Post on 26-Mar-2015
International Economics
Classical and Neoclassical Trade Theory
Historical development of trade theory Mercantilism
Regulation to ensure a positive trade balance Critics: possible only for short term; assumes static
world economy Absolute advantage (Adam Smith)
Countries benefit from exporting what they make cheaper than anyone else
But: nations without absolute advantage do not gain from trade
Comparative advantage (David Ricardo) Nations can gain from specialization, even if they lack
an absolute advantage
Foundations of trade theory
Absolute & Comparative Advantage
Comparative advantage
Absolute advantage: each nation is more efficient in producing one good
Output per labor hourNation Wine Cloth
United States 5 bottles 20 yardsUnited Kingdom 15 bottles 10 yards
Comparative advantage: the US has an absolute advantage in both goods
Output per labor hourNation Wine Cloth
United States 40 bottles 40 yardsUnited Kingdom 20 bottles 10 yards
Ricardo’s Comparative Advantage in money prices
Comparative advantage
Cloth (yards) Wine (bottles)Nation Labor Wage Quant. Price Quant. Price
US 1 hr $20/hr 40 $0.50 40 $0.50UK 1 hr £5/hr 10 £0.50 20 £0.25UK 1 hr $8 10 $0.80 20 $0.40 (at $1.6 = £1)
Production possibilities schedule Generalizes theory to include all factors,
not just labor Shows combinations of products that can
be made if all factors are used efficiently Slope, or marginal rate of transformation,
shows the opportunity cost of making more of one good (how much of one good must be given up to make more of another)
Comparative advantage
Marginal Rate of Transformation
Comparative advantage
Production possibilities schedules: constant opportunity costs
Comparative advantage
Trading under constant opportunity costs
Comparative advantage
Production gains from specialization: constant opportunity costs
Comparative advantage
Autos Wheat Autos Wheat Autos Wheat
US 40 40 120 0 80 -40Canada 40 80 0 160 -40 80
World 80 120 120 160 40 40
Before After Net GainSpecialization Specialization (Loss)
Consumption gains from trade: constant opportunity costs
Comparative advantage
Autos Wheat Autos Wheat Autos Wheat
US 40 40 60 60 20 20Canada 40 80 60 100 20 20
World 80 120 120 160 40 40
Before After Net GainTrade Trade (Loss)
Production possibilities schedule under increasing costs
Increasing opportunity costs
Indifference curves and int'l. trade
Bringing demand into the model
Trading under increasing costs: US
Increasing opportunity costs
Trading under increasing costs: Canada
Increasing opportunity costs
trade pattern-”Trade triangle”
1. FT cons’n point
2. FT prod’n point3. NB: Home consumes
more food than it produces (i.e. imports food)
4. NB: Home produces more cloth than it consumes (i.e. exports cloth)
Production gains from specialization: increasing opportunity costs
Autos Wheat Autos Wheat Autos Wheat
US 5 18 12 14 7 -4Canada 17 6 13 13 -4 7
World 22 24 25 26 3 3
Before After Net GainSpecialization Specialization (Loss)
Increasing opportunity costs
Consumption gains from trade: increasing opportunity costs
Autos Wheat Autos Wheat Autos Wheat
US 5 18 5 21 0 3Canada 17 6 20 6 3 0
World 22 24 25 27 3 3
Before After Net GainTrade Trade (Loss)
Increasing opportunity costs
Basis for trade, gains from trade
Bringing demand into the model
Factor endowment theory (Heckscher-Ohlin)
Comparative advantage is explained entirely by different national supply conditions, especially resource endowments
Nations export products that use inputs which are relatively abundant (cheap) at home, and import products which need inputs which are relatively scarce (expensive) at home
Why relative price differentials?
Factor endowment theory: assumptions Nations all have the same tastes and
preferences (same indifference curves) They use factor inputs which are of uniform
quality They all use the same technology
Why relative price differentials?
Comparative advantage according to factor endowment theory
Factor endowment model
Autarky equilibrium
Comparative advantage according to factor endowment theory
Factor endowment model
Post-trade equilibrium
Factor endowment theory: implications Factor price equalization
The shift within each nation towards use of cheaper factors, and away from expensive ones, leads to more equal factor prices (if factors are mobile)
Distribution of income Trade changes domestic distribution of income as
demand for different factors changes Tests of factor endowment theory
Emphasize the importance of varieties of different factors (such as human capital) and accounting for changes in resource endowment; other explanations are also important
Factor endowment model
Factor Price Equalisation Theorem
In Hecksher-Ohlin's world, by trade, each countries' factor price (W/r) will be eventually the same. (Remember that in the H-O world, commodities can freely move while factors cannot. However, as a result of free trade of commodities, factor prices will be the same as well as commodity prices).
The relation between factor price (W/r) and factor intensity (K/L) Assumptions we sustain: As wage is relatively higher (W/r ), producers use more K-intensive
technology (k = K/L ) X is more labour intensive (kX = KX /LX < kY = KY /LY) Both countries have the same production technologies.
Relazione tra prezzo relativo dei fattori e prezzo relativo dei beni-paese H
If H country's total endowment ratio is kh, the wage-rental ratio in H will range (W/r)U < (W/r) < (W/r)L
La relazione tra prezzo dei fattori (W/r) e prezzo dei beni (PX / PY)
As (W/r) increases, PX / PY increases, because X is more labour intensive.
Before trade, (PX / PY )F is greater than (PX / PY)H as H is labour abundant.
Therefore, from the corresponding factor prices, (W/r)F > (W/r)H before trade.
Relazione tra prezzo relativo dei fattori e prezzo relativo dei beni-paese F
Teorema del pareggiamento del prezzo dei fattori By trade, the two countries' commodity prices will
converge (1) to the one world price (PX / PY).W
Eventually, (PX / PY).F = (PX / PY).W = (PX / PY).H
after trade. When (PX / PY). = (PX / PY).W, the only
corresponding factor price (1) is (W/r)W
With (W/r)W , both H and F use kX and kY for the two sectors' production.
Teorema del pareggiamento del prezzo dei fattori
Teorema del pareggiamento del prezzo dei fattori
We sustain the assumption that X is (always) more labour intensive. However, sometimes it is possible that two industries change the order of factor intensities. Suppose kY > kX when (W/r) is low, but kY < kX when (W/r) is high.
Then the graph we saw before changes:
Il caso della inversione dell’intensità fattoriale
Il caso della inversione dell’intensità fattoriale The relation between (W/r) and (PX / PY) is not
linear any more. When (W/r) is low, (1) as (W/r) increases, PX / PY increases because X is more labour intensive. Once (W/r) is higher (1) than (W/r)*, Y is more labour intensive. Therefore, as (W/r) increases, Py increases faster than Px, i.e. (PX / PY ) decreases.
In this case, even if there is one commodity price (PX / PY )w in the world by trade, two factor prices (1) (W/r)' and (W/r)" can exist. We cannot guarantee that H and F have the same (W/r).