🏦Business Macroeconomics Unit 12 – International Trade & Balance of Payments

Key Concepts and Definitions

• International trade involves the exchange of goods, services, and capital across national borders
• Absolute advantage refers to a country's ability to produce a good or service more efficiently than another country
• Comparative advantage occurs when a country can produce a good or service at a lower opportunity cost than another country
• Terms of trade represent the ratio of export prices to import prices for a country
• Tariffs are taxes imposed on imported goods to protect domestic industries and generate revenue for the government
• Quotas limit the quantity or value of goods that can be imported or exported during a specific period
• Embargoes prohibit trade with a particular country or region for economic or political reasons
• Exchange rates determine the value of one currency in terms of another currency

Theories of International Trade

• Mercantilism emphasizes maximizing exports and minimizing imports to accumulate wealth in the form of gold and silver
• Adam Smith's theory of absolute advantage suggests that countries should specialize in producing goods they can make more efficiently than others
• David Ricardo's theory of comparative advantage proposes that countries should specialize in goods they can produce at a lower opportunity cost
  • Even if a country has an absolute advantage in producing all goods, it can still benefit from specialization and trade based on comparative advantage
• Heckscher-Ohlin model explains international trade patterns based on differences in factor endowments (land, labor, capital) between countries
• New trade theory incorporates economies of scale, product differentiation, and imperfect competition to explain modern trade patterns
• Gravity model of trade predicts bilateral trade flows based on the economic sizes and distances between countries

Trade Policies and Agreements

• Free trade allows countries to exchange goods and services without government restrictions or interventions
• Protectionism involves the use of trade barriers (tariffs, quotas, subsidies) to shield domestic industries from foreign competition
• World Trade Organization (WTO) is a global organization that establishes rules for international trade and resolves trade disputes among member countries
• Preferential trade agreements (PTAs) reduce trade barriers between specific countries or regions (NAFTA, EU)
• Trade liberalization refers to the removal or reduction of trade barriers to promote free trade
• Trade creation occurs when a trade agreement leads to increased trade between member countries due to lower trade barriers
• Trade diversion happens when a trade agreement diverts trade away from more efficient non-member countries to less efficient member countries

Exchange Rates and Currency Markets

• Exchange rates can be fixed (pegged to another currency or a basket of currencies) or floating (determined by market forces of supply and demand)
• Appreciation occurs when a currency increases in value relative to another currency
  • Appreciation makes exports more expensive and imports cheaper for the country experiencing currency appreciation
• Depreciation happens when a currency decreases in value relative to another currency, making exports cheaper and imports more expensive
• Purchasing power parity (PPP) theory suggests that exchange rates should adjust to equalize the prices of identical goods in different countries
• Foreign exchange markets facilitate the buying and selling of currencies, with the largest being the spot market for immediate transactions
• Central banks can intervene in currency markets to influence exchange rates through open market operations, interest rate changes, or capital controls

Balance of Payments Structure

• Balance of payments (BOP) is a record of all international transactions between a country and the rest of the world over a specific period
• Current account records transactions involving goods, services, income, and unilateral transfers
  • Trade balance is the difference between exports and imports of goods
  • Service balance includes transactions related to tourism, transportation, and financial services
• Capital account tracks transactions involving the purchase or sale of non-financial assets (land, buildings, copyrights)
• Financial account records transactions related to international investments and borrowing
  • Foreign direct investment (FDI) involves acquiring a lasting interest in a foreign enterprise
  • Portfolio investment includes the purchase of foreign stocks, bonds, and other financial assets
• Official reserve account shows changes in a country's official reserve assets (foreign currencies, gold, SDRs)
• BOP should theoretically balance, with the sum of the current, capital, and financial accounts equaling zero

Current Account vs. Capital Account

• Current account focuses on transactions involving goods, services, income, and unilateral transfers
• Capital account deals with transactions related to non-financial assets and unilateral transfers of ownership
• A current account surplus occurs when exports exceed imports, while a deficit happens when imports exceed exports
• A capital account surplus indicates a net inflow of foreign investment, while a deficit suggests a net outflow
• Current account deficits are often financed by capital account surpluses, as foreign investment helps fund the excess of imports over exports
• Twin deficits hypothesis suggests that a country with a current account deficit will also have a fiscal deficit (government spending exceeds revenue)

Global Trade Patterns and Trends

• Intra-industry trade involves the exchange of similar products within the same industry (automobiles)
• Inter-industry trade occurs when countries exchange products from different industries based on their comparative advantages (agricultural goods for manufactured goods)
• Global value chains (GVCs) involve the fragmentation of production processes across multiple countries
  • GVCs allow countries to specialize in specific stages of production rather than producing entire goods domestically
• Trade in services has grown rapidly, driven by advancements in technology and the rise of the digital economy
• Emerging economies (China, India, Brazil) have become increasingly important players in global trade
• Trade tensions and protectionist measures (US-China trade war) can disrupt global trade flows and supply chains

Economic Impacts of International Trade

• Trade can promote economic growth by allowing countries to specialize based on their comparative advantages and access larger markets
• International trade can lead to increased competition, encouraging innovation and efficiency improvements
• Trade can create jobs in export-oriented industries but may lead to job losses in import-competing sectors
  • Displaced workers may require retraining and assistance to transition to new industries
• Consumers benefit from trade through access to a wider variety of goods and services at lower prices
• Trade can contribute to the diffusion of technology and knowledge across countries
• Uneven distribution of trade benefits can lead to income inequality within and between countries
  • Trade policies should be accompanied by measures to support affected workers and communities
• Environmental concerns arise when trade leads to increased production and transportation of goods, contributing to pollution and climate change