International Trade Economics

Economics is the study of reconciliations between unlimited wants and limited resources. Those reconciliatory attempts extend across geographic boundaries. A central issue in international trade is whether gains accrue to citizens in the global market place due to their exchanges. Theoretically, larger quantities and wider choices of goods are available with international trade than without it. Exchanges include both goods and currencies because of the interactions among firms, households, and governments located around the globe. In this essay, students will learn economic concepts and philosophical differences that allow them to examine policies affecting the prices and the quantities of items traveling between nations. We will focus some initial attention on the production possibilities model, the opportunity cost concept, and the foreign exchange market. Afterwards, readers will gain a better understanding about the processes and content of payments between trading partners. Those exchanges take into account how much of one currency is worth in terms of another currency, which is something that continues to captivate the attention of many peoples. Readers will find that international trade is a rather odd concoction of free trade practices and trade restrictions. Across time and space, international leaders and their countries come together in an attempt to lessen trade restrictions in some instances and increase them in other instances. The essay closes by providing readers some insight into various arguments and rationales for trade restrictions.

Keywords Absolute Advantage; Ceteris Paribus; Comparative Advantage; Exchange Rate; Export; Free Trade; Import; Law of Demand; Law of Supply; Macroeconomics; Market; Microeconomics; Net Exports; Normative Economics; Opportunity Cost; Positive Economics; Production Possibilities Model; Quantity Demanded; Quantity Supplied; Quota; Tariff; Trade Restriction Rationale

Economics > International Trade Economics

Overview

Readers may come to understand economics as a study of reconciliations between unlimited wants and limited resources. Reconciliation is an attempt to find some optimal middle ground in problem solving. The economic problem arises due to resource scarcity and it prompts decision makers to make rational choices from amongst all the alternative solutions. Each and every choice involves a sacrifice because it is very difficult, if not impossible, to avoid tradeoffs.

International trade is an interesting topic and lends itself to being one of the most controversial topics in economics. Getting to the conceptual foundations for international trade, the main purpose of this essay is to inform undergraduate students about the economic context in which exchanges of physical quantities of products and currencies occur between countries. To some extent, the author assumes readers are familiar with principles of economics. Nonetheless, the information found in this essay appeals to those unfamiliar with economics, but engages all readers in pondering and attempting to answer some important initial questions.

Where do you stand regarding the issue of international trade? Do you favor protecting domestic jobs? If so, what cost attachments are there to job preservation measures? To what extent are you willing to make sacrifices in terms of accepting fewer choices in the market place and paying higher prices for them? Where does product quality and safety fit into all this? Perhaps recent news reports about recalls of foreign-made products diminishes the concern about higher prices. One could reasonably argue that consumers realize that high quality is available at a high price though some major retailers of imported goods claim quality is available at a low price.

Basic Economic Concepts & International Trade Components

At issue is whether benefits or gains accrue through international trade. Economists tend to believe that international trade does indeed provide benefits to consumers, producers, and workers. However, their views fall short of being universally acceptable due, in part, to the various dimensions of any international trade issue. Free trade may be an ideology given the existence of constraints such as trade barriers, international politics, and isolationist strategies. All those issues and concerns provide a rich backdrop against which to learn the major tenets of international trade theory as the reader may find in an introductory economics course.

International trade theory fits well with a basic understanding of how a country progresses through various stages of an economic maturation process. As countries move from an economy primarily based on hunting and gathering through manufacturing, services, and information heading toward and beyond a knowledge-based economy, a larger portion of domestic production becomes available for exchange with a trading partner. Opportunities arise to trade that excess production for other goods, which are the excess production of another country. In accordance with theory, specialization in production creates those opportunities (Razmi & Refaei, 2013).

Absolute Advantage

For varied reasons some countries are better at producing specific items than are other countries. As a case in point, the US is better at growing wheat and Columbia is better at growing coffee beans. In essence, each country will specialize in producing those goods best suited to their resource bases. Specialization arises from the discovery and acknowledgement that one country in the absolute sense is better suited at producing more of one specific item than is another country. Absolute advantage by definition is the ability of one country to produce more of something than another country. However, maximizing the gains from trade is reliant upon a country's ability to produce more than another, doing so in a most efficient manner.

Opportunity Cost

The gains from trade are observable when a country's citizenry attains a combination of goods that consists of larger amounts of each good than would be possible in the absence of trade. Comparative advantage by definition is specializing in that product for which the country's sacrifice in terms of other goods is minimal. The value of the foregone alternative is, by definition, an opportunity cost. In essence, finding solutions to the economic problem of scarcity involves minimizing opportunity costs. In brief, the gains from trade accrue through specialization, which in turn, reflects a country's recognition of what it can and should produce at a lower opportunity cost than another country.

Opportunity costs sometimes take the form of sacrifices that are linear in their relationship, which translate into the correspondence of a benefit with some given or constant amount of cost. However, economists tend to view the equation as one involving increasing amounts of cost in the form of a curvilinear relationship. The illustration of the opportunity cost concept is most effective when one attempts to consider all the possible choice combinations whether the opportunity costs are increasing as in the case of a curved-line concave-shaped arrangement or they are constant as in the case of a straight-line downward-sloping arrangement. A study of international trade introduces students to both forms within a larger model of production, specialization, and exchange often in the context that the world contains only two countries. Furthermore, students and other readers should think of a model as a tool that simplifies reality and remain cognizant of the fact that a key component in any economics model is the ceteris paribus assumption, which in translation from Latin into English means all else held constant.

Under this and some other assumptions, Country A will eventually purchase products from Country B and vice versa by virtue of their being trading partners within the population of countries around the globe. At any given moment, for the sake of simplicity if for no other reason, there is an immediate need to hold constant the state of technology, the availability of resources, and the level of productivity. This constraint limits production possibilities to an initial set of specific combinations. With a view toward a nation's current ability to produce two items, say goods X and Y, there is some precise point at which a specific combination of X and Y is possible in equal amounts, but any attempt to produce more of one essentially translates into the production of less of the other. In brief, the opportunity cost associated with producing one unit of X is the sacrifice of one unit of Y. This situation illustrates the opportunity cost concept while holding all else constant.

Marginal Analysis

Economics, in general, involves applying the opportunity cost concept to decisions made at the margin. In other words, how a change in one variable results in a change in another variable. As an introduction to the orientation of economics toward marginal analysis, the production possibilities frontier is a model that portrays all those combinations that a country's entire economy can produce. It is a macroeconomic concept, which effectively conveys the interdependencies among scarcity, choices, and tradeoffs. The difference between those economic divisions resides in their scope. Macroeconomics is a study of economics using models of the whole economy whereas microeconomics is a study of the behaviors of consumers and producers as they interact through price mechanisms in models we can refer to as a market.

Microeconomics & Macroeconomics

International trade is a topic that spans microeconomics and macroeconomics. The foundation of microeconomics emphasizes consumers and demand as integral components. With regard to the consumer or demand side, students learn very early in their coursework that an inverse relationship exists between price and quantity demanded in accordance with the Law of Demand. Relatively speaking, smaller amounts are in demand at higher prices and vice versa. On the producer or supply side, they learn that a positive relationship exists between price and quantity supplied according to the Law of Supply.

Positive & Normative Economics

International trade is also a topic that spans positive economics and normative economics. A call for governmental policies or interventions suggests that something should occur in order to alleviate a problem. That call would fit the classification of normative economics, which is one of two types of economic analysis. The other type is positive economics which occurs when analysts deal strictly with data or facts centering their attention on whether that information is accurate. For example, individuals are more likely to agree on matters regarding the accuracy of data than they are on matters regarding what ought to occur in response to their interpretations of the data. In sum, differences exist in the content of a statement containing the word "is" versus others containing the word "ought" or "should." Macroeconomics is more normative than microeconomics due primarily to its orientation toward policies promoting economic growth, employment, and price stability.

Expenditures

Students in macroeconomics courses receive an introduction to how the total expenditures of the household sector, the business sector, the public sector, and the trade sector provide an aggregate numeric estimate of a county's annual production. The last sector is comprised of national expenditures on imports and exports. Subtracting import expenditures from export expenditures yields a mathematical difference, which defines the term net exports. The value of net exports may be negative (known as a trade deficit), zero (balanced trade), or positive (trade surplus). Expression of trade balances and expenditures are in terms of the importing country's own unit of currency; for instance, the US Dollar or the Japanese Yen.

The aforementioned set of clarifications, distinctions, and assumptions provide a foundation with which readers can form an understanding of the way economists view the world. In the pages that lay ahead, readers will also gain a better sense of international trade theory and they will receive suggestions for learning reinforcement. As they move through this condensed essay, readers are encouraged to consult textbooks and other sources for additional details, examples, and cases because those omissions help achieve brevity.

Applications

Any study of international trade will hone student abilities to apply microeconomics and macroeconomics. In addition, they will find it integrates normative and positive economics by examining policies that affect the prices and the quantities of items exchanged on a global scale. Furthermore, students will recognize value in applying the production possibilities model and opportunity cost concept. However, Pearce (1992) and others point out that the essential difference between domestic or internal trade and international or foreign trade is the use of different currencies in payment for the exchanges between and among countries.

Prices of Exports: The Need to Convert Currencies

It is prudent to begin by taking note that each trading partner pays in the currency of the country from which they are acquiring the product. Most countries have foreign currencies on hand in addition to their own currency. For example, most banks in the United States contain deposits of the Japanese Yen and other currencies along with the US Dollar. In order for a buyer located in the US to purchase a motor vehicle made in Japan, for instance, the buyer needs to convert Dollars into Yens as part of the payment processes. Likewise, purchases of US-made products by foreigners require payment in some amount of Dollars equivalent to the agreed-upon price of that item.

Prices in a global context usually reflect international marketplace situations whether left to free trade or artificial sanctions. Sometimes governments restrict trade through regulations or they impose a tariff or a tax on an import thereby raising the item's price. The tariff becomes revenue for the government of a country that purchases the imported item. An import is by definition an item received by one country from another country whereas an export is an item sent from the providing country to the purchasing country. Price increases can also result from the imposition of a quota, which by definition is a limit on the quantity of an item imported into a country. An import quota effectively reduces the amount of an item available for purchase or the quantity of that item supplied.

Exchange Rates

Exchange rates are, by definition, the price of a domestic currency in terms of foreign currency. As they examine exchange rates, which are readily available through daily publications, students will find the US dollar as a standard against which to compare foreign currencies. In general, there are a variety of perspectives on exchange rate determination, but two are worthy of brief mention at this juncture.

• One perspective holds that exchange rates originate from supply and demand conditions that exist in the foreign exchange market. For instance, a trade surplus will generate a greater demand for the currency of the exporting country than would a trade deficit as trading partners seek to convert their currencies into that of the exporter. If the supply of its currency remains constant, then the domestic price of its currency will rise affecting the exchange rate.
• Another perspective, which takes into account actual and expected changes in the domestic supply of money, holds that exchange rate is a direct function of fluctuations in the value of a nation's currency. According to this perspective, the value of a unit of currency depends on its relative scarcity. Therefore, any increase in the supply of a currency while holding demand for the currency constant will then decrease its price and affect the exchange rate.

Currency Demand & Supply: The Foreign Exchange Market

Whether one emphasizes the supply side or the demand side of the foreign exchange market, any exchange rate is an expression of how much of one currency it will take for the conversion into or the purchase of another currency. Certainly, it will take more foreign currency to acquire a US Dollar when there is an increase in the latter's value. This situation represents an increase in the price of exports from the US to a trading partner because it has to convert more of its currency to obtain the dollar amount required in payment for that export or their import. By extension, a higher price may spark a chain of events increasing the likelihoods of a decrease in the quantities sold, a lower amount of expenditures on exports, a smaller level of national output, higher unemployment rates, and/or a lower rate of economic growth; immediately, the reader may see the value of holding other things constant. In essence, the volume of goods traded internationally is partly a function of comparisons between the world price and the domestic price (Yutaka, 2013). A country selling at a price that is lower than most other countries may increase its volume of exports. That is the situation when free trade occurs on a global level.

Free Trade, Restricted Trade, or Both?

International trade is an odd combination of free trade practices and trade interventions. From a historical standpoint, countries banded together with their trading partners and established the parameters through which they engaged in and promoted free exchange in the global marketplace. Evidently, that undertaking was and is a formidable challenge. In 1948, the General Agreement on Trade and Tariffs (GATT) came into existence in which a number of countries set out to find ways to resolve trade problems, eliminate tariffs, and reduce barriers to trade. A series of rounds occurred during the course of almost five decades with mixed results prompting other agreements and sub-agreements all with mixed results. In a concise summary of more recent agreements directly involving the United States, Guell (2007) refers to: The World Trade Organization (WTO) as an organization that arbitrates trade disputes; the North American Free Trade Agreement (NAFTA), which involves the US, Canada, and Mexico; and the CAFTA, which involves the US and five other countries in Central America.

The International Monetary Fund

About the same time GATT came about, the International Monetary Fund (IMF) began its pursuits encouraging international cooperation among monetary authorities or central banks, facilitating a balanced expansion in international trade, and promoting stability in foreign exchange markets. Consequently, exchange rates became both constant, but indexed to allow for a slight deviation around the value of the US Dollar; at that time, the Dollar was directly convertible into gold according to a fixed rate. Readers who have an interest in learning how international trade stabilization relates to the manipulative exchange of currencies in detail are encouraged to examine the IMF and the so-called "Bretton Woods System."

Tariffs

The international trade literature contains a lot of material describing various organizational attempts to orchestrate free trade by reducing barriers to trade. Tariff and non-tariff barriers form a useful dichotomy. By way of a review, as we head toward this essay's closure, a tariff is like a tax as it effectively raises the price of import. Non-tariff barriers are of different types. A quota is one type and it limits the amount of imports. Other methods of limiting trade include government regulations, which may arise from politics and/or address issues of safety or quality, and voluntary export restraints. The latter, as the name implies, will likely occur in the absence of and/or as a precursor to official regulations or sanctions.

Arguments for Trade Limitations

The final section of this essay lists six reasons and arguments for limiting trade. It draws from the presentations in introductory economics' textbooks authored by Arnold (2005), Guell (2007), and McConnell & Brue (2008) and many others.

• First, the national-defense argument designates some industries as being vital to homeland security.
• Second, the infant-industry protection argument, as introduced long ago by Alexander Hamilton, encourages a level playing field and protected the colonies from potential abuse by Europe.
• Third, the anti-dumping argument is used to prevent foreigners from selling exports below cost in order to drive domestic competitors out of business
• Fourth, the foreign-export subsidies argument discourages the negotiation of below-market interest rates that could favor trade with specific organizations or countries.
• Fifth, the low-foreign-wages argument addresses the lower costs of, and wages paid by, offshore producers and calls into question the quality of exports and the regulatory and safety orientations of foreign governments.
• Lastly, the saving-domestic-jobs argument is an attempt to protect domestic jobs and to promote full employment.

Conclusion

International trade as a topic of study in economics certainly exhibits a dynamic tension between free trade and restricted trade. Perhaps those dynamics alone explains why it is so fascinating yet challenging at the same time. Nonetheless, this essay presents a conceptual framework that allows students and others to realize how the gains from international trade are the consequence of scarcity-induced choices, opportunity cost minimization, and product specialization. In closing, this essay aims to shed some light on the complexities and the components in an exchange of goods and services that happen to cross a nation's geographical boundaries.

Terms & Concepts

Absolute Advantage: Occurs when one country produces more of something than another country.

Comparative Advantage: Occurs when a country specializes in products for which the sacrifice in terms of other goods is minimal.

Ceteris Paribus: A key assumption in economics, which translates from Latin into English meaning "all else held constant."

Exchange Rate: The price of a domestic currency in terms of foreign currency.

Export: An item produced in one country and sent to consumers in another country.

Import: An item produced in one country and received by consumers in another country.

Law of Demand: Specifies the inverse or negative relationship that exists between an item's demand quantity and its price; quantity and price move in opposite directions.

Law of Supply: Specifies the direct or positive relationship that exists between an item's demand quantity and its price; quantity and price move in same direction.

Macroeconomics: A division within economics for studying a nation's whole economy.

Market: A virtual space where consumers and producers interact while exchanging a specific item in accordance with their demand and supply schedules.

Microeconomics: A division within economics for studying behaviors of firms and households as they engage themselves in the exchange of resources and goods.

Net Exports: The difference after subtracting import expenditures from export expenditures; if value is negative, it is a trade deficit; zero is balanced trade; and, positive is a trade surplus.

Normative Economics: A branch within economics that suggests what should occur to achieve a goal or objective.

Opportunity Cost: The value of the best, yet foregone alternative because of making a decision due to scarcity.

Positive Economics: A branch within economics that deals with facts and their accuracy.

Production Possibilities Frontier: A model portraying all combinations an entire country can produce while holding constant the state of technology, the amount of resources, and the productivity of workers.

Quantity Demanded: The amount of goods or services that consumers desire at given prices.

Quantity Supplied: The amount of goods or services that suppliers are willing and able to produce at given prices.

Quota: A limit imposed by governmental action on the quantity of an item imported into a country.

Tariff: A tax imposed by a governmental body on an import.

Bibliography

Arnold, Roger A. (2005). Economics (7th ed.) Mason, OH: Thomson South-Western.

Guell, R. C. (2007). Issues in economics today (3rd ed.). Boston, MA: McGraw-Hill Irwin.

McConnell, C. R. & Brue, S. L. (2008). Economics (17th ed.). Boston, MA: McGraw-Hill Irwin.

Razmi, M., & Refaei, R. (2013). The effect of trade openness and economic freedom on economic growth: The case of Middle East and East Asian countries. International Journal of Economics & Financial Issues (IJEFI), 3, 376-385. Retrieved on November 25, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=92528956&site=ehost-live

Yutaka, K. (2013). Effects of exchange rate fluctuations and financial development on international trade: Recent experience. International Journal of Business Management & Economic Research, 4, 793-801. Retrieved on November 25, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=91750634&site=ehost-live

Suggested Reading

Crenshaw, E., & Robison, K. (2006). Globalization and the digital divide: The roles of structural conduciveness and global connection in internet diffusion. Social Science Quarterly (Blackwell Publishing Limited), 87, 190-207. Retrieved October 12, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=19615863&site=ehost-live

Fuller, D., & Geide-Stevenson, D. (2003). Consensus among economists: Revisited. Journal of Economic Education, 34, 369-387. Retrieved October 12, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=10846231&site=ehost-live

Gawande, K., & Hoekman, B. (2006). Lobbying and agricultural trade policy in the United States. International Organization, 60, 527-561. Retrieved October 12, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=21924420&site=ehost-live

Gilbert, J., & Oladi, R. (2011). Excel models for international trade theory and policy: An online resource. Journal of Economic Education, 42, 95. Retrieved on November 25, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=57225292&site=ehost-live

Hainmueller, J., & Hiscox, M. (2006). Learning to love globalization: Education and individual attitudes toward international trade. International Organization, 60, 469-498. Retrieved October 12, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=20832670&site=ehost-live

Hira, A. (2003). The brave new world of international education. World Economy, 26, 911-931. Retrieved October 12, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=10219929&site=ehost-live

Thurow, L. (2004). Do only economic illiterates Argue that trade can destroy jobs and lower America's national income? Social Research, 71, 265-278. Retrieved October 12, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=13986318&site=ehost-live

Winchester, N. (2006). A classroom tariff-setting game. Journal of Economic Education, 37, 431-441. Retrieved October 12, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=23427975&site=ehost-live