Chapter 7 Growth and Trade

Balanced Versus Biased Growth Growth in a country’s production capabilities shifts the country’s production-possibility curve outward. As the ppc shifts out, we are interested in knowing the effects on: The general shape of the production-possibility curve The specific production quantities for the different products, if product prices remain the same © 2016 McGraw-Hill Education. All Rights Reserved.

Balanced and Biased Growth © 2016 McGraw-Hill Education. All Rights Reserved.

Balanced and Biased Growth In balanced growth, the country’s production possibilities curve (PPC) shifts out proportionately so the its relative shape is the same In biased growth, the expansion favors proportionately more of one of the products, so that the PPC will skewed toward the faster-growing product. © 2016 McGraw-Hill Education. All Rights Reserved.

Growth in Only One Factor Rybczynski Theorem: In a two-good world, and assuming that product prices are constant, growth in the country’s endowment of one factor of production, with the other factor unchanged, has two results: An increase in the output of the good that uses the growing factor intensively A decrease in the output of the other good © 2016 McGraw-Hill Education. All Rights Reserved.

Single-Factor Growth: The Rybczynski Theorem © 2016 McGraw-Hill Education. All Rights Reserved.

Changes in the Country’s Willingness to Trade Production and consumption change with growth, a country’s willingness to or interest in engaging in international trade can change Increase willingness to trade (export and import more) Decrease willingness to trade (export and import less) © 2016 McGraw-Hill Education. All Rights Reserved.

Effects on the Country’s Terms of Trade Small country case: If the country is small (i.e. a price-taker in world trade), then its trade has no impact on the international price ratio ( the country’s terms of trade, TOT) Large country case: If a country is large, a change in willingness to trade affects the equilibrium international price ratio. This change could either improve the country’s TOT, or deteriorate the TOT. © 2016 McGraw-Hill Education. All Rights Reserved.

Growth Biased Toward Replacing Imports in a Large Country A reduction of a large country’s demand for imports reduces the relative price of import good—this change is an improvement in the country’s terms of trade The country gains from growth for two reasons: Production benefit from growth shifts the ppc out Better price for its exports relative to the price paid for imports © 2016 McGraw-Hill Education. All Rights Reserved.

Growth Biased Toward Replacing Imports in a Large Country © 2016 McGraw-Hill Education. All Rights Reserved.

Growth That Increases a Large Country’s Willingness to Trade The increase in the country’s demand for imports increases the relative price of the import good (or the increase in the country’s supply of exports reduces the relative price of the export good). This change in the equilibrium international price ratio is a deterioration in the country’s terms of trade, the overall effect on the country’s well-being is not clear. © 2016 McGraw-Hill Education. All Rights Reserved.

Immiserizing Growth Immiserizing growth: Growth that expands the country’s willingness to trade can result in such a large decline in the country’s terms of trade that the country is worse off. © 2016 McGraw-Hill Education. All Rights Reserved.

Immiserizing Growth Three crucial conditions : 1. The country’s growth must be strongly biased toward expanding the country’s supply of exports (increasing its willingness to trade), and the increase in export supply must be large enough to have a noticeable impact on world prices. 2. The foreign demand for the country’s exports must be price inelastic, so that an expansion in the country’s export supply leads to a large drop in the international price of the export product. 3. Before the growth, the country must be heavily engaged in trade, so that the welfare loss from the decline in terms of trade is great enough to offset the gains from being able to produce more. © 2016 McGraw-Hill Education. All Rights Reserved.

Immiserizing Growth in a Large Country © 2016 McGraw-Hill Education. All Rights Reserved.

Technology and Trade Another basis for comparative advantage can arise over time as technological changes occur at different rates in different sectors and countries. In some ways technology-based explanation is an alternative that competes with the H-O model. In other ways technology differences can be consistent with an H-O view of the world. © 2016 McGraw-Hill Education. All Rights Reserved.

Individual Products and the Product Cycle According to the product cycle hypothesis, first advanced by Raymond Vernon: When a product is first invented, the major demand is mostly in high-income countries, and the product still must be perfected by using additional R&D and local production. Over time, the product and its production technology become more standardized and familiar. Factor intensity in production tends to shift away from skilled labor toward less skilled labor. The technology diffuses and production locations shift into other countries, eventually into developing countries with abundant less-skilled workers. © 2016 McGraw-Hill Education. All Rights Reserved.

Openness to Trade Affects Growth Openness to international trade can enhance the technology that a country can use by facilitating the diffusion of foreign-based technology into the country and by accelerating the domestic development of the technology The growth rate for the country (and world as a whole) increases in the long run © 2016 McGraw-Hill Education. All Rights Reserved.