1 CHAPTER 3 The Commodity Composition of Trade. 2 OVERVIEWOVERVIEW Factor Proportions Theory...
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Transcript of 1 CHAPTER 3 The Commodity Composition of Trade. 2 OVERVIEWOVERVIEW Factor Proportions Theory...
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OVERVIEWOVERVIEWOVERVIEWOVERVIEW
• Factor Proportions Theory
• Alternative Theories
• Sector-Specific Factors
• An Emerging Consensus?
• Economic Adjustment to Changing Circumstances
• Factor Proportions Theory
• Alternative Theories
• Sector-Specific Factors
• An Emerging Consensus?
• Economic Adjustment to Changing Circumstances
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Important ConceptsImportant Concepts• Factor proportions
(endowment) theory
• Capital-intensive products
• Capital-abundant country
• Direct foreign investment
• Product cycle
• Monopolistic competition
• Factor price equalization
• Leontief scarce-factor paradox
• Sector-specific model
• Labor-intensive products
• Labor-abundant country
• Inter-industry trade
• Intra-industry trade
• Product variety
• Dynamic changes in comparative advantage
• Export-biased growth
• Import-biased growth
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Factor Proportions TheoryFactor Proportions Theory• Production functions (isoquants)
• Labor- and capital-intensive commodities
• Resource endowment ratios, factor endowment model
• Direct foreign investment
• Rise in U.S. income inequity over the past 20 years
• Concentrates solely on most elementary properties of trading countries
• Employs the country’s economic structure to explain trade, and can be reversed to inquire about the effect of international trade on the economic structure
• With incomplete specialization, trade leads to equalization of factor prices between trading nations.
• Mixed results of empirical testing
• Leontief scarce-factor paradox contradicts factor-endowment model.
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Additional Insights:Additional Insights:Consequences of Factor Price Consequences of Factor Price
EqualizationEqualization• Internal income distribution in each country changes,
with relatively abundant factor gaining, relatively scarce factor losing (Stolper-Samuelson theory).– Losses to scarce factor outweighed by gains to
abundant factor
• Introduction of trade lowers price of capital in UK and raises it in U.S.; similar labor price convergence also occurs. – In absence of other real-world factors, complete factor-
price equalization occurs only when specialization is incomplete
– Inequality of technologies, transport costs, etc., prohibit complete price convergence. Hence, there is only a tendency in this direction.
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Alternative TheoriesAlternative Theories
• One simple theory cannot account for complex trade phenomena– Especially intraindustry trade expansion– Alternative explanations of 1970s and 1980s
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Sector-Specific FactorsSector-Specific Factors
• Assumes two-sector economy (agriculture and manufacturing)
• Product Cycle (standardization process)
• Monopolistic Competition and Intra-Industry Trade
– Economies of scale allow intraindustry trade of specialized varieties.
– The greater similarities in countries’ technologies and factor endowments, the less interindustry trade and the greater intraindustry trade occurs.
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An Emerging Consensus?An Emerging Consensus?
• Interindustry trade
• Intraindustry trade
• Trade benefits:– Reallocation of resources– Economies of scale– Greater competition– Larger product variety – All productive factors gain
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Economic Adjustment to Economic Adjustment to Changing CircumstancesChanging Circumstances
• Dynamic Changes: Comparative advantage changes with shifts in factor endowment, technology.Example: Japan’s postwar economy changed from labor- to capital- to technology-intensive.
• Human hardships arise from resource shifts.
• Protectionism hampers consumer gains and excludes LDCs from trade.
• Government can maintain high level of aggregate production, so labor and capital released from declining industries will find alternative employment, provide direct assistance.