INTERNATIONAL

TRADE

Economics, IB 2
 International Trade and Globalisation
Learning Outcomes: At the end of this lesson, you should be able to:

01 02 03
Explain the Identify the gains Distinguish
concepts of from International between the
international trade Trade theories of
and specialization absolute and
comparative
advantage
Lesson starter
(Brain Teasers)
 (Send your answers to the chat room)
1. What month of the year has 28 days?
2. I shave every day, but my beard stays the same. How is this possible?
3. A man dies of old age on his 25th birthday. How is this possible?
4. I have branches, but no fruit, trunk or leaves. What am I?
5. What three numbers, none of which is zero, give the same result
whether they’re added or multiplied?
6. A man describes his daughters, saying, “They are all blonde, but two;
all brunette but two; and all redheaded but two.” How many
daughters does he have?
1. What month of the year has 28 days?
Answer: All of them
2. I shave every day, but my beard stays the same. How is this possible?
Answer: A barber
3. A man dies of old age on his 25th birthday. How is this possible?
Answer: He was born on February 29.
4. I have branches, but no fruit, trunk or leaves. What am I?
Answer: A bank
5. What three numbers, none of which is zero, give the same result whether they’re
added or multiplied?
Answer: One, two and three
6. A man describes his daughters, saying, “They are all blonde, but two; all brunette
but two; and all redheaded but two.” How many daughters does he have?
Answer: Three: A blonde, a brunette and a redhead
 International Trade
International trade or foreign trade is the
exchange of goods and services between
countries. It involves mainly import and export.

Most countries in the world are open economies

(they trade with other countries through
imports and exports). They export goods to earn
foreign currency which they use to import
products that they cannot produce.
 International Specialisation
Specialisation occurs when individuals, firms,
regions or countries concentrate on the
production of a particular good or service.
International specialisation occurs when
countries concentrate on the production of
certain goods or services due to having cheaper
production methods and an abundance of
superior resources. For example Nigeria
specializes in crude oil and Brazil, coffee.
 Gains from International Trade

There are many gains that can be

realized from international trade.
See Next Slide
Lower prices: Consumers may Differences in resources:
Greater choice: Consumers
have access to cheaper foreign Different countries have
may have access to a wider
products and firms may have different resource
variety of goods and services
access to cheaper imported endowments, thus some may
inputs need to rely on other
Gains from countries for products that
Increased competition: This International they cannot produce or
raises product quality and Trade produce as efficiently.
reduces prices
Economies of scale: Countries producing for
Source of foreign exchange: Foreign
domestic and foreign markets may enjoy lower
currency can be earned from a country’s
average costs from large scale production via
exports and, in turn, used to import
technical economies, purchasing economies,
products useful to the local economy
managerial economies etc.
 The theories of absolute advantage and comparative
Which goods should a country export and which ones should it import? This can be
answered using the two theories explained below:
1. Theory of Absolute advantage:
A country is said to have absolute advantage in the A B
production of a good if it can produce it at a lower cost
or using fewer resources than another country. A
country with this advantage should therefore produce
this good and leave to other countries goods that it has Average cost per unit Average cost per unit
$100 $130
an absolute disadvantage at producing. If countries
follow this rule, total world output will be maximized.
X Y
2. Theory of Comparative advantage:
A country is said to have comparative advantage in
the production of a good if it can produce it at a lower
opportunity cost than another country. To produce 100 more To produce 100 more
cars, country X must give cars, country Y must give
up 4,000 televisions up 7,000 televisions
INTERNATIONAL
TRADE
Economics, IB 2
 International Trade
Learning Outcomes: At the end of this lesson, you should be able to:

01 02 03
Define free trade Define trade Define terms of
and give the protection and trade and explain
arguments for it. advance arguments how it is calculated.
for it.

04
Analyse imports, exports,
tariffs, quotas using the
international trade
diagram.
 Lesson
Starter…
(next slide)
 Starter (Send your answers to the chat room)
Match each statement on the right with the related term on the left.
TERM MATCHING A. The excessive B. A self-sufficient country
LETTER concentration of an that produces all it needs
economic agent on the locally and does not buy
production of a very limited products from or sell to
1 Labour turnover range of goods and other countries.
rate services.
2 Deregulation C. Takeover of the D. A proportion of the entire
ownership and control of a pool of workers that leave
3 Autarky state owned enterprise by their jobs in search of other
private individuals. jobs in a year.
4 Privatisation E. Policy aimed at F. When a country
reducing the monopoly in concentrates on and
5 Overspecialization an industry by allowing becomes efficient at the
more businesses to enter production of a product or a
6 International that industry, thereby limited rage of products.
Specialisation making it more competitive
 Solution to Starter (Send your answers to the chat room)
Match each statement on the right with the related term on the left.
TERM MATCHING A. The excessive B. A self-sufficient country
LETTER concentration of an that produces all it needs
economic agent on the locally and does not buy
production of a very limited products from or sell to
1 Labour turnover D range of goods and other countries.
rate services.
2 Deregulation E C. Takeover of the D. A proportion of the entire
ownership and control of a pool of workers that leave
3 Autarky B state owned enterprise by their jobs in search of other
private individuals. jobs in a year.
4 Privatisation C E. Policy aimed at F. When a country
reducing the monopoly in concentrates on and
5 Overspecialization A an industry by allowing becomes efficient at the
more businesses to enter producing a product or a
6 International F that industry, thereby limited range of products.
Specilaisation making it more competitive
 Terms of Trade (TOT)
Terms of trade (TOT) is defined as the ratio between a country's export prices and its import prices. It relates
the prices that a country receives for its exports to the prices it pays for its imports, and can be calculated as:

or

The terms of trade (TOT) measure prices of exports relative to prices of imports; it is also a
measure of the amount of imports that can be bought per unit of exports. An increase in the
price of exports, with the price of imports constant, means more imports can be bought with the
same quantity of exports. Conversely, an increase in the price of imports, with the price of
exports constant, means fewer imports can be bought with the same quantity of exports.
If TOT is greater than 100, it is said to be favourable as export prices are greater than import
prices. However, if TOT is less than 100, it is said to be adverse as import prices are greater than
export prices
 Difference between Improvement and Deterioration in Terms of Trade
If the Terms of trade (TOT) value increases (which means the export prices increases relative to import
prices), this is an improvement in the terms of trade improvement. This means for every import a country
buys, it receives a higher amount from its exports than before.

If the Terms of trade (TOT) value decreases (which means the export prices decreases relative to import
prices), this is an improvement in the terms of trade improvement. This means for every import a country
buys, it receives a lower amount from its exports than before.

Illustration 1: From the following data, calculate the terms of trade for 2002 and 2003 and comment on the
figures and whether there was an improvement or deterioration.

Solution:
Average price
of wheat
2002 2003
$ per kg $ per kg The TOT was favourable in 2002 but adverse in
Export of 2003. The Terms of Trade deteriorated from 2002 to
wheat 15 18 2003 since the value fell from 125 to 90.
Import of
coffee 12 20
 Illustration 2
The terms of trade for 2002 was 105. In 2004 the index of export prices was 115 and
index of import prices was 104.

Calculate the terms of trade for 2004. How does it compare with the value in 2002?

This indicates that the terms of trade improved over the 2002– 2004 period. Average
export prices have increased relative to average import prices.
 Determinants
of Terms of
Trade

Short Run Long Run

Changes in global demand Changes in national income
Changes in global supply Changes in productivity
Changes in domestic inflation Technological advances
Changes in exchange rate Trade protection
 Free Trade
Free trade is defined as a situation
whereby trade takes place between
countries without any barriers to
trade imposed by government or
international organizations.

Under a free trade agreement, goods and services move freely between
countries.
 It allows countries to It increases consumer
benefit from choice: Consumers can
specialization: They enjoy a greater variety of
can produce what they goods and services from
are best able to and across the world
then trade their surplus

Arguments for
free trade
It creates extra business It increases competition and
It increases competition
and job opportunities: efficiency: Firms must
and efficiency: Firms
New and existing firms improve their costs and
must improve their costs
can expand their sales to product quality to compete
and product quality to
growing consumer with overseas producers
compete with overseas
markets overseas
producers
 Why should trade be controlled?
(Arguments against free trade)
• Trade with low-cost economies is threatening jobs in many developed economies and
reducing opportunities for less-developed economies to grow their industries

• Trade is increasing the rate at which we are depleting natural resources

• Trade may increase the exploitation of workers and the environment in many less-
developed economies as multinationals are attracted to them by low wages and taxes

• It has increased the gap between rich and poor nations

because developed and rapidly developing economies dominate global demand for
many natural resources, including foodstuffs, timber and metal ores, and have used their
purchasing power to force down their market prices
Trade Protection
Trade protection, also called
protectionism, is the economic policy of
restricting imports from other countries
through methods such as tariffs on
imported goods, import quotas, and a
variety of other government regulations.
 Tariff: A tariff is a tax on imported products: It
Tariff
makes imports more expensive and reduces the
method demand for imports .

Methods of
Trade Embargo: This is a complete ban on an
Protection imported product.
Quota: This is a limit on the quantity of a product
Non-tariff allowed to be imported into a country
methods Subsidies on exported goods, which makes
exports cheaper and more competitive in
international markets
Unreasonable quality controls, standards and
licensing requirements for imports, making
importation more difficult and costly
 Arguments for Trade Protection
1. To protect infant (or sunrise) industries (Infant industry argument)
•Protecting new firms from overseas competition gives them the time and chance to
develop, grow and become more globally competitive
2. To protect sunset industries (sunset industry argument)
•Protection from overseas competition will help to slow down the rate of decline in
and loss of jobs from some major industries, allowing time for other industries to
develop to provide new jobs and incomes
3. To protect strategic industries, such as agriculture, energy and defence equipment
•So that a country is not entirely dependent on such important supplies from
overseas countries
4. To protect domestic firms from dumping
•Dumping is a form of predatory pricing involving one country‘flooding’ another
with a product at a price significantly below its market price to force rival producers
out of business.
 Arguments for Trade Protection
5. To limit over-specialization
•Trade barriers can help a country to maintain a wider range of different industries
to reduce the risk of its main industry failing or declining due to overseas
competition
6. To correct a trade imbalance/To correct balance of payment deficit
•By reducing the amount of imports coming into a country
 Inefficient domestic firms It limits consumer choice:
protected from overseas consumers may not have
competition will continue to be access to a large variety
inefficient of products

Other countries
It restricts new
may retaliate Arguments
Against Trade business
against the
Protection opportunities
trade
protection

Protectionism may raise the It reduces specialization and world

prices of consumers, businesses trade, thus hindering economic
who buy imports growth.
 International Trade Graph - The Case of Imports
Assume a country produces oil and the economy does not trade
oil with other countries. That means the equilibrium price (Pe) and
S (Domestic)
quantity (Qe) for oil within the country will be determined by the

Price
intersection between domestic supply S (Domestic) and domestic
demand D (domestic). If the country decides to open its borders
and trade oil with other countries, the world supply of oil will be
represented by the world market supply curve (Pw) which is
Pe
perfectly elastic. This is because the international market is much
larger than the domestic market, and domestic consumers and
S (World)
producers will not be able to impact the international price. Pw
Consumers will be able to import oil at the world price. Domestic
suppliers will not supply 0Qe but they will supply OQ1 at price Pw.
But domestic demand will be OQ1 at Pw. This will create an excess D (Domestic)
domestic demand of Q1Q2 which will be imported from abroad.
Thus, when a product’s domestic price Pe is higher than its 0 Q1 Qe Q2 Quantity
world’s price Pw, the product will be imported the product to meet
excess demand. imported
 International Trade Graph - The Case of Exports
Suppose an economy trades oil with other countries and the
world price Pw is higher than the domestic price Pe of oil. S
S (Domestic)

Price
(Domestic) represents domestic supply of oil and D exported
(domestic) represents domestic demand as usual. If the world
price Pw is higher than the domestic equilibrium price Pe (as Pw S (World)
seen in the graph below), producers will not produce Q e. They
will increase production to the quantity where the domestic
Pe
supply intersects the world price (Q2).. This will create an excess
domestic supply of Q1Q2 which will be exported abroad. Hence,
when a product’s domestic price is higher than its world’s price,
suppliers will export the excess domestic supply to other
countries. The suppliers are able to sell more oil at a higher
price by being involved in international trade. D (Domestic)

0 Q1 Qe Q2 Quantity
 International Trade Graph- Case of Tariffs
A tariff is a tax that is charged on imported goods. Any tax placed
upon a good shifts the supply curve upwards by the amount of the
tax. A tariff will shift the world supply curve upwards, since it is
placed on the foreign producers of the good and not the domestic
producers. The effect of a tariff on imported wheat is shown in the
figure below.
Before the tariff, 0Q2 tons of wheat were being consumed at a price
of Pw Domestic production was OQ1 and imports were Q,Q. When the
tariff is imposed, S (World) shifts up by the amount of the tariff to S
(World) + tariff and so the market price rises to Pw+ T. Total quantity f
demanded falls from 0Q2 to 0Q4, because the price has risen.
Domestic producers increase production to OQ3, and so their revenue
increases from g to g+a+b+c+h. Foreign producers supply the rest,
which is now Q3Q4. They receive P + T, but have to pay the tariff (T) to
the government. Thus their revenue falls from h+i+j+k to only i + j.
The government now receives tariff revenue of d + e.
 International Trade Graph- Case of Tariffs- continued
The importers must pay a higher price for the imported good. In
the case of wheat, the higher price will be passed on to millers and
eventually to the cereal companies or bakeries that buy the refined
wheat. As another example, if a government introduced a tariff on
automobile component parts, then this would raise the costs to
car-makers and eventually lead consumers to have to pay higher
prices for their cars. If the car-maker is an exporter, then the higher
cost of imported components could reduce its international
competitiveness. f
Take note:
1. Loss of consumer surplus = f
2. Loss of efficiency = c
3. Deadweight loss/Loss of community (social) surplus = c + f
 International Trade Graph- Case of Subsidies
A subsidy is an amount of money paid by the government to a firm, per
unit of output, lowering the firm's costs. Assume the government is
giving a subsidy to domestic producers to make them more competitive
and so the effect will be to shift the domestic supply curve downwards
by the amount of the subsidy. Assuming the country trades in wheat,
then the effect of a subsidy granted to domestic wheat producers is
shown in the figure below. Before the subsidy, OQ2 tons of wheat were
being consumed at a price of Pw. Domestic production was OQ1 and
imports were Q1Q2. When the subsidy is granted, S (Domestic) shifts
downwards by the amount of the subsidy to S (Domestic)+subsidy. The
market price stays at Pw. and so demand remains at OQ2. However,
domestic producers increase production to OQ3, because they are now
receiving Pw+subsidy per unit that they produce. This means that their
revenue increases from a to a+b+e+f+g. Foreign producers supply the
Note that there is no loss consumer rest, which is now Q3Q2. Thus their revenue falls from b+c+d to only c+d.
surplus, because the price of wheat The government pays the subsidy, which is shown by the area e + f + g in
does not change. total.
International Trade Graph- Case of Quota
A quota is a physical limit on the numbers or value of goods that can be
imported into a country. For example, the EU imposes import quotas on
Chinese garlic and mushrooms. The imposition of a quota has a peculiar
effect on the international trade diagram as shown below, once more
using the example of the wheat market. Before the quota is imposed,
OQ2 of wheat is purchased at a price of Pw, Domestic supply is OQ1 and
imports are Q1Q2. Assume that the government imposes a quota of Q1Q3
tons of wheat. Domestic producers supply OQ1, at a price of Pw and the
importers produce their quota of Q1Q3. However, once this happens,
there is an excess demand of Q3Q2 at the price Pw and so price begins to
rise. As the price rises, importers are not allowed to supply more wheat,
because they have filled their quota, and domestic producers begin to
enter the market, attracted by the higher price of wheat. The domestic
supply curve has, in effect, shifted to the right, above Pw. Eventually, the
price settles at PQuota where demand now equals supply again and the
total quantity of wheat demanded falls to Q4.
International Trade Graph- Case of Quota- continued
Domestic producers now supply 0Q1 and Q3Q4 tons of wheat at a price
of PQuota. Their revenue rises from a to a+c+d+f+i+j. Foreign producers
now supply their quota of Q1Q3 tons of wheat and also receive a price of
PQuota. Thus their income changes from b+c+d+e to b+g+h. This is usually
a fall in income but, in theory, it does not have to be.

Efficiency loss equals the area: j

Loss of consumer surplus equals the area: k
Deadweight loss / Loss of community (social) surplus equals the area:
j+k
 Worked Example SDomestic
1. The graph below shows the market for
cooking oil in a country.
2

Price of cooking oil per litre ($)

a) Indicate the domestic equilibrium price and
quantity on the graph.
b) Cooking oil may be imported. The world
price is $1 per litre. Add the world supply
curve to the graph.
c) Explain how much cooking oil will be
supplied by domestic suppliers and how
much will be supplied by foreign producers 1
when free trade takes place.
d) The government imposes a tariff of 30¢ per
litre. Show the effect of this on the graph.
e) Calculate the change in consumer spending
before and after the imposition of the tariff. DDomestic
f) Calculate the government tax revenue after
the tariff is put in place.
g) Explain the impact of the tariff on any two of
the stakeholders in the cooking oil market. 1 2
Quantity of cooking oil (millions of litres)
 Price/litre ($)
Worked Example 1 - SOLUTION SDomestic
1. The graph below shows the market 2
for cooking oil in a country.
a) Equilibrium price = $1.50 and
Equilibrium quantity = 1,000,000
litres. 1.5
b) Cooking oil may be imported. The 1.3 Sworld+Tariff
world price is $1 per litre. Add the
world supply curve to the graph. SEE 1 Sworld
GRAPH
c) Domestic supply under free trade =
0.5 million litres. Foreign producers
supply under free trade = 1.5 million –
0.5 million = 1 million. DDomestic
d) Show the effect of a 30¢ per litre tariff
on the graph. SEE GRAPH
0 0.5 0.8 1 1.2 1.5 2
Quantity of cooking oil (millions of litres)
Worked Example 1 - SOLUTION

Price/litre ($)
SDomestic
1. The graph below shows the market 2
for cooking oil in a country.
e) Consumer spending before tariff =
$1 × 1.5 million = $1.5 million.
Consumer spending after tariff = 1.5
$1.30 × 1.2 million = $1.56 million. 1.3 Sworld+Tariff
Change (increase) = $1.56 million -
$1.5 million = $0.06 million or 1 Sworld
$60,000
f) Tax revenue after the tariff =
$0.3(200,000) + $0.3 (200,000) =
$120,000.
g) Explain the impact of the tariff on any DDomestic
two of the stakeholders in the cooking
oil market: Home Work
0 0.5 0.8 1 1.2 1.5 2
Quantity of cooking oil (millions of litres)
 Worked Example 2
The diagram below is for a country involved in
international trade.. The country trades in bags. In
the diagram, DD stands for domestic demand, SD
stands for domestic supply and SW stands for
40 SD
world supply.
SW
a) Calculate the value of bag exports per year

Price/unit ($)
from the country. 30
b) Calculate the social/community surplus earned
by stakeholders in the bag market in the
country under conditions of free trade.
c) Calculate how much the revenue earned by 20
bag producers in the country would decrease if
the world price of bag falls by $3 per unit.
10

DD
25 50 75 100
Quantity (‘000 units)
 Solution to Worked Example 2
The diagram below is for a country involved in
international trade.. The country trades in bags. In
the diagram, DD stands for domestic demand, SD
stands for domestic supply and SW stands for world
40 SD
supply.
a) Calculate the value of bag exports per year from SW
the country.

Price/unit ($)
SW-$3
30
b) Calculate the social/community surplus earned by
stakeholders in the bag market in the country
under conditions of free trade.
20

c) Calculate how much the revenue earned by bag

producers in the country would decrease if the
10
world price of bag falls by $3 per unit.

DD
25 50 75 100
Quantity (‘000 units)
 Practice Question
On 17 December 2020, Turkey eliminated a 20% tariff it had
imposed on wheat imports from Russia. Russia had recently
decided to introduce a tax on its wheat exports. Turkey is the
largest flour exporter in the world and Turkish flour exporters
buy 85% of the wheat they need in their production process
from Russia.
a) Explain two likely reasons that may account for Turkey’s
decision to eliminate the 20% tariff on wheat imports from
Russia.
b) The graph below illustrates the Turkish wheat market. Before
the 20% tariff was eliminated, the price for wheat in Turkey
was US$7.20 per kilogram. S is domestic supply, D is domestic
demand, Sw is world supply and St is world supply with the
tariff.
i. What is the quantity of the wheat supplied by Turkish
producers after the tariff is eliminated?
ii. Calculate the value of domestic supply of wheat after the
tariff is eliminated.
iii. How many kilograms of wheat will be demanded
(domestic plus foreign) after the tariff elimination?
Question continues on next page
 Practice Question- continued
On 17 December 2020, Turkey eliminated a 20% tariff it had
imposed on wheat imports from Russia. Russia had recently
decided to introduce a tax on its wheat exports. Turkey is the
largest flour exporter in the world and Turkish flour exporters
buy 85% of the wheat they need in their production process
from Russia.
a) The graph below illustrates the Turkish wheat market. Before
the 20% tariff was eliminated, the price for wheat in Turkey
was US$7.20 per kilogram. S is domestic supply, D is
domestic demand, Sw is world supply and St is world supply
with the tariff.
iv. What is the value of the wheat imported after the tariff
elimination.
v. Calculate the change in social/community surplus that
resulted from the elimination of the 20% tariff.
vi. The currency of Turkey is the Turkish lira (TL). If TL1.00 =
US$0.134, calculate in TL, the change in the monthly total
revenues of Turkish wheat producers as a result of the
elimination of the 20% tariff. (Express your answer
correct to 2 decimal places).