Specialization in International Trade - Coursework Example

International Trade Part Specialization in international trade happens when a country concentrates on a task or product whose opportunity cost in production is lower than in the trading partner (Dahlman, 2007, p. 29). In looking at the gains of trade and specialization using the neoclassical trade theory of international trade, we use a 2*2*2 matrix. This implies that there are two nations, two products or goods and two factors of production. Both countries are taken to have identical production functions: yi1 (Ci1, Li1) = yi2 (Ci2, Li2), i = 1, 2 with, ∂yij / ∂x > 0, ∂2 yij / ∂x2 < 0 x = Cij, Lij and constant returns to scale. Factors between the two countries are assumed to be immobile. Mobility occurs only between the sectors. There are unambiguous factor intensities for good i = 1, 2 with no reversals. The countries are assumed to be enjoying full employment and in perfect competition. Transaction as well as transportation costs are taken to be at zero with the countries having identical homothetic preferences and different relative factor endowments represented as: C1/L1 > C2/L2 The two nations under consideration are: Nation 1 = United States of America Nation 2 = Germany The two nations are developed nations with capital-intensive factors of production, but different relative factor endowments (Cunat and Maffezzoli, 2004, pp. 707--736). This means that there will be different frontiers of production. The autarky condition will result when welfare indifference curves employ the same scheme obtaining different relative prices. A country will enjoy comparative price advantage in the abundant factor good. That is either labor or capital or both, but in whichever case, there is sufficient condition to carry out trade. Terms of trade will exist in between the price relation at autarky: p1 < p > p2 Consumption and production points are different creating exports and imports leading to increased welfare. Under these conditions, each country specializes on production as well as exporting the good on which, it utilizes its abundant factor of production intensively (G and Olfo, 2014, p. 3-7). Both Germany and the U.S. enjoy abundance of technological advancements, but can still benefit from international trade in the capital intensive goods they produce. This is occasioned by specialization resulting from comparative advantage in ability of one country to produce a certain service or good at lower opportunity and marginal cost over the other. Another reason for trade to take place favorably for both countries is relative differences in wage rate where disadvantages of high costs are compensated by lower wage rates. In the neoclassical approach, there is equalization of factor prices making gains in trade possible for both U.S. and Germany (Ahearn and Belkin, 2010, p. 33-35). This approach tends towards an efficient global allocation where production factors are directed into opportunities with the greatest productivity resulting in factor price equalization on a global scale. Free trade ensures a tendency towards such a direction even in the absence of global factor mobility. In these capital abundant developed nations, capital is relatively cheap or inexpensive in comparison to labor. This means that specialization in the capital intensive good increases capital demand with lower wage rates, whose tendency is towards equalization of factor prices. Trade or mobility of goods compensates immobility of factors of production. Gains from trade and specialization are captured in assessment of a country’s comparative advantage (Ham and Johnson et al., 2003, pp. 197--203). Countries that specialize are able to make use of economies of scale advantageously and end up achieving increased efficiency. Economies of scale dictate that the average cost falls to a particular point as output increases on the LRAC (long run average curve). A country will naturally export and specialize in products, which intensively use the factor inputs they are endowed with in abundance (Hummels and Ishii et al., 2001, p. 75-96). Remarkably, developed countries such as Germany and the United States of America and have a comparative advantage leaning towards specialization in as well as exportation of manufactured goods of high value using high technology. These nations also export services of high knowledge from a skilled and educated labor/expatriate perspective. Effects of specialization can be captured in the PPF (production possibility frontier). In this part, the consideration is two countries producing two products (Schott, 2004, p. 647-678). The two products are digital cameras and vehicles. In order to manufacture digital cameras, there are resources put into use such as labor and capital that could have been used for production of other goods. The potential production of the other goods foregone to manufacture one digital camera is the O.C. (opportunity cost) of that digital camera. The two countries under consideration are the United States and Germany. Production possibilities: United States Production First Possibility Second Possibility Quantity of Vehicles 500 0 Quantity of Digital Cameras 0 1000 Germany Production First Possibility Second Possibility Quantity of Vehicles 1000 0 Quantity of Digital Cameras 0 500 Assumption made in the first table is that the U.S. can produce 500 vehicles if no digital cameras are produced or 1000 digital cameras if no vehicles are produced. The slope of the PPF will be -1000/500, which is -2. This implies that the production of an additional vehicle will entail the U.S. foregoing production of two digital cameras. Likewise, Germany is assumed to produce 1000 vehicles if no digital cameras are produced or 500 digital cameras if it does not produce any vehicles. The slope of the PPF will be -500/1000, which equals -0.5. Translated it implies that the production of one additional vehicle results in Germany foregoing production of 0.5 digital cameras. Germany enjoys comparative advantage in vehicle production brought about by lower opportunity cost in Germany than in the U.S (Weihrich, 2009, p. 9-22). This is translated as 0.5 digital cameras per vehicle in Germany as opposed to two digital cameras per vehicle in the U.S. Consequently, the United States enjoys a comparative advantage in production of digital cameras. To produce an additional digital camera in the U.S. production of 0.5 vehicles is foregone, while production of one extra digital camera in Germany entails foregoing production of two vehicles. Each country is allowed to specialize in producing the good that gives it comparative advantage in international trade, digital cameras in the U.S. and vehicles in Germany leading to gains for both. Part 2 Concentrating on what businesses and people do best as opposed to relying on self-sufficiency occasions possible opportunities for any country to gain from specialization (Hummels and Ishii et al., 2001, p. 75-96). Specialization translates to higher output where total production of services and goods is increased coupled with improvement of quality. Specialization has also led to consumers gaining access to a wider variety of high quality goods through international trade. Global trade and specialization increase the market size enhancing economies of scale opportunities. Increase in competition from specialization due to international trade serves as an incentive for minimization of costs. This ensures prices are kept down maintaining low inflation. From the example of international trade between the U.S. and Germany, Germany has a comparative advantage in vehicle manufacture while the U.S. enjoys comparative advantage in digital camera production. Both nations are able to benefit from trading and specialization under the condition that the international price for every good is equal to or less than the opportunity cost of domestic production of the imported good (Lai and Chun Zhu, 2004, p. 459-483). Greater efficiency in production will lead to the nation tapping benefits from increasing returns to scale for these goods’ production. Increased learning benefits a nation in line with having skilled personnel making the products in which they are specialized. Based on the idea of comparative advantage, trade and specialization have been proved in leading to improved welfare. Specialization also has some downsides to it. One is the threat posed to uncompetitive sectors. Some parts of the economy are unable to compete with better or cheaper imports leading to structural unemployment (Mahutga and Smith, 2011, p. 257-272). Strategic vulnerability occurs where dependence may arise from relying on another nation for important resources. In the event of economic or political changes in the independent country, there will be a negative impact on supply of services and goods to the dependent nation. A country should specialize moderately in production of several goods and services to avoid the risk of over-specializing, which may work against the nation when demand for its products falls. References Ahearn, R. J. and Belkin, P. 2010. THE GERMAN ECONOMY AND US-GERMAN ECONOMIC RELATIONS. Current Politics & Economics of Europe, 21 (4), 33-35. Cunat, A. and Maffezzoli, M. 2004. Neoclassical growth and commodity trade. Review of Economic Dynamics, 7 (3), 707-736. Dahlman, C. 2007. Technology, globalization, and international competitiveness: Challenges for developing countries. asdf, 29. G and Olfo, G. 2014. Introduction to International Trade Theory and Policy. Springer, 3-7. Ham, C. L., Johnson, W., Weinstein, A., Plank, R. and Johnson, P. L. 2003. Gaining competitive advantages: analyzing the gap between expectations and perceptions of service quality. International Journal of Value-Based Management, 16 (2), 197-203. Hummels, D., Ishii, J. and Yi, K. 2001. The nature and growth of vertical specialization in world trade. Journal of international Economics, 54 (1), 75-96. Lai, H. and Chun Zhu, S. 2004. The determinants of bilateral trade. Canadian Journal of Economics/Revue canadienne deconomique, 37 (2), 459-483. Mahutga, M. C. and Smith, D. A. 2011. Globalization, the structure of the world economy and economic development. Social Science Research, 40 (1), 257-272. Schott, P. K. 2004. Across-product versus within-product specialization in international trade. The Quarterly Journal of Economics, 119 (2), 647-678. Weihrich, H. 2009. Analyzing the competitive advantages and disadvantages of Germany with the TOWS Matrix-an alternative to Porter’s Model. European Business Review, 99 (1), 9-22. Read More