International Trade

Specialization and Trade

Absolute Advantage
• The producer that can produce the most
output or requires the least amount of inputs
(resources)
Comparative Advantage
• The producer with the lowest opportunity cost
countries should trade if they have a
relatively lower opportunity cost
 Wheat Sugar
USA 30 (1W costs 1S) 30 (1S costs 1W)
Brazil 10 (1W costs 2S) 20 (1S costs ½ W)
 Output Questions and Input
Questions
Output Planes Cars
Canada 50 20
Mexico 40 10

Input 100 Phones 1000 Bikes

Australia 50 Hrs 20 Hrs
USA 40 Hrs 10 Hrs
• The principle of comparative advantage
shows that trade can make everyone
better off.
• The principle of comparative advantage
applies to countries as well as to people.
Economists use the principle of
comparative advantage to advocate free
trade among countries
 Terms of Trade
• Both countries can benefit from trade if they
each have relatively lower opportunity costs
Terms of trade: The agreed upon conditions that
would benefit both countries
The International Flows of Goods and
Capital
Exports
Goods and services that are produced domestically and sold abroad
Imports
Goods and services that are produced abroad and sold domestically
Net exports
The value of a nation’s exports minus the value of its imports; also called the
trade balance
Trade balance
The value of a nation’s exports minus the value of its imports; also called net
exports
Trade surplus
An excess of exports over imports
Trade deficit
An excess of imports over exports
Balanced trade
A situation in which exports equal imports
Net capital outflow
The purchase of foreign assets by domestic residents
minus the purchase of domestic assets by foreigners
The Equality of Net Exports and Net Capital Outflow
For an economy as a whole, net capital outflow (NCO)
must always equal net exports (NX):
NCO = NX.
This equation holds because every transaction that
affects one side of this equation affects the other side
by exactly the same amount.
 Balance of Payments (BOP)
Balance of Payments (BOP)- Summary of a
country’s international trade.
The balance of payments is made up of two
account. The current account and the financial
account
Balance of Trade
Trade Surplus = X > M An excess of exports over imports
Trade Deficit = X < M An excess of imports over exports
 Current Account
The Current Account is made up of three parts:
1) Trades in Goods and Services (Net Exports)- Difference
between a nation’s exports of goods and services and its
imports of goods and services
E.g.: Toys imported from China, Pakistani cars exported to
Mexico
2) Investment Income-Income from the factors of production
including payments made to foreign investors.
E.g. : Money earned by Japanese car producers in Pakistan
3) Net Transfers- Money flows from the private or public
sectors
E.g. : Donations, aids and grants, official assistance and
remittance
 Financial (Capital) Account
The Financial Account measures the purchase
and sale of financial assets abroad
Net Capital Outflow- The difference between
the purchase of foreign assets and domestic
assets purchased by foreigners
Financial Account Surplus = Inflow > Outflow
Financial Account Deficit = Inflow < Outflow
 Example
Pakistan China
Current Account X<M X>M
Deficit Surplus
Financial (Capital ) account Inflow > Outflow Inflow < Outflow
NCO (-) NCO (+)

• If a country has a current account deficit, they will

have a capital account surplus because their Net
Capital Outflow is negative
• If a country has a current account surplus, they will
have a capital account deficit because their Net
Capital Outflow is positive
Thank You…