Chan Ying

May
13A01D

International Economics
International Trade refers to the exchange of goods and services between countries,
involving the use of different currencies and crossing international borders.
Law of CA states that countries would have to gain from trade if there are
differences in the relative opportunity costs of producing specific goods among
them. They benefit from specializing and exporting products in which they have
the greatest relative advantage in, and importing products in which they have
least relative advantage in.
How to explain the theory of CA:
Table 1: Production pattern before specialization
Wheat
Cloth
USA
100
60
CHINA
5
10
World Total
105
70
USA has absolute advantage over China in the production of both wheat and cloth, since it
is able to produce more of both goods with the same amount of resources.
Table 2: Opportunity Cost of producing
USA
CHINA

1 unit of wheat to 0.6 unit

of cloth
1 unit of wheat to 2 unit of
cloth

1 unit of cloth to 1.67 unit

of wheat
1 unit of cloth to 0.5 unit
of wheat

As shown in Table 2, to produce one unit of wheat, USA gives up less cloth. Thus, USA is
said to have comparative advantage in wheat production. On the other hand, to produce
one unit of cloth, China gives up less wheat. Therefore, China is said to have comparative
advantage in cloth production.
Assuming that USA decides to transfer 1/10 of her resources from cloth production to
wheat production and then trade with China, who will completely specialize, the
production with specialization pattern will be as below.
Table 3: Production pattern with specialization
USA (Partial specialization)
China (complete
specialization)

Wheat
110
0

Cloth
54
20

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May
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World Total

110

74

Assuming the terms of trade is 1 wheat: 1 cloth in the international market, the US can
export 10 units of wheat to China in exchange for 10 units of imported cloth.
Table 4: Consumption after trade
USA
CHINA
World Total

Wheat
100
10
110

Cloth
64
10
74

Assuming the consumption level after trade is as Table 4 above, it can be seen that USA
gains 4 units of cloth while China gains 5 units of wheat after specialization and trade.
Both countries benefit from a higher level of total output consumed, thus allowing them to
consume beyond their production possibility curve (PPC).
~end of explanation~
One para explanation: The theory of CA states that it is mutually beneficial for two
countries to specialize and trade as long as the opportunity costs of production differ
between the two countries. A country is said to have a comparative advantage in a good if
she can produce that good at a lower opportunity cost than in other countries. Countries
gain from trade if they specialize and export those goods in which they have a
comparative advantage and import those goods in which they have a comparative
disadvantage. This allows the country to consume at a level that is beyond its PPC.

Conditions for trade to be beneficial

1. Different opportunity cost in the production of the good
2. Favourable terms of trade
3. Favourable exchange rate
Sources of Comparative Advantage
1. International differences in Factor endowments such as skilled/unskilled labour, capital
stock, amount of land and climate Different relative prices of FOP Different relative
prices of final goods and services
e.g. America: relatively abundant capital and skilled labour, making it a net exporter of
products that are skilled labour-intensive or technologically intensive such as chemicals,
aircrafts and precision instruments

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May
13A01D

Singapore: land and labour scarce, causing her to import all her wheat/rice requirements.
HOWEVER, endowments may change over time. But at each point in time, the endowment
determines the productive potential of the economy, the relative productivity of the
economy in each good and hence the comparative advantage of the country.
2. Differences in technology such as different levels of engagement in R & D to generate
comparative advantage)
3. Dynamic CA, governments can establish policies to promote opportunities for changes
in comparative advantage over time.

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Advantages and Disadvantages of Trade
Advantages
Microeconomic effects
Theory of CA: Specialization leads to greater world output
Consumption beyond countrys PPC Countries can achieve
higher levels of consumer welfare

Reap IEOS due to higher levels of production by catering to a

larger market
firms can choose to pass on the cost savings to consumers as
lowered prices increase consumer welfare
increase profits can be put into R & D improvement in the quality
of goods produced increased dynamic efficiency and consumer
welfare
(producers are more motivated to do the above due to increased
competition)
With specialization, country can become a high-volume, low-cost
producer Even smaller countries whose domestic markets are too
small to exploit IEOS, can specialize in producing a limited range of
commodities on a larger scale, catering to a wider world market, such
that they reap the available cost savings from IEOS greater
productive efficiency
For big countries, a broadening of their markets allows IEOS to be
reaped in sub-product lines. (e.g. production of Toyota in Japan and

Disadvantages
Dumping refers to the selling of goods in overseas
markets below the marginal costs of production.
Objective: to drive out rival producers in the importing
country, monopolize the market (gain market share),
price-setting ability allows it to set high prices reduced
consumer welfare
Unfair competition: esp so if production is subsidized
by the government of the exporting country unfair
competition with producers of importing countries.
e.g. the steel industry in USA is highly subsidized
Increase susceptibility to external shocks:
Complete specialization means narrowing its
industrial/economic structure composition of G & S
produced and the types of jobs available will become
limited
- Changes in market conditions, e.g. falling demand or
exhaustion/depletion of non-renewable resources will
cause serious economic decline. An overly specialized
economy will face structural rigidity and have difficulty
recovering from an economic crisis.
- Certain goods are basic or strategic to a country
cannot afford to depend fully on foreign suppliers for such
goods (e.g. Singapores aim to be self-sufficient in water)

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BMW in Germany )
An example of IEOS: Learning by Doing
Costs may vary with the time that a product has been in existence. As
countries gain experience in particular task, workers become more
efficient in the production of a good, causing unit cost of production to
fall.
Importation of large varieties of G & S makes catering to the different
tastes of consumers becomes possible greater consumer choice
e.g. Malaysians who believe that Thai rice is superior can have the
choice of consuming Thai rice
d) trade exposes domestic producers to foreign competition
demand for the firms product reduces and becomes more price
elastic due to the increase in substitutes (draw diagram) lower
prices

b) Importation of demerit goods such as alcohol, drugs,

tobacco consumption of such goods results in
negative externalities in the economy (go on to
elaborate on the externality)
e) Widening income disparities
- more opportunities for those who are skilled rather than
those with low skills and education
- between tradable sectors and non-tradable sectors:
incomes of those tradable sectors will rise due to the
increase in demand and output while incomes of those in
non-tradable sectors (e.g. hairdressers) remain constant

encourages domestic firms to put their profits into R & D better

quality of products and dynamic efficiency
Prevents complacency among local producers. Difficult for
companies to merge or to gain monopoly control in an open economy
(WHY) local producers will strive for lowered prices lowering
inflationary pressures locally.
Macroeconomic effects
Stimulate economic growth and development
Countries may be overly reliant on foreign countries as sources for
- (esp small and open economies) Wider export markets
export markets economic crisis in importing country will lead to
rise in net exports increase AD increase
reduced demand for exports negative economic growth in the
employment and national income generating actual
exporting country externally-induced cyclical unemployment

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growth
- International trade facilitates transfer of technology and
ideas increase the efficiency of production and raise the
productive capacity stimulating potential growth
- With rise in AD and AS, allowed for sustainable
economic growth without inflationary pressure (diagram)
Lower inflationary pressure
- cheaper imports reduced imported inflation (esp. sig
for singapore)
- cheaper raw materials COP domestic
inflationary pressure
- competition forces firms to be efficient prices
inflationary pressures locally
Improvements in BOP
-in trade of G & S net exports improve CA
- in FDI flow improve financial account

(to avoid such over-reliance, governments can diversify their exports

and trading partners)
- Changing market conditions structural decline of industries that
have lost CA labour made redundant in sunset industries labour
cannot find jobs in rising sectors due to mismatch of skills (lacks
occupational mobility to higher valued-added sectors) structural
employment
c) Import-push inflation (esp open economies)
-When exporting countries face inflationary pressures imports
become more expensive import-push inflation

BOP deficit
- Fall in net exports due to loss of CA current account deficit

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Terms of trade
TOT: the rate at which a country exchanges its exports for imports. It is the quantity of imports
that can be obtained per unit of exports.

Terms of trade =

Price Index
x 100
( Export
Import Price Index )

Singapores pattern of trade : Direction and Composition of Trade

Total trade volume is approximately 3 times GDP. Major export destinations are China, HongKong, Malaysia, Indonesia, Japan, EU and US.
Sources of Comparative Advantage:
a) Strategic location Natural CA in transportation and maritime trade services
b) High GDP per capita can engage in capital intensive production and has the skilled labour
resources to undertake value-added production such as chemical processing, manufacturing
electronic components
c) Skilled labour precision engineering, aerospace, industry
High value-added services: finance, banking, business, tourism services
Government working on raising CA in the following industries: Clean energy (solar grids),
pharmaceuticals, biotechnology, medical technology.
Lack CA in (and thus import):
a) Land-intensive products Raw materials, agricultural products
b) Labour intensive products Assembled, manufactured products
Factors that limit free trade
Artificial Barrier to trade (PROTECTIONISM)
Natural Barriers to trade:
Assumptions of CA
theory
No transport costs or
trade restrictions

Constant opportunity
costs of production

Key limitations of CA theory

High transport costs add a significant margin to the price
of traded commodity. Lowers the gains from trade that
arise from the differences in relative cost of production.
Protectionism practiced by many countries
Diminishing returns will set in beyond a certain level of
output, raising average costs of production. Likely to
experience increasing opp cost. Expansion of industry
drives up factor prices, or necessities the use of factors
less suited for the type of production.

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Perfect mobility of
resources within country
Same amount of
resource endowment

Resources may not be as efficient when used elsewhere.

Obviously countries are not endowed with the same
amount/types of resources.

Protectionism
Protectionism is a policy of sheltering domestic industries from foreign competition
through the imposition of trade barrier on imports.
Methods of protectionism
a) Tariffs
Figure: The effects of a specific tariff on the market for cars

In the absence of international trade, the domestic price is set at P. Assuming foreign car
producers are willing to supply all the cars that are demanded by the country at world price Pw.
The supply curve of imported cars is perfectly price-elastic.
Under free trade, domestic price cannot differ from the world price especially in the case of a
price taker.
Tariffs force the consumer to reduce consumption from OQ4 to OQ3, reduce consumption of
imports and switch to domestically produced substitutes. Consumers also have to pay for the
OQ3 amount they now consume Consumer surplus falls (Consumption effect)
Tariffs allow the protected domestic import-substituting industry to expand production from OQ1
to OQ2. The firm increases revenue due to the expanded production and higher price Increase
in Producer Surplus (Production effect)
The government receives the extra amount paid by consumers for the imported quantity.
Effectiveness depends on PEDm! Foreign firms may choose to absorb part of the tariff by

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decreasing prices.
b) Non-tariff barriers (Quotas)
Import quotas are limits imposed on the physical quantities or values of goods imported into a
country. An import quota generally limits imports to a level below that which will prevail under
free trade conditions. However, since the government merely restricts the quantity of imports,
both foreign and domestic suppliers charge the same higher price. Thus foreign suppliers now
receive the extra amount paid by domestic consumers for the units that are still imported.
Quotas provide a greater certainty of protection for local producers compared to tariffs.
c) Export subsidies cash grants given by the government to local producers Reduces COP
domestic producers can sell more of the good at the prevailing price.
d) Foreign exchange controls
e) Embargo
f) Trade agreements
g) International cartels collusive agreements among producing countries to fix prices and
output policies with the objective of diminishing competition and increasing profits.
h) New protectionist measures. E.g. Safety and hygiene regulations on food products so as to
benefit the home producers
Economic case for and against protectionism
Reasons
To protect an infant industry
Infant industries have potential
comparative advantage.
Restrict trade to shield domestic infant
industries from foreign competition, so as
to allow time to reap IEOS and lower
average costs of production.

To reduce BOP deficits

Restrict imports to correct the BOP
disequilibrium
To protect against unfair trade practices
Dumping: Foreign firms sell goods in a
market at price below that in their home
market, or below marginal cost, to destroy
local competition. The firm becomes a

Evaluation
- Difficult to determine which countries have
that potential CA (high opp. cost,
unemployment over time)
- Long term protection may lead to a lack of
incentive to mature into efficient producers
- Difficult to decide when the industry is fully
and able to survive without protection
- Better alternative to stimulate export
competitiveness may be to make efforts to
improve productivity and lower unit COP,
through better training, education
- Depends on PEDm and PEDs
- Short term measure, should look at root
cause of deficit
- Retaliation from trade partners
- Since dumping brings about market
distortions which results in long term damage,
protection is justifiable
- Difficult to tell as exporting country may
simply have CA in the production of the said

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monopoly in that market, subsequently

raise prices to exploit consumers.

To protect sunset/mature industries

Traditional industries may lose their
comparative advantage, should they close
down, itll result in massive structural
unemployment. By temporarily protecting
these mature industries, the decline can
be slowed down, time can be gained to
switch resources into other areas of
economic activity.

good.
- Domestic producers may accuse foreign
firms of dumping when they fail to match
their lowered prices.
- Usually brought about under the pressures
of trade unions, where wage growth has
outstripped growth in productivity.
- Benefits of increased employment enjoyed
by the protected country achieved at the
expense of its trading partners. The partners
who experience a decline in export sales and
consequently a lower unemployment will
trigger similar retaliatory measures.
In USA, the VRA placed on steel in 1984 saved
16999 jobs but destroyed 52400 jobs in
industries that use steel.
Political reasons
May be essential to produce its own
armaments and aircrafts for use in war, as
well as industries involved in producing the
FOPs of weaponry.
Trade can be used as a weapon of foreign
policy, where a country does not trade with a
country it disagrees with politically.

To increase domestic production and

national income in times of recession
Emergency short run measure to avoid
heavy unemployment. Imposition of tariffs
and quotas on imported goods create jobs
by raising the prices of imports and
diverting demand towards domestic
production.
Synthesis of Arguments for Protectionism
- Goes against the Law of Comparative Advantage.
- Countries practicing protectionism usually experience welfare loss in the form of reduced
consumer choice, higher prices and reduced export earnings.
- Retaliatory actions by trading partners.
- Causes misallocation of resources: firms have less incentive to respond swiftly to changes in
market conditions or to reduce prices, produce better quality products and/or improve
productivity.
- Once a protectionist measure is in place, it will be politically difficult to remove it.
Future challenges for Singapore (may be useful for evaluation)
- Increasing trend of protectionism since the global financial crisis
- Singapore will be hard-hit as our domestic market in too small to make-up for the loss of
overseas orders. Large numbers of firms producing products for exports will go out of existence
- Therefore, Singapore works closely with like-minded economies and international financial
institutions such as the IMF, WB to continue the advancement of free trade.

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Globalisation
defined as the growing economic interdependence of countries worldwide through
increasing volume and variety of cross-border transactions, largely in goods and
services, free flows of international capital, spread of technology as well as labour
migration OR
Globalisation is the process through which an increasingly free flow of goods and
services, capital flows, labour and technological transfers result in closer integration
of economies in the world.
Accounting for the trend of globalization
(need to mention the economic theory that globalization is based on aka CA?)
1. Reduction in barriers to trade and commerce and established international agreements to
promote trade in goods, services and investment. Governments recognize the benefits to
globalization and free trade; hence, they agree to work together to reduce trade barriers
together with the work of international organizations, such as the WTO. E.g. General Agreement
on Tariffs and Trade (GATT), predecessor to WTO, served to promote trade in manufactured goods
among developed countries.
2. Advancement of technology: Through improvement in technollogy, costs of communicating
information have fallen dramatically since the post-war period. A 3-minute telephone call from
the USA to Britain cost only 4% today of what it cost in 1946. Telegrams were the only rapid
means of written communication then. Today, Nike, an American shoe company can oversee the
manufacture of its shoes in Vietnam without having to be there physically. The internet has
reduced dramatically coordination costs of multinational companies that base their production
activities overseas. It is clearly the availability of cheap, rapid and reliable communication that
permits such phenomena.
3. Dramatic fall in transport cost. Shipping costs today have fallen by half while air transport
costs have fallen to one-sixth of costs in the 1930s. This fall in transport costs have removed a
major trade barrier to trade where in the past, high transport costs used to prevent trade even
when difference in comparative advantages exist among countries; the high transport costs
would have made the imported goods more expensive to buy than to make domestically.
Effects of Globalisation
1. Effects of Free Trade
Some key points: (refer to full set of points under effects of free trade)
Microeconomic effects
2. Domestic firms in both developed and developing countries face higher levels of
competition, with the entrance of foreign producers into the domestic market. This
provides incentive for producers to price their goods more competitively and pass
on their cost savings to consumers in the form of lower prices. Producers may also

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be more motivated to undertake research and development to improve their quality
of products so as to better compete with foreign producers. Both of this will lead to
an improvement in consumer welfare.
Macroeconomic effects
1. Countries can gain access to larger export markets, enhancing growth in export
sales, generating an increase in aggregate demand (AD) which translates into
increase in employment levels, rising national incomes as well as actual growth.
2. Increase in trade balance improve CA
increase in capital inflows improve KA when inflows exceeds outflows, BOP
improves

2. Free Trade Agreements and its effects (see section on free trade agreements)
3. On Foreign Direct Investment (FDI)
FDI refers to the movement of capital that involves foreign ownership and control of production
facilities.
Benefit
s of FDI

Short
Term

Long
Term

Source country (usually developed country)

Recipient country (usually

developing country)

- Production is shifted overseas Reduced AD

unemployment reduced actual growth
- Outflow of investment outflow on KA worsens
BOP
- Stimulates exports of machinery and other capital
goods, when subsidiaries are set up overseas
increase X Increase in AD increase nat.
incomes through the multiplier effect, fostering
actual growth.
Return flow of income in the form of interests and
dividends improve the CA c.p. BOP improves

- increase I increase AD
actual growth
- technological transfers as
knowledge and skills applied
to how G & S are produced are
taught to workers
- increases in corporate tax
revenue for the host govt
- Increase in I higher levels
of capital accumulation,
improvements in technical &
managerial skills as well as
technological improvements
higher level of productivity
increase productive capacity
as seen in increase in LRAS

Main cost of FDI: Destruction of the environment (e.g. pollution, congestion) allocative
inefficiency due to negative externalities

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3. Effects of international movement of factors of production

3.1 Equalization of wages between countries
When two countries enter a FTA, wages for identical jobs in both countries tend to approach
each other.

Originally the average wage rates in country A and country B were $9 and $3 respectively.
Responding to the wage differential, workers in country B migrate to country A, this leads to a
reduction in labour supply in country B and an increase in country A. Wage rates will continue to
fall in country A and rise in country B until they are eventually equalized, assuming that labour is
homogeneous and mobile and markets are working freely and perfectly.
3.2 World Output increases
Country B has a lower level of demand for labour due to lower labour productivity. Wage
differentials attract workers to those areas where they will be more efficiently used. Also, workers
also tend to migrate from countries where job opportunities are low (they could be unemployed)
to countries where job opportunities are more abundant. Hence, the outflow of labour from
country B will resulted in a smaller reduction in output value than the expansion in output arising
from inflow of labour into country A.
3.3 Income inequality
in ss of low-skilled labour --> fall of wages of low-skilled workers in the domestic economy
widen Y gap.
3.4 Improvement in current account of recipient countries of remittances from abroad
Increase in remittances from workers who have emigrated improvement in CA (income
balance) of recipient countries in some cases, can contribute significantly to a countrys AD
***3.5 Brain drain
Emigration of highly-educated and skilled professionals, usually from developing to developed
countries loss in productive capacity limit potential growth LRAS shifts inwards

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4. Effects of Globalisation (developing countries vs developed countries)

+++
impa
ct

--impa
ct

Chan Ying May

Developing countries
Developed countries
13A01D
Benefits of trade:
Theory of CA: Specialization leads to greater world output Consumption beyond countrys PPC Countries
can achieve higher levels of consumer welfare
micro benefits Domestic firms in both developed and developing countries face higher levels of competition,
with the entrance of foreign producers into the domestic market. This provides incentive for producers to price
their goods more competitively and pass on their cost savings to consumers in the form of lower prices.
Producers may also be more motivated to undertake research and development to improve their quality of
products so as to better compete with foreign producers. Both of this will lead to an improvement in consumer
welfare.
***macro benefits Countries can gain access to larger export markets, enhancing growth in export sales,
generating an increase in aggregate demand (AD) which translates into more than proportionate
increase in national income due to the multiplier effect, generating actual growth and resulting in a higher
material standard of living.
Increase in FDI increase in BOP and
- Remittances of profits from FDI which will improve the
investment in the ST increase in
current account and the BOP in the long term.
productive capacity and the AS
Increase in remittances from worker who - influx of foreign labour from developing countries will lead to
have emigrated improvement in
an increase in the size of workforce increase in productive
current account (e.g. Indonesia maids
capacity and outward shift of the AS.
working in Singapore send a portion of their
income home)
Freer movement of labour results in brain
-Loss in CA in traditional industries. Manufacturing jobs for
drain as skilled workers migrate to developed example, have been dramatically cut in the US and Canada as a
countries in search for higher salaries and
result of globalization. Developed countries that have lost its CA
standard of living. This will place limitation to
to China would experience a fall in demand for its low-end
a countrys potential growth due to reduced
manufactured products. This results in unemployment arising
productive capacity.
from the closure of sunset industries. These workers may fail to
find work in other industries due to a mismatch of skills, leading
- Dumping (goods priced at below marginal
to structural unemployment.
cost) closure of domestic industries
foreign firms gain market dominance and
FDI outflow in KA worsening of BOP
price-setting ability high prices loss in
consumer welfare and allocative
Worsening income inequality:
inefficiency
1. Wages in tradable sectors vs non-tradable sectors worsen
- increase in FDI environment issues
Y inequality
allocative inefficiency due to presence of
2. Increase in supply of low-skilled labour from developing
negative externalities and worsening of SOL
countries wages for low-skilled labour fall worsen Y
inequality

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5. Evaluation of the Effects of globalization
-SR vs LR effects of globalization (SR costs vs LR benfits)
- Benefits from globalization depends on governments ability to allocate the gains or to minimize the losses
- alleviate negative impact through ss-side policies
- Gains from globalization are not even across countries (developed and developing countries)

Free Trade Agreement: A legally binding agreement between two or more counties to reduce or eliminate barriers
to trade in, and facilitate the cross border movement of goods and services between the territories of the Parties.
Customs Union: same as FTA but member countries all impose the same trade barriers on non-member countries.
- Esp important for Singapores trade architecture. By 2011, Singapore has signed a total of 18 regional and bilateral FTAs, with
Australia, Japan, New Zealand and the US.
Trade Creation vs Trade Diversion
Consider how Country A and Country B are in an FTA. Country C is the lowest-cost world producer and Country B is the lowest
cost FTA member country.
Trade creation arises when economic integration leads to a shift in trade from a higher-cost producer to a lower-cost member
country. (welfare gain)
Trade diversion takes place whenever there is a shift in trade from a lower-cost non-member country to a higher-cost member
country. (welfare loss)
(refer to lecture notes appendix for economic analysis of the welfare gains and losses from FTAs)
Final words:
Discuss effects of globalization with regards to effects of trade, FDI (can include tech transfers) and labour flows.
Can also effects on microeconomic aims and macroeconomic aims
When discussing the role of the government, say that the government aims to fulfill the six economic goals: Efficiency, Equity,
EG, Low UN, Low and stable inflation, Healthy BOP.