Why do countries trade?
Countries trade because they gain from trade.
What are some common misconceptions that exist about international trade?
1. Since US is part of global economy now, standard economic principles don't apply anymore.
2. Countries in global market compete with one another like companies do in the same industry.
3. Government needs to help American businesses compete with foreig
What determines the volume of trade between any two countries? (Gravity model)
VT12 =A xGDP1x GDP2/Distance12
Economic size (GDP)
Distance
Geography: ocean harbors, ports
Cultural Affinity
Trade policy/barriers (NAFTA)
Political factors (wars, embargoes)
What determines the pattern of trade?
Labor and Capital abundant countries.
What pattern of trade ensures gains from trade?
Abundant factor good is exported, scarce factor good is imported. This ensures gains from trade.
Absolute versus comparative advantage
Absolute advantage: ability to produce a good using less production inputs (labor)
Comparative advantage: the ability to produce a good at a lower opportunity cost.
Principle of comparative advantage
Trade between two countries can benefit both countries if each country exports the goods in which it has a comparative advantage
Ricardian: What is the source of comparative advantage?
Differences in technology
Ricardian: What is the predicted pattern of specialization and trade?
complete specialization in a comparative advantage good.
Ricardian: Gains from trade (2 ways to show)
Real Income Approach: show that our country's consumption possibilities increase with trade. You can consume more than PPF because you are gaining in trade. Trade as indirect way of production that you can consume.
Real Cost Approach: show that a country'
Ricardian: Real cost approach
US has comparative advantage in computers
India has comparative advantage in sofware
Let Pc/Ps=3/2 (pick any international price in between the range � and 2)
direct: when you directly produce a good that you don't have comparative advantage in.
Direct pr
Ricardian: Prediction about relative factor prices (relative wages)
Differences in wages affect differences in production
What are the limitations of the Ricardian model?
Ricardian model considers only one resource (L), as a result it makes some misleading predictions:
-It predicts an extreme degree of specialization that we do not observe in the real word
-It allows no role for differences in resources among countries as
HO: Relative factor abundance of countries and relative factor intensity of goods
A country will export the good that uses its abundant factor intensively.
Automobiles are K-intensive
Cotton is L-intensive
If US is K-abundant, it will export automobiles and import cotton.
If Mexico is L-abundant, it will export cotton and import automo
HO: How does a change in the relative price of goods affect the relative price of factors?
Trade causes convergence of the relative prices of goods. Relative goods prices uniquely determine relative factor prices. Thus if the two countries face the same relative prices of automobiles and cotton, they will also have the same factor prices.
HO: How does a change in the relative factor endowment of a country (e.g., endowment of one of the factors increases) affect the outputs of the two goods produced?
If cloth is L-intensive and food is k-intensive
And if L increases (endowment of one of the factors increases), Qc (output of cloth) will increase while Qf (output of food) decreases. There is a biased expansion of production possibilities.
What is the source of comparative advantage in the HO model?
Differences in factor abundances (endowments)
What is the predicted pattern of specialization and trade (HO theorem)?
both countries in trade still produce both goods but specialize in a comparative advantage good.
HO: Does the country as a whole gain from trade?
gains from trade on aggregate but there are winners and losers (abundant/scarce)
HO: Which economic agents within each country win and which lose as a result trade?
If the country is L-abundant, it's workers win because with trade, their wages increases. If the country is K-abundant, it's capital owners win because of trade, their rental rate increases. Owners of relatively abundant factors are better off. Owners of
Prediction about relative factor prices (FPE)
Trade leads to a convergence of relative commodity price => convergence of relative factor prices. (indirectly exporting labor and importing capital)
Trade is a perfect substitute for factor mobility. (exporting L-intensive goods is the same thing as havi
International labor migration
-What is the economic motive to migrate and how many workers will migrate if international labor movement is allowed?
The economic motive to migrate is to increase wages of the L-abundant country. Depends on relative price of L (wage).
What is the corresponding change in overall production efficiency?
Increases by ABC from both countries
Income redistribution winners and losers
-Real wages converge
-Total output of 2 economies increase by ABC
-Gainers and losers:
1) Workers who started in home are better off (workers are leaving so the ones who stay will get more money), workers who started in foreign are worse off (too many wor
Compare the effects of free labor migration to the effects of free trade in goods. What is the economic intuition behind this comparison?
Free labor migration leads to the same outcomes as free trade:
1) Convergence of wages in the two countries;
2) Increase in the total surplus;
3) Income redistribution that leaves the owners of the relatively abundant factor better off and the owners of t
Standard Trade Model
General model of classical trade theory that allows us to evaluate changes in TOT, welfare and income distribution.
Standard Trade Model: How are country's TOT determined?
TOT= Price(exports)/Price(imports) TOT*= 1/TOT
Standard Trade Model: What are welfare implications of changes in TOT?
If ToT increases in a country, that country's welfare increased. If ToT decreases in a country, that country's welfare is decreased.
Standard Trade Model: How does economic growth in one of the trading countries affect both nations' TOT and welfare?
A country that experiences export biased growth will see ToT decrease and ToT* increase. It is the bias of economic growth.
a. export-biased growth
Pc/Pf=ToT (down) ToT* (up)
b. import-biased growth
Pc/Pf=ToT (up) ToT* (down)
Standard Trade Model: How do tariffs and export subsidies affect countries' TOT and welfare?
They both create a distortion between their domestic prices and international equilibrium prices.
import tariffs - tax on import
export subsidy - payment given to domestic producers who sell their good abroad.
How can comparative advantage theory be applied to intertemporal trade (international borrowing and lending)? How is the equilibrium interest rate determined?
If Home have comparative advantage in cloth
In financial autarky PfcPpc>Pfc
Ppc
If you invest $100, the equilibrium interest rate is determined by:
$(1+r)x100
Explain the analogy between international borrowing and lending and ordinary international trade.
International borrowing and lending is the trade off between present consumption and future consumption and ordinary international trade is regular trade through one period
Which of the following countries would you expect to have a higher interest rate in the absence of international borrowing and lending?
A developing country that has discovered the knack of producing industrial goods and is rapidly gaining on advanced countries.