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www.trungtamtinhoc.edu.vn

ECO121

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Principles of economics

Lecturer: Nguyen Thanh TamClass: FB 0901

Group members:

Nguyen Hoang Cuong SB01403Le Trung Hieu SB01319

Vu Minh Tuan SB01273Dinh Quoc Quy SB01271Lam Thi Sim BA00221

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Contents

Absolute and comparative advantage

International trade advantage

Relate the terms of trade to the balance of trade

The consequences on the living standards as a

result of change in terms of trade

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1. Absolute advantage and

comparative advantageCOMPARATIVE ADVANTAGE THEORYstates that a countryshould sell to other countries those products that it

produces most effectively and efficiently and should buy

from other countries those products that it cannot produceas effectively or efficiently.

ABSOLUTE ADVANTAGEexists when a country has amonopoly on producing a specific product or is able to

produce it more efficiently than all other countries. Todaythere are few examples of an absolute advantage, but SouthAfrica diamonds use to be one such instance.

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A country has an absolute advantage economically overanother, in a particular good, when it can produce thatgood at a lower cost. Using the same input of resources a

country with an absolute advantage will have greateroutput. Assuming this one good is the only item in themarket, beneficial trade is impossible.

An absolute advantage is one where trade is notmutually beneficial, as opposed to a comparativeadvantage where trade is mutually beneficial.

Absolute advantage

Sources: http://wiki.answers.com/Q/What_are_the_differ

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Comparative advantage

A country has a comparative advantage in the productionof a good if it can produce that good at a loweropportunity cost relative to another country. The theoryof comparative advantage explains why it can bebeneficial for two parties (countries, regions, individualsand so on) to trade if one has a lower relative cost ofproducing some good.

What matters is not the absolute cost of production butthe opportunity cost, which measures how much

production of one good, is reduced to produce one moreunit of the other good.

Sources: http://wiki.answers.com/Q/What_are_the_differ

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2. International trade

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Advantages International trade

1. Job Creation

Example: Canada Foreign businesses buy Canadian products and

services, which leads to more jobs for Canadians Exports are critical to the Canadian economy

One out of three Canadian jobs depends on exports

More than 40% of everything Canada produces is

exported (50% for Ontario) Every $1 billion in exports means over 6000 jobs for

Canadian

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Advantages

2.Attracting Investment

Investment follows trade

Many foreign companies, when demand isproven through trade, will invest in anoffice, factory or distribution warehouse inCanada to simplify their trade and reduce

costs This investment creates other jobs in

construction, sales and office management

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Advantages

3. New Technology and Material

Development of new technology promotes

competitiveness and profitability Newly developed technology sold through

patents to foreign companies collectingannual fees, royalty percentage or a one-

time payment, outlined very specifically in acontract

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Advantages

4. New Technology and Material

E.g. Reliability Software, Asset

performance Management Software Capital Intensive Industries metals,mining, steel, utilities, power generation,oil and gas

Sell software maintenance and support,and services (professional ,implementation, technical services)

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Advantages

5. Diverse Products and Services

Foreign trade opens up the world as a market,delivering a wide range of foods, high fashions, and

new inventions to the Canadian market Foreign travel, banking, consultation and other

services are also available to the Canadian consumer Businesses must consider that their competition for

similar products and services is no longer just in thesame city but anywhere in the world.

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3 Relate Terms of trade to balance oftrade

The terms of trademeasures therelative prices of

the products thatwe exportcompared to the

cost (prices) of thegoods and servicesthat we import

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BALANCE OF TRADE

BALANCE OF TRADEis a nations ratio ofexports to imports.

A favorable balance of trade exists whenthe value of a nations exports exceeds itsimports

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How do we measure the terms of trade?

By dividing an index ofexport prices by anindex of import prices

If the terms of tradeindex goes up, we saythat the terms of tradehave improved

If the index falls, we saythat the terms of tradehave deteriorated

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Why does this matter?

The terms of tradeaffect the gains fromtrading with other

countries

It also impacts onvariables such as the

balance of paymentsand living standards

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Terms of trade and the exchangerate

The terms of trade ratio is heavilyinfluenced by changes in the exchange rate

A rise in the value of a country domesticcurrency decreases prices for its importsbut also makes exports less competitive

Thus a higher currency improves the termsof trade but might worsen the balance oftrade

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Relate Terms of trade to balance oftrade

The overall impact on the balance of payments of a change inthe terms of trade depends on the combined price elasticitiesof demand for imports and exports:

An improvement in the terms of trade will worsen thebalance of payments if the demand for exports and importsis price elastic, and improve it if demand for exports andimports is price inelastic.

A deterioration in the terms of trade will worsen thebalance of payments if the demand for exports and importsis price inelastic andimprove it if demand is price elastic.

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. e consequences on e v ngstandards of change in terms of trade

Th th li i

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The consequences on the livingstandards of change in terms of trade

The main impact of changes in the terms of trade theeffect on the standard of living.

An improvement in the terms of trade may improvethe standard of livingin a country the same volumeof exports will buy more imports.

A deterioration in the terms of trade may reducethe standard of livingas more exports have to be soldto pay for the same volume of imports.

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The consequences on the livingstandards of change

Terms of trade has improved, then this means that export priceshave increased more than import prices. This may indicate adeterioration in competitiveness and in the medium term may leadto a fall in export demand. How much export demand falls willdepend on the price elasticity of demand for exports. This mayadversely affect the balance of payments.

Deterioration in the terms of trade may indicate an improvementin competitiveness. This is because import prices have risen morethan export prices, perhaps showing that exports are morecompetitive. In the medium term demand for exports may rise and

lead to an improvement in the current account.

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standards of change in terms of

tradeAnalysing the terms of trade is not a simple matter.Prices of imports and exports will constantly bechanging according to supply and demand and theaverage changes in these prices will show up in theterms of trade.An improvement in the terms of trade may well begood news for exporters, but are they perhaps less

competitive in the medium term as a result? Fordeveloping countries that are very dependent on anarrow range of primary exports, the terms of tradewill be crucial to their ability to grow and to fund

essential imports.

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ECO121