Theories of International Trade

Theory Factor Products Economic theories Nontrade conditions International Trade Benefit of Int. Trade
Production Assumption
Absolute Labor Two types  Unit labor αLX < αLY  αLX / α*LX and αLY /α*LY  Increasing quantity of
Advantage requirement (αL) Specialization of Home is more production
 Production products productive in the  Specialization
Possibility production of both  Expand consumption
Frontier goods than Foreign of products
(*).
Comparative Labor Two types  Unit labor  PX/PY = αLX < αLY   αLX /αLY < α*LX /α*LY  Increasing quantity of
Advantage requirement (αL) Both X and Y are the opportunity cost production
 Production produced. of X in terms of Y is  Specialization
Possibility  Px/Py > αLX/αLY  lower in Home than  Expand consumption
Frontier Specialization of it is in Foreign (*). of products
 Relative price of Product X
good X in term of
good Y (PX/PY)
 Opportunity cost
(αLX/αLY)
Resources and Labor (L) and Land-  Factor intensity;  PC > PF  ↑  Factor Abundance  The Heckscher-Ohlin
Trade: land (T). intensive Ratio land to Relative price L/T > L*/ T* model emphasizes the
The Heckscher- production labor (TF/LF > TC/ (PC/PF), will:  Heckscher-Ohlin role of resources in
Ohlin Model and labor- LC) a) ↑ income of Theorem: A country trade.
intensive  Relative price workers relative will export that  A rise in the relative
production. (PC/PF) to landowners commodity which price of the labor-
 Relative the (w/r) uses intensively its intensive good will
income of b) ↑ ra o T/L both abundant factor and shift the distribution of
workers relative of C/F import that income in favor of
to that of  Rybczynski commodity which labor
landowners (w/r) Theorem (effect)
 uses intensively its  For any given
scarce factor. commodity prices, an
 PC/PF > PC/PF*  ↑ increase in a factor of
Relative price production increases
(PC/PF), will ↑ the supply of the good
production of C but that uses this factor
↓ consumption of C. intensively and
Home will export C, reduces the supply of
and import F. the other good.
 Conversely, Foreign  The owners of a
will be exporter of F, country’s abundant
be importer of C. factors gain from
trade, but the owners
of scarce factors lose.
 In reality, complete
factor price
equalization is not
observed because of
wide differences in
resources, barriers to
trade, and
international
differences in
technology.
 Most researchers do
not believe that
differences in
resources alone can
explain the pattern of
world trade or world
factor prices.
Standard trade Differences in Two goods,  PPF is a smooth  The relative price of  Terms of trade refers  The terms of trade
model: Ricardian, labor services, food (F) and curve. cloth to food is to the price of refers to the price of
specific factors, labor skills, cloth (C).  Isovalue line determined by the exports relative to exports relative to the
and Heckscher- physical equals –(PC /PF). intersection of the price of imports. price of imports.
Ohlin models. capital, land,  Relative prices, relative demand  When a country  Export-biased growth
and relative demand, and relative supply exports cloth and the reduces a country’s
technology and relative for that country relative terms of trade,
supply price of cloth reducing its welfare
 An indifference increases, the terms and increasing the
curve represents of trade rise. welfare of foreign
combinations of  A higher relative countries.
cloth and food. price for exports  Import-biased growth
 Terms of trade means that the increases a country’s
refers to the price country can afford to terms of trade,
of exports buy more imports, an increasing its welfare
relative to the increase in the terms and decreasing the
price of imports. of trade increases a welfare of foreign
country’s welfare. countries.
 A decline in the  When a country
terms of trade imposes an import
decreases a country’s tariff, its terms of
welfare. trade increase and its
 Export-biased welfare may increase.
growth is growth  When a country
that expands a imposes an export
country’s production subsidy, its terms of
possibilities dispro- trade decrease and its
portionately in that welfare decreases.
country’s export
sector.
 Import-biased
growth is growth
that expands a
 country’s production
possibilities dispro-
portionately in that
country’s import
sector.
 Import tariffs are
taxes levied on
imports.
 Export subsidies are
payments given to
domestic producers
that export.

Economies of Two basic Two goods  Economies of Intra-industry trade Specialized Suppliers.  Trade can result from
Scale, Imperfect reasons of or many scale External: allows countries to The production of increasing returns or
Competition, international products The cost per unit benefit from larger goods and services and economies of scale.
and International trade: depends on the markets. the development of  Economies of scale
Trade  Differences size of the The Economics of new products requires can be internal or
in their industry but not Dumping the use of specialized external.
resources necessarily on the Price discrimination equipment or support  The presence of scale
or in size of any one The practice of services. A localized economies leads to a
technology. firm. charging different industrial cluster can breakdown of perfect
 To achieve Internal: The cost customers different provide a large enough competition.
scale per unit depends prices market to support  Trade in the presence
economies on the size of an Dumping specialized suppliers. of economies of scale
or individual firm but A pricing practice in A cluster of firms can must be analyzed
increasing not necessarily on which a firm charges create a pooled market using models of
returns in that of the a lower price for an for workers with highly imperfect
production. industry. exported good than it specialized skills. competition.
 Intra-industry does for the same Knowledge is one of  Trade can result from
trade: The good sold the important input increasing returns or
exchange of domestically economies of scale,
 manufactures for Reciprocal Dumping factors in highly that is, from a
manufactures A situation in which innovative industries. tendency of unit costs
 Interindustry dumping leads to External economies to be lower at larger
trade: The two-way trade in the can give rise to levels of output.
exchange of same product increasing returns to  Intra-industry trade
manufactures for scale at the level of the benefits consumers
food national industry. through greater
 Interindustry -- product variety and
trade reflects External Economies lower prices.
comparative and the Pattern of  Trade may be divided
advantage, Trade into two kinds: intra-
whereas intra- A country that has industry trade and
industry trade large production in inter-industry trade.
does not some industry will tend  Dumping occurs
to have low costs of when a firm charges a
producing that good. lower price abroad
Countries that start out than it charges
as large producers in domestically.
certain industries tend  External economies
to remain large give an important
producers even if some role to history and
other country could accident in
potentially produce the determining the
goods more cheaply. pattern of
international trade