We live in a world of intensifying global relationships, one in which international business has become the key determinant of economic development and prosperity. This course, Global Business Environment, Part I, introduces students to a fundamental understanding of the socioeconomic political, cultural, and linguistic environment in which international businesses operate. This course utilizes an inquiry-based approach to understanding country level relationships in the Global Business Environment. It surveys the global business environment by asking and answering key questions about society, the global economy, cultures, institutions and languages. The questions we will ask are: 1. What is Globalization?, 2. Is Globalization New?, 3. How do Political and Social Institutions impact National Economic Development?, 4. What is the role of Culture?, 5. What are the Gains from Trade?6. Free Trade, Free-r Trade or Managed Trade?, 7. What are Foreign Currencies and how are Exchange Rates Determined?, 8. What does the Current Global Business Environment look like? This inquiry-based approach creates reflective opportunities for students to better understand the environment in which businesses operate. Lectures are delivered in an engaging manner, which encourages reflection and inquiry.
Module 5, Part 3
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Do curso por University of New Mexico
International Business I
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Week 5
What are the Gains from Trade?
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Doug E Thomas, Ph.D.Professor
International Management, Anderson School of Management
Hi guys. Welcome back to
Global Business Environment.
We are in module five, this is part three of module five,
in which we've been trying to answer the question,
what are the gains or benefits from trade between countries,
and we've talked about the history of trade, and
the anti free trade philosophies which dominated much of the 15, 16 and 1700s.
And we talked about that philosophy being called mercantilism, and
it wasn't until a couple of economists, philosophers Adam Smith and
David Ricardo came out with some very powerful quantifiable examples that
the world started to shift its opinion about the benefits from trade.
And these and other economists were able to demonstrate to policy makers,
governments, citizens, business people, that there could be a win-win,
situation when trade occurred, that both sides could benefit, and they demonstrated
this using somewhat artificial examples artificial because of the assumptions.
But they were nonethe,
nevertheless very powerful at convincing people of these potential benefits.
And so, let me go through this example with you and
the first idea that came forward is known as absolute advantage.
In part four we'll look at a sister concept comparative advantage, but
absolute advantage was the first one that was brought forth and
the assumptions in this example of absolute advantage are that
there are only two countries in the world.
That's obviously not real, there are more than two countries for
the purposes of our example we'll use Mexico and India.
And there's also an assumption that each country has the exact same
number of resources at their disposal and
there's only one resource needed to make any type of products.
So each country, Mexico, each country, Mexico and India are in our example, have
has 1,000 units of this resource, this generic productive resource, and
where they differ is in their ability to utilize their resources to make products.
And we're going to assume that there are only two products in the world.
Obviously not real an artificial setting.
And in our case we're going to talk about there being smartphones and
motorcycles, and each country is going to have an advantage or
more specifically, an absolute advantage.
They will have this advantage in production in other words they'll be more
productive, more efficient it's less costly,
it's cheaper for them to make one of the products or the other.
In this example it will take India 20 resources
of their thousand to make one of these smartphones and
it will take Mexico only 10 of these resources to make the smartphone.
So India is much less productive than Mexico is, in fact you might say that
Mexico is twice as efficient as India is at making smartphones.
When we look at motorcycles, the reverse is true, and
in fact it's a bigger gap Mexico is much less efficient, it's,
it's not as good at making motorcycles compared to India, it takes India
only 20 units of these resources to make one motorcycle, and it takes Mexico 50.
So India is more than twice as productive or
efficient at making motorcycles than Mexico.
And so what happens it's,
if each of these countries decide to buy into the ideas of mercantilism and
isolate themselves as two separate islands and don't trade, don't interact?
What if each of them decides to dedicate 50%
of its resources to the production of each of these products?
How much will they produce?
You can see here, on this second line that Mexico will end up,
because of their advantage, their absolute advantage in making smartphones with 50,
if they use 500 of their resources at 10 each, they can make 50 smartphones, and
India will be able to make 20 only 25.
As we saw the difference here, in their ability to make motorcycles,
Mexico will only make 10 motorcycles, whereas India will make 25 and
the total world consumption of each of these goods is right here.
This is the production and consumption.
This is what society in each of these countries gets to utilize.
And, so they're, they're cut off from each other.
You might say to be a little bit silly, that Mexico can talk a lot.
And India can travel a lot.
But Mexico's not going very many places, not able to travel.
It's not very many motorcycles,
and India, and can't communicate that well because they have far fewer smartphones.
What if, though these countries embraced the idea of the benefits of trade?
Would there be benefits from trade?
Well, let's go through an example here in number three.
What if each of these countries first specializes in the production of
one of these goods?
For example, what if Mexico decided to use its absolute advantage,
it's obvious clear dominant advantage in making smartphones, and
used all of its resources, they would end up making 100 of the smartphones.
And India is, obviously, better than Mexico at making motorcycles.
Each country has a clear advantage,
that's what's unique about this case, at making something.
And so it's clear that India should focus on making motorcycles.
Well what you see is that the total world consumption has increased, now the world
is consuming 25 more of the smartphones and 15 more of the motorcycles.
But without trade the country of Mexico is
better off in that they're talking more, but now they're not traveling at all.
And India is is traveling everywhere but
not speaking to each other on the phone at all or using their phones to communicate.
So we need to introduce trade and there could be lots of different terms of
trade that these two countries could gree, agree upon.
But what if each country decides to trade 40% of its production?
Well, with trade, and specialization, which we saw before, Mexico would
trade 40 motorcycles to India in exchange for 20,
excuse me 20 smart 40 smartphones to India for 20 motorcycles.
So, Mexico would end up with 60 phones.
It made 100.
It would leave it have 60 left over.
Trade 40 phones to India and it would get 20 motorcycles in return.
So India gives up 20 of these motorcycles and is left with 30.
We still have this increase in total world production and
consumption but now it's more balanced.
Now as we see down here, we see win-win gain from trade.
And Mexico ends up with ten more smartphones than they had before
specializa, specialization in trade, have gone from 50 to 60 which is a,
a positive net gain of ten.
India gets 15 more motorcycles than it had originally so
it's clear that Mexico benefits from trade because
they end up with a total of 60 of the, the smartphones,
which is ten more than they had originally with no trade and no specialization.
India ends up with 15 more smartphones, and here we see this again,
this total world increase of 25 smartphones consumed.
We went from 75 to 100.
The whole world is better off and it's balanced, each country is better off.
And that's what me mean by win-win.
That's what we mean by the gains or benefits from trade.
And with motorcycles we see the same thing.
We see a gain of ten motorcycles consumed in Mexico,
they went from ten to 20, doubled their consumption of motorcycles.
And India gained five from 25 to 30 and we still see this overall jump from 35 to 50.
So this powerful example showed the world,
if you will, that there were gains from trade, that there were these benefits from
trying to work together, and that it wasn't a win-lose proposition.
One side didn't have to, to be worse off, and while the other side gained, and so
those gains come from specializing using this differentia,
differential advantage, that each country has and then trading with each other.
What we'll see next time in part four of module five, will be similar,
but slightly tweaked example called comparative advantage.
And so we'll see you back next time in part four of module five.
Thanks a lot guys.
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