Question:
1. Long-term Growth, International Trade & Globalization
a. In terms of understanding the importance of trade to an economy, the most important consideration is the trade balance - deficit or surplus.
i. True or False? ii. Why?
b. The US is the largest exporter in the world. The US has run a persistent trade deficit (importing more than we export) for over two decades.
Explain how both these statements can be true?
c. A country can only have a comparative advantage in those products and services that it produces at the lowest absolute cost (for a given quality).
i. True or False? ii. Why?
d. Comparative advantage is the ability of an individual, a firm, or a country to produce a good or service at a lower i._______________________ cost than competitors.
ii. Briefly Explain?
e. In the "Gains from Trade" framework, the win-win proposition obviously means that everyone wins from international trade.
i. Yes or No? ii. Why or why not?
f. i. Briefly explain and ii. quote how Charles Wheelan pulls together productivity, specialization, and trade as the "formula" for a country to create wealth.
Summary:
This question deals with concepts such as long-term growth, international trade and globalization. Questions related to trade deficit, trade surplus, gains from trade, an international trade scenario and Charles Wheelan's quote are answered.
Answer:
(a) False. International trade emerges from the exchange of goods and services across national boundaries, which are political in nature and not economic. This means that people buy goods from a foreign nation because that good cannot be produced in theirs. This is an economic phenomenon whereby consumers buy goods which they want, if we ignore the national boundaries. Therefore, it is the flow of goods and services and the fulfillment of wants of the consumers which is important. Trade surplus or deficits are just a reflection of whether the demand of goods from outside geographies is lower or higher compared to demand from the domestic country.
(b) International trade has seen rapid growth over the last 50 years or so due to fall in shipping costs and increased connectivity across the world. This means that the exports and imports of the US has also increased rapidly as a consequent. However, the increase in imports has been higher than increase exports. This has led to persistent and often increasing trade deficit for the US. What this also means in real economic terms is that the demand for foreign goods in the US has experienced higher increase than the demand for goods produced in the US by the outside world.
(c) False. The concept of comparative advantage rests upon the assumption of opportunity costs of production and not the absolute cost. Even if a country is producing a good at lower absolute cost than other, it may not have the comparative advantage as it may produce a different good more efficiently if the resources are freed from this good and shifted to the another good's production.
(d) (i) opportunity cost
(ii) Suppose two countries are producing the same two goods, A and B. Also, first country is producing 3 units of A and second country is producing 4 units of A by using one unit of labor. Now, suppose the first country moves one unit of labor out of good A to good B and can produce 2 units of good B while the second country can produce 3 units of B by shifting the same amount of labor out. In this case, the country producing 3 units of B has a comparative advantage in production of good B as the opportunity cost is just one unit of A while for the other country it is 1.33 units of good A.
(e) False. A country gains from trade if it specializes in the production of good in which it has comparative advantage. However, the sector in which it does not specialize will suffer in this country if the resources are not completely shifted to the good in which it has comparative advantage, as this sector's domestic and foreign demand will be zero and there will be unemployment of both men and resources.
(f) Charles Wheelan quotes, "Productivity is what makes us rich. Specialization is what makes us productive. Trade allows us to specialize."
This statement comes in the light of the fact that by utilizing the concept of comparative advantage, we can specialize in the sector where we have the highest productivity hence, leading to maximum possible production. After this, trade allows us to exchange goods from the rest of the world so that we can acquire other goods at a lower cost than what it would have been had it been produced in our country.