INTERNATIONAL TRADE THEORYECN 308 / INB 302Aminur RahmanHead of the Department of EconomicsIndependent University, Bangladesh

Absolute Advantage & Comparative Advantage

USA: Absolute Advantage in the Production of foodUK: Absolute Advantage in the Production of Clothing

Absolute Advantage USAUKFood21Clothing46

Comparative Advantage USAUKFood41Clothing86

International TradeComparative AdvantageUSA: Wheat Brazil: Coffee

Gains From Trade

INTRODUCTION TO NEOCLASSICAL TRADE THEORY (CHAPTER 3)

CH-3 MC P:44

As indicated in panel (a), in autarky the partner country produces and consumes at point e. With trade it now faces the international price ratio (Ps/Py)2, which is flatter than its internal relative prices in autarky. Consequently, production of the relatively more expensive good Y expands and production of good X contracts, until further adjustment is no longer profitable at point e. Consumers now find good X relatively less expensive and adjust their consumption expenditures by moving from point e to point e. The opening of trade allows the country to consume outside the PPF on the higher indifference curve W2, thus demonstrating the gains from trade (the difference between W1 and W2). Note that, with trade, both countries face the same set of relative product prices, (Px/Py)2.

OBSERVATIONT/T Autarkic prices of two countriesT/T Sw= Dw in both commodity marketsBetter off Higher indifference curveNo complete specializationFree trade equalizes opportunity

OFFER CURVESDetermination of International Equilibrium Offers of a country at Alternative terms of tradeRelative Price of Food = Imports of clothingExports of foodsA: Gains from tradeB: Derivation of Demand Curve: AC: Derivation of Demand Curve: BD: International equilibriumEquilibrium terms of trade

TOT USA offer is smaller than Britains offer (Ux) (USA not willing Fx) excess demand for food PF : Excess Sc Pc Relative Price of Food => K

INTERNATIONAL EQUILIBRIUM

THE HECKSHER-OHLIN MODEL (FACTOR ENDOWMENTS THEORY)Two Premises:

Commodities differ in their factor endowmentsCountries differ in their factor endowments

Hecksher-Ohlin: A country has a comparative advantage in those commodities thatuse its abundant factors intensively.

Major ingredients: Factors intensity and factor abundance

BASIC ASSUMPTIONSTwo countries, Two commodities with homogenous factors of production ( Labor and capital)Technology: Same Constant Returns to ScaleStrong Factor Intensity: Labor of Capital IntensivesIncomplete specializationPerfect competition: Law of One PriceFactor mobility: Perfectly mobile within countries, immobile between countriesSimilarity of tastes: Similar but not Identical ( Same Social Indifference Curve)Free TradeTransportation Costs: Zero

FACTOR INTENSITYFIXED COEFFICIENT OF PRODUCTIONLabor Ratio and Capital RatioCloth needs 6 labor and 2 capital and Steel nees 8 labor and 4 capitalCloth is labor intensive relative to steel as cloth needs more unit of labor than the production of steel.Labor- Capital Ratio is higher in Cloth Production (6/2 > 8/4).Steel is Capital Intensive as Capital-Labor ratio is (4/8 > 2/6)

Optimal techniquesSEE36S36W/R2 W/R 3/4CapitalL/K = 0.5_______________1. Physical and economic abundance

FACTOR PRICE EQUILIBRIUM THEOREM Free trade equalizes factor rewards ( real rental) between countries and thus serves as a substitute for external factor mobility

Stopler Samuelson Theorem: An increase in the relative price of a commodity raises in terms of both commodities the real rewards of factor used intensively in production of the commodity and reduces, in terms of both commodities, the real reward of the other factorRelative price of cloth W/P in terms of cloth and steel and lowers (W/P) real rental rate of capital => C/S

THE RYBCZYNSKI THEOREMWhen the coefficients of production are given and factor supplies arefully employed, an expansion in the endowments of one factor of productionraises the output of the commodity that uses the expanded factor intensivelyand reduces the output of the other commodity.ClothCapitalJVHGLabourMSteel LsCloth production Steel => capital released to match with expanded cloth production

Once constraints become binding JEH is the PPF

STOPLER- SAMUELSON THEOREM

Q GMClothSteelProduction at Qx with tariffRICARDO: Free Trade Benefits all S-s- Protection hurts everyone Disagreed Cheap Labor (Foreign) for protectionLaborCapitalTechnology: Cloth 4 1 Steel 2 2Magnification effect: W/P Rental Relative price of cloth => for steel (Q-Q)Reorganziation of the structure of Production technology MPLK change Excess demand for labor _ less capital

FACTOR PRICE EQUALIZATION THEOREMAs labor becomes cheaper compared to capital W/R labor intensive commodities become cheaper relative to the capital intensive commodityWhen W steel S1 and Cloth C1Cloth Cheaper relative to steel as C1 lies on lower isocost less than S1

MSS1c1cClothSteel NUnit Cost ( Save 100) of each productFMRPBEAODNSWW/RAmericaPC/PSAutarky priceUSA: OSBRITAIN: ODON= Common Commodity Price Ratio

ALTERNATIVE TRADE THEORIES AND EMPIRICAL TESTINGMAC Dougall- Balassa- Steru1937 Wage in the USA twice as high as UK

OUTPUT PER WORKER MORE THAN TWICE US MONEY COST LOWER COST ADVANTAGE FOR US OVER UK.

TWICE => NO COST ADVANTAGELess than twice: UK AOUT

TESTING OF HYPOTHESIS:EXPORT RATIO: US ex to UK exPRODUCTIVITY RATIO: output per US worker to UK workerWHEN PRODUCTIVITY RATIO WAS HIGHER THAN 2, then US had a larger share of EXPORT market and when lower UK had this.

THE LEONTIEF PRADOXIMPORT COMPETING PRODUCTION REQUIRED 30% MORE CAPITAL PER WORKER THAN US EXPORT PRODUCTIONJUST OPPOSITE OF HECKSCHER-OHLIN THEOREMEXPLANATION OF PARADOXFACTOR INTENSITY REVERSALS SEPARATE US FROM REST OF THE WORLD- INVALIDATE H-O THEOREMBY PROTECTING US INDUSTRIES THAT ARE RELATIVELY INTENSIVE IN UNSKILLED LABOR- US TARIFF AND NON-TARIFF BARRIER TO INTERNATIONAL TRADE EXCLUDE LABOR INTENSIVE IMPORTSSCARCITY OF NATURAL RESOURCES IN USA -> IMPORT CAPITAL INTENSIVE PRODUCTUS EXPORT INDUSTRY USES SKILLED LABORCONSUMPTION BIAS towards capital intensive good- But on the contrary it is toward labor intensive goods

SPECIFIC FACTOR MODEL COMPARATIVE ADVANTAGE Relative abundance of specific factorSPECIFIC FACTOR USE P Better off and other factor worse off Specific factor ( Small economy) OUTPUT OUTPUT OF OTHER COMMODITY Mobile factor output of both commodity Mobile factor worse off specific factor better off

BANIJ*JOH*HCornSteel

Linders Thesis: COUNTRY EXPORTS THOSE MANUFACTURED GOODS FOR WHICH THERE IS BROAD LOCAL MARKET NO BIG SUPPORT

TECHNOLOGICAL GAP THEORY IS BASED ON THE SEQUENCE OF INNOVATION AND IMITATION. USA ADVANTAGE IN R&D Export Technologically Advanced Product

A2BTSRU13AutoPlantNV

DECREASING OPPORTUNITY COSTS- ALL GAINS : EU CASE

E= Before trade production point for US vs UK at UVAfter tradeUSA = V and Consumes A, UK U and B

Both gain even though no differenceGF T/T

GROWTH AND TRADE

CAPITAL ACCUMULATION:

CAPITAL DEEPENING(CAPITAL STOCK POPULATION HIGHER Y AND STANDARD OF LIVING ENDOGENOUSI S CAPITAL STOCK

TECHNICAL PROGRESSCLASSIFICATION --? NEUTRAL (NT)LABOR SAVING (LS)HICKSIAN DEFINITION CAPITAL SAVING (CS)

LS:

baAaCBaLOK

bbaMAbaKLOOB TO OALabor is saved per unit of capital employed At W R ratio shown by the slope of bb at B K-L ratio > at OA then OB

UUEEVVSTEELCLOTH

UEEVVLabor growth worse offSTEELCLOTHBALANCED GROWTH NEUTRAL PRODUCTION EFFECT. WELFARE CONSTANT

EEUUVVO Capital Growth BETTER OFFSTEELCLOTHLabor Supply Labor Intensive good Less capital to work with NegativeEffects on Small Country

EECLOTHSTEEL

EECLOTHWORSE OFFSTEEL

EECLOTHSTEELBETTER OFF

THE THEORY OF TARIFFTYPES: IMPORT DUTY, EXPORT DUTY, AD VALOREM, SPECIFIC, COMPOUNDConsumption effect: GCProduction effect: KH( Protective effect)Trade effect: JFRevenue effect: JHGFRedistribution effectConsumer surplus ( Area 1,2,3 and 4)Area 1 -> ProducerArea 2 and 4: dead weight loss

GENERAL EQUILIBRIUM ANALYSISEFFECT ON DOMESTIC PRICEEFFECT ON PRODUCTIONEFFECT ON VALUE OF PRODUCTION AND WELFAREEFFECT ON CONSUMPTION

DISTRIBUTION OF INCOME : TARIFF REVENUE VOLUME OF TRADE

EFFECT ON LARGE COUNTRYTERMS OF TRADE EFFECTEFFECTS OF TARIFF ON DOMESTIC PRICESMETZLERS PARADOXTARIFF AND WELFARETARIFF WORLD OUTPUTSUBOPTIMAL ALLOCATION OF COMMODITIES AMONG CONSUMERS

TARIFF IMPROVES LARGE COUNTRY TERMS OF TRADESMALL COUNTRY TARIFF VOLUME OF TRADE ( POINT D)MONOPOLY- MONOPOLY POWERUSA DESIRED VOLUME OF TRADE CONTRACTS ( OEo OD)SUPPLY BY S1SoDEMAND FOR CLOTH C1CoSTEEL MARKET MONOPOLISTCLOTH MARKET- MONOPSONISTRESTRICTS SUPPLY TO RAISE PRICERESTRICTS DEMAND TO BUY IT AT LOWER PRICERELATIVE PRICE OF STEEL TOT

TARIFF AND WORLD WELFARETARIFF INTERFERES WITH THE MAXIMIZATION OF WELFARETARIFF REDUCES THE WORLD OUTPUT OF COMMODITIES BY REVERSING THE PROCESS OF INTERNATIONAL DIVISION OF LABOR, WHICH IS DICTATED BT THE LAW OF COMPARATIVE ADVANTAGE MRTA MRTB THE TARIFF FORCES A SUBOPTIMAL ALLOCATION OF COMMODITIES AMONG THE CONSUMERSCommodity price equation FREE TRADE MRSA MRSBTARIFF MRSA MRSB AS PRICE DIVERGENCE OCCURS

TARIFF AND DOMESTIC PRICELARGE COUNTRY: TARIFF MAKES IMPORTED COMMODITY RELATIVELY CHEAPER IN THE REST OF THE WORLDPARADOX? METZLERTARIFF CAUSES the price of the imported commodities to fall more than the tariffWHY? (a) the foreign demand for imports is inelastic (b) the tariff levying countrys MPI is very low the protection provided to the import competing industries is negative

EFFECTIVE RATE OF PROTECTIONERP = V-V VV Value added at domestic pricesV Value added at world prices

Stopler- Samuelson theoremAM relative price of a commodity or of factor used intensively in its production

ARGUMENT FOR PROTECTIONOPTIMAL TARIFF

TWO CONFLICTING EFFECTS ON WELFARE:IMPROVE TERMS OF TRADEVOLUME OF TRADE FALLS WELFARE

Max Welfare Marginal T/T benefits = Marginal Volume of trade cost

Monopoly Monopsony Power

Brazil : Coffee Japan: AutoAverage and Marginal T/T

Volume of trade Max WelfareMTT = Opp. Cost Domestic of exportable

ECONOMIC ARGUMENT FOR TARIFF

TARIFF FOR REVENUE PROTECTIONCHEAP FOREIGN LABORTARIFF TO MAINTAIN EMPLOYMENTINDUSTRIAL POLICY

NON-ECONOMIC ARGUMENTPolitical, cultural, and sociological goals

FOUR SPECIFIC OBJECTIVESA CERTAIN LEVEL OF PRODUCTION ( MILITARY)A CERTAIN LEVEL OF CONSUMPTION ( RESTRICTION OF LUXURY GOODS)SELF- SUFFICIENCYEMPLOYMENT OF A FACTOR OF PRODUCTION (LABOR)

CPT:9 INSTRUMENTS OF COMERCIAL POLICYEXPORT TAXESEFFECTS OF EXPORT TAXES(GRAPHICAL PRESENTATION)

AT WORLD PRICE 60 = DOMESTIC PRODUCTION 1150

90 CONSUMED (F)1060 EXPORT (FG)EXPORT TAX 25 P 35DOMESTIC PRODUCTION 700 (C)DOMESTIC CONSUMPTION 300(B) EXPORT FALLS 400 (BC)PRODUCTION SURPLUS 1 5AREA 4 TAX REVENUE1+2 = CONSUMER SURPLUS3= OVER CONSUMPTION5= UNDER PRODUCTION

II EXPORT SUBSIDY: NEGATIVE EXPORT TAXQUANTITATIVE RESTRICTIONSRESTRICTION OF PHYSICAL VOLUME OF EITHER EXPORT OR IMPORTOPEN QUOTA OR IMPORT LICENSESSpecific amount from any where abnormal profit PDOM IMPORTERS AT COMPETITIVE PRICES?KFree TradeSupply of Export

III DIFFERENCE BETWEEN QUOTAS AND IMPORT TAXRevenue Effect, CertaintyQUOTA- LICENCE FEE CERTAIN UNCERTAINTIESIMPORT TAX: REVENUEEXPORT QUOTA : F. PRICE PD VOLUNTARY EXPORT RESTRICTIONSVoluntary cut of export otherwise import tax by IMPORTERINTERNATIONAL CARTELS

GEFGQGSDPPPDUMPING: PERSISTENT- PREDATORY- SPORADIC- GATT MAX => CARTEL

CUSTOM UNION

Approaches of International Trade Liberalization International Approach Regional Approach

Preferential Trading ClubFree Trade AreaCustoms Union Common Market Economic Union

Reduce Tariff but keep original tariff with rest of the world

Abolish tariff but keep original tariff with rest of the world

Abolish Tariff but Common Tariff with rest of the world

COMMON MARKET

CUSTOM UNION + FREE MOVEMENTS OF ALL FACTOR OF PRODUCTIONS

ECONOMIC UNIONCOMMON MARKET + UNIFICATION OF DEMANDMANAGEMENT POLICY + MONETARY UNION SINGLE CURRENCY

TRADE CREATION

IMPROVES THE INTERNATIONAL MOVEMENT OF RESOURCES BY SHIFTING THE NATIONAL FOCUS OF PRODUCTION FROM HIGH COST TO LOW COST PRODUCER WELFARE

TRADE DIVERSION

DIVERSION OF TRADE FROM CHEAP PRODUCER TO HIGH PRICE PRODUCER WELFARE INCREASING COST