Transcript Carbaugh, Intl Economics, Chapter 2

International Economics
Classical and Neoclassical
Trade Theory
Foundations of 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
Comparative advantage
Absolute & Comparative Advantage
Absolute advantage: each nation is more efficient in
producing one good
Output per labor hour
Nation
Wine
Cloth
United States
United Kingdom
5 bottles 20 yards
15 bottles 10 yards
Comparative advantage: the US has an absolute
advantage in both goods
Output per labor hour
Nation
Wine
Cloth
United States
United Kingdom
40 bottles 40 yards
20 bottles 10 yards
Comparative advantage
Ricardo’s Comparative Advantage in
money prices
Nation
Labor
Wage
US
1 hr
UK
1 hr
UK
1 hr
(at $1.6 = £1)
$20/hr
£5/hr
$8
Cloth (yards)
Quant. Price
40
10
10
$0.50
£0.50
$0.80
Wine (bottles)
Quant. Price
40
20
20
$0.50
£0.25
$0.40
Comparative advantage
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
Before
Specialization
After
Specialization
Net Gain
(Loss)
Autos Wheat
Autos Wheat
Autos Wheat
US
Canada
40
40
40
80
120
0
0
160
80
-40
-40
80
World
80
120
120
160
40
40
Comparative advantage
Consumption gains from trade: constant
opportunity costs
Before
Trade
After
Trade
Net Gain
(Loss)
Autos Wheat
Autos Wheat
Autos Wheat
US
Canada
40
40
40
80
60
60
60
100
20
20
20
20
World
80
120
120
160
40
40
Increasing opportunity costs
Production possibilities schedule under
increasing costs
Bringing demand into the model
Indifference curves and int'l. trade
Increasing opportunity costs
Trading under increasing costs: US
Increasing opportunity costs
Trading under increasing costs: Canada
 trade
pattern”Trade
triangle”
3. 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)
1. FT cons’n
point
2. FT
prod’n
point
Increasing opportunity costs
Production gains from specialization:
increasing opportunity costs
Before
Specialization
After
Specialization
Net Gain
(Loss)
Autos Wheat
Autos Wheat
Autos Wheat
US
Canada
5
17
18
6
12
13
14
13
7
-4
-4
7
World
22
24
25
26
3
3
Increasing opportunity costs
Consumption gains from trade: increasing
opportunity costs
Before
Trade
After
Trade
Net Gain
(Loss)
Autos Wheat
Autos Wheat
Autos Wheat
US
Canada
5
17
18
6
5
20
21
6
0
3
3
0
World
22
24
25
27
3
3
Bringing demand into the model
Basis for trade, gains from trade
Why relative price differentials?
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
Factor endowment model
Comparative advantage according to factor
endowment theory
Autarky equilibrium
Factor endowment model
Comparative advantage according to factor
endowment theory
Post-trade equilibrium
Factor endowment model
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 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).