrease in the value of a currency
The one who controls the supply of foreign currency: the government
 - If the government wanted to drive the value of its own currency up, it would decrease
the supply of dollars.
- If the government wanted to drive the value down, it would increase the supply of
dollars.

Closed economy: An economy that does not interact with other economies in the world
Open economy: An economy that interacts with other economies around the world
- It buys and sells goods and services in world product markets
- It buys and sells capital assets such as stocks and bonds in world financial markets

The flow of goods:

- Exports: Goods and services that are produced domestically and sold abroad
- Imports: Goods and services that are produced abroad and sold domestically
- Net exports (Trade balance) = Value of exports – value of imports
- Factors that might influence a country’s exports, imports, and net exports:
+ Consumers’ preferences for foreign and domestic goods
+ Prices of goods at home and abroad
+ Incomes of consumers at home and abroad
+ Transportation costs
+ Government policies
+ Exchange rates at which foreign currency trades for domestic currency

Trade surpluses and deficits:

- Trade surplus (Positive net exports): Exports are greater than imports
=> NX: Ex > Im
- Trade deficit (Negative net exports): Imports are greater than exports
=> NX: Ex < Im
- Balanced trade: Exports = Imports
=> NX = 0 : Ex = Im

The Nominal Exchange Rate:

- The rate at which one country’s currency trades for another
- We show all exchange rates as foreign currency for each unit (1) of the domestic
currency.