Presentation on theme: "International Economics"— Presentation transcript:
1 International Economics Classical and Neoclassical Trade Theory
2 Historical development of trade theory Foundations of trade theoryHistorical development of trade theoryMercantilismRegulation to ensure a positive trade balanceCritics: possible only for short term; assumes static world economyAbsolute advantage (Adam Smith)Countries benefit from exporting what they make cheaper than anyone elseBut: nations without absolute advantage do not gain from tradeComparative advantage (David Ricardo)Nations can gain from specialization, even if they lack an absolute advantage
3 Absolute & Comparative Advantage Absolute advantage: each nation is more efficient in producing one goodOutput per labor hourNation Wine ClothUnited States 5 bottles 20 yardsUnited Kingdom 15 bottles 10 yardsComparative advantage: the US has an absolute advantage in both goodsUnited States 40 bottles 40 yardsUnited Kingdom 20 bottles 10 yards
5 Production possibilities schedule Comparative advantageProduction possibilities scheduleGeneralizes theory to include all factors, not just laborShows combinations of products that can be made if all factors are used efficientlySlope, 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)
6 Marginal Rate of Transformation Comparative advantageMarginal Rate of Transformation
8 Trading under constant opportunity costs Comparative advantageTrading under constant opportunity costs
9 Production gains from specialization: constant opportunity costs Comparative advantageProduction gains from specialization: constant opportunity costsBefore After Net GainSpecialization Specialization (Loss)Autos Wheat Autos Wheat Autos WheatUSCanadaWorld
10 Consumption gains from trade: constant opportunity costs Comparative advantageConsumption gains from trade: constant opportunity costsBefore After Net GainTrade Trade (Loss)Autos Wheat Autos Wheat Autos WheatUSCanadaWorld
11 Production possibilities schedule under increasing costs Increasing opportunity costsProduction possibilities schedule under increasing costs
12 Indifference curves and int'l. trade Bringing demand into the modelIndifference curves and int'l. trade
13 Trading under increasing costs: US Increasing opportunity costsTrading under increasing costs: US
14 Trading under increasing costs: Canada Increasing opportunity costsTrading under increasing costs: Canada
15 trade pattern-”Trade triangle” 1. FT cons’n point2. 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)
16 Production gains from specialization: increasing opportunity costs Before After Net GainSpecialization Specialization (Loss)Autos Wheat Autos Wheat Autos WheatUSCanadaWorld
17 Consumption gains from trade: increasing opportunity costs Before After Net GainTrade Trade (Loss)Autos Wheat Autos Wheat Autos WheatUSCanadaWorld
18 Basis for trade, gains from trade Bringing demand into the modelBasis for trade, gains from trade
19 Factor endowment theory (Heckscher-Ohlin) Why relative price differentials?Factor endowment theory (Heckscher-Ohlin)Comparative advantage is explained entirely by different national supply conditions, especially resource endowmentsNations 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
20 Factor endowment theory: assumptions Why relative price differentials?Factor endowment theory: assumptionsNations all have the same tastes and preferences (same indifference curves)They use factor inputs which are of uniform qualityThey all use the same technology
21 Comparative advantage according to factor endowment theory Factor endowment modelComparative advantage according to factor endowment theoryAutarky equilibrium
22 Comparative advantage according to factor endowment theory Factor endowment modelComparative advantage according to factor endowment theoryPost-trade equilibrium
23 Factor endowment theory: implications Factor endowment modelFactor endowment theory: implicationsFactor price equalizationThe 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 incomeTrade changes domestic distribution of income as demand for different factors changesTests of factor endowment theoryEmphasize the importance of varieties of different factors (such as human capital) and accounting for changes in resource endowment; other explanations are also important
24 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.
25 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
26 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.
27 Relazione tra prezzo relativo dei fattori e prezzo relativo dei beni-paese F
28 Teorema del pareggiamento del prezzo dei fattori By trade, the two countries' commodity prices will converge (1) to the one world price (PX / PY).WEventually, (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)WWith (W/r)W , both H and F use kX and kY for the two sectors' production.
29 Teorema del pareggiamento del prezzo dei fattori
30 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:
31 Il caso della inversione dell’intensità fattoriale
32 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).