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Classic Trade Theory Ricardian Model - Technological Comparative Advantage: – Basic 2 Good Ricardian model (Feenstra, Chapter 1) – Continuum of Goods [Dornbush,

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Presentation on theme: "Classic Trade Theory Ricardian Model - Technological Comparative Advantage: – Basic 2 Good Ricardian model (Feenstra, Chapter 1) – Continuum of Goods [Dornbush,"— Presentation transcript:

1 Classic Trade Theory Ricardian Model - Technological Comparative Advantage: – Basic 2 Good Ricardian model (Feenstra, Chapter 1) – Continuum of Goods [Dornbush, Fischer and Samuelson (1977)] Heckscher-Ohlin Factor Endowment Model: – 2 Good 2 Factor Model (Feenstra, Chapters 1) – Stolper Samuelson – Leontief Paradox Heckscher-Ohlin-Vanek Model and Tests of HO theory

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3 y1*y1* y1y1 y2*y2* y2y2 L/a 2 L*/a 2* L/a 1 L*/a 1* papa pa*pa* A A* Home PPFForeign PPF Economic Output under Autarchy (no trade)

4 Technology determines Comparative Advantage

5 p pa*pa* pepe papa Relative Demand Relative Supply World Relative Supply and Demand

6 p p e = p a * papa Here the demand for good one is high enough that the equilibrium price of trade is equal to the autarchy foreign price Foreign is no better off with trade. When might this occur? Relative Demand Relative Supply

7 p pa*pa* pepe papa Relative Demand Relative Supply Gains from Trade Here the trade price of good one is higher than in autarchy at home, and lower than in autarchy in foreign. Both countries can gain from trade, and will fully specialize in their comparative advantage.

8 y1*y1* y1y1 y2*y2* y2y2 L/a 2 L*/a 2* L/a 1 L*/a 1* papa pa*pa* A A* B B* C* C p p Points B and B* represent the level of production of goods 1 and 2 in each country under specialization. C and C* are consumption in home and foreign.

9 Comparative advantage and Wages (Feenstra pg. 4 note 2) Suppose Home has a comparative advantage in good 1. a 1 /a 2 < a 1 */a 2 * and an absolute disadvantage in both goods. a 1 > a 1 * a 2 > a 2 * In Free Trade suppose each country specializes (p a < p < p a *) -workers at home produce good 1 and earn w = p / a 1 -workers in foreign produce good 2 earn w* = 1 / a 2 * p = a 1 /a 2 p / a 1 * We assumed a 1 > a 1 *, resulting in p / a 1 * > p / a 1 Wages in Foreign, w* = 1 / a 2 * > p / a 1 *> p / a 1 = w

10 Beyond 2 Goods, Dornbush, Fischer and Samuelson (1977)

11 Strong Structure on Demand

12 Trade Equilibrium (DFS 1977)

13 Gains from Trade (DFS 1977) Rest of the World

14 Hypothetical DFS Population Growth Suppose that the foreign country increases their population (possibly by integrating with another country). B(L*/L) is increasing in L*. Home will produce fewer goods, but wages rise. Home is better off, Real income rises Workers in F lose, wages decline in terms of goods produced abroad. – This is a Terms of Trade effect. The terms of trade are said to improve if the index of the price of a country's exports in terms of its imports rises.

15 DFS and a Gravity Equation Image © The Whipple MuseumImage © The Whipple Museum.

16 Criticisms of DFS/ Ricardian Model Does not generalize easily to more than two countries Comparative Advantage is generated by an exogenous technology – Assuming that costs are different across countries makes prediction difficult. – Why wouldnt technology spill across borders?

17 The Heckscher-Ohlin (HO) Model The law of comparative advantage says that countries trade when autarky prices are different from free trade prices Assuming persistent differences in technology seemed unprincipled. Variation in autarky prices can come from differences in factor endowments (capital, labor, skilled labor, land) Heckscher-Ohlin model At least two factors Factors are stuck in countries Technology is identical in all countries

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19 Duality: Unit Cost Functions

20 Equilibrium Conditions

21 Factor-price Insensitivity (Feenstra Theorem 1) With two goods and two factors, factor prices are uniquely determined by goods prices, irrespective of factor endowments.

22 Factor-price equalization (Feenstra Theorem 2) Assume free trade, no transport cost, two goods, two countries, two factors, identical technologies, no factor-intensity reversals, and both countries produce both goods. Then factor prices are equalized in both countries irrespective of factor endowments.

23 Stolper Samuelson Theorem An increase in the price of a good will more than proportionally increase the returns to the factor intensively used in the production of that good. Trade raises the real reward of a countrys abundant factor and reduces the real reward of its scarce factor. – Trade leads to a conflict of interest between the scarce and abundant inputs. – Trade leads to factor price convergence (Ohlin emphasized the tendency towards factor price convergence, but not equalization).

24 Mathematical Statement of the Stolper Samuelson Theorem

25 (1)

26 (2)

27 Many Goods Heckscher-Ohlin-Vanek Model (Feenstra chapter 2)

28 Factor Content of Trade

29 Pattern Of Trade in Each Factor

30 The Leontief Paradox Using U.S. input-output tables from 1947: – The capital labor ratio in U.S. exports was $13,700 of capital per man-year – The capital labor ratio in U.S. imports was $18,200 of capital per man-year The U.S. is relatively capital abundant after WWII and should export capital intensive products and import labor intensive products.

31 Leamer 1980 Observation

32 Edgeworth Box of Factor content of Trade Good 1 Good 2

33 Edgeworth Box and Share of trade w/r

34 Integrated Equilibrium: Imagine there are no countries

35 Return to Factor Price Equalization Goal is to replicate the equilibrium in the integrated equilibrium using trade in goods. Assume: – every country uses the same input mix as in the integrated equilibrium. – Full employment of factors in all countries. Because every country is using the same technologies, the factor prices will be the same. Because the factor prices are the same the goods prices p will be the same. Full employment and identical (p, w) imply the same income and production as the integrated equilibrium.


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