CH 07

CHAPTER S E V E N
7 International Economics
Tenth Edition
Economic Growth and

International Trade
Dominick Salvatore
John Wiley & Sons, Inc.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Learning Goals:
 Explain how the change in a nation’s factor
endowments affects its growth, terms of
trade, volume of trade, and welfare.
 Explain how technological change affects
growth, trade, and welfare.
 Explain how a change in tastes affects
growth, trade, and welfare.
Introduction
 Most trade theory discussed so far is static in

nature.
 However, factor endowments, technology
and tastes can change over time, changing a
nation’s comparative advantage.
 Changes in factor endowments, technology
and tastes affect a nation’s production
frontier, offer curve, volume and terms of
trade, and gains from trade.
Growth of Factors of Production
 Increases in labor (L) and capital (K) shift the

production frontier outward. Type and
degree of shift depend on rate of growth:
 Balanced growth is when L and K grow at the
same rate, shifting frontier out evenly in all
directions.
 Slope on each frontier are equal where cut by a ray
from the origin.
 Increases in labor (L) and capital (K) shift the

production frontier outward. Type and
degree of shift depend on rate of growth:
 If only L grows, output of both commodities
increases.
 Output of the L-intensive commodity will increase
faster than that of the K-intensive commodity (the
opposite is true if only K grows).
FIGURE 7-1 Growth of Labor and Capital Over Time.
 The Rybczynski Theorem

 At constant commodity prices, an increase in
the endowment of one factor will increase by a
greater proportion the output of the
commodity intensive in that factor and will
reduce the output of the other commodity.
 The Rybczynski Theorem

 For example, if only L grows in Nation 1, the
output of commodity X (the L-intensive
commodity) expands more than
proportionately, while the output of
commodity Y (the K-intensive commodity)
declines at constant PX and PY.
 Magnification effect is formally proved in the
Appendix.
FIGURE 7-2 The Growth of Labor Only and the
Rybczynski Theorem.
Technical Progress
 All technical progress reduces the amount of

both labor and capital required to produce
any given level of output.
 Three different types of Hicksian technical
progress:
1. Neutral – increases productivity of L and K in
same proportion, so K/L remains the same after
the technical progress as before, at unchanged
relative factor prices (w/r).
Technical Progress
 Three different types of Hicksian technical

progress:
1. Neutral
2. Labor-saving – increases productivity of K
proportionately more than the productivity of L.
SO K is substituted for L in production and K/L
rises at unchanged w/r.
3. Capital-saving – increases productivity of L
proportionately more than the productivity of K.
So L is substituted for K in production and L/K
rises at unchanged w/r
Technical Progress
 The same rate of neutral technical progress in

production of both commodities has the same
effect on the production frontier as balanced
factor growth.
 The production frontier will shift out evenly
in all directions at the same rate at which
technical progress takes place.
FIGURE 7-3 Neutral Technical Progress.
Growth and Trade: The Small-Country Case
 A “small country” is too small to affect the

relative commodity prices at which it trades
(so the nation’s terms of trade remain constant).
 Growth is protrade if:
 output of a nation’s export commodity grows
proportionately more than the output of its import
commodity at constant relative commodity prices,
leading to greater than proportionate expansion of
trade.
 Otherwise, growth is antitrade, or neutral.
 Production is protrade if:

 output of a nation’s export commodity grows
proportionately more than the output of its import
commodity.
 Consumption is protrade if:

 The nation’s consumption of its import
commodity increases proportionately more than
consumption of its export commodity.
 What happens to the volume of trade in the

process of growth depends on the net result of
production and consumption effects.
Protrade Antitrade Neutral Impact on Trade Volume
Production Trade expands proportionately
Consumption FASTER than output
Production Trade expands proportionately
Consumption LESS than output
Production Consumption Trade growth depends on net effect
of opposing forces
Consumption Production Trade growth depends on net effect
of opposing forces
Production Trade expands at same rate as
Consumption output
(Figure continues on next slide)
FIGURE 7-4 Factor Growth and Trade: The Small-Country Case.

FIGURE 7-4 (continued)
Growth and Trade: The Large-Country Case
 A “large country” is sufficiently large to affect

the relative commodity prices at which it
trades (so the nation’s terms of trade can change).
 Terms of trade effect

 If growth expands the nation’s volume of trade at
constant prices, terms of trade deteriorate.
 If growth reduces the nation’s volume of trade at
constant prices, terms of trade improve.
 Wealth effect
 Change in output per worker as a result of growth.
 Alone, positive welfare effect improves welfare, and
vice versa.
 Impact on welfare depends on net effect of wealth
effect and terms of trade effect:
Wealth Terms of Trade
Impact on Welfare
Effect Effect
+ + Welfare increases
- - Welfare declines
+ - Welfare may, rise, fall or not change, depending on
relative strength of opposing effects.
- + Welfare may, rise, fall or not change, depending on
relative strength of opposing effects.
FIGURE 7-5 Growth and Trade: The Large-Country Case.

 Immiserizing Growth
 If the wealth effect is positive, but the terms of
trade deteriorates so much that the nation’s
welfare declines, nation experiences immiserizing
growth.
 More likely to occur in developing nations,
although not prevalent in the real world.
FIGURE 7-6 Immiserizing Growth.
FIGURE 7-7 Growth That Improves Nation 1’s Terms

of Trade and Welfare.
Growth, Change in Tastes, and Trade in Both
Nations
 With balanced growth and neutral technical

progress in both commodities in both nations:
 Both nations’ offer curves will shift outward and
move closer to the axis measuring the nation’s
export commodity.
 Volume of trade expands, terms of trade either does
not change or improve for one nation, and
deteriorates for the other.
 Depends on the shape of each nation’s offer curve
and the degree by which each offer curve rotates.
Growth, Change in Tastes, and Trade in Both
Nations
 With growth and/or change in tastes in both

nations:
 Both nations’ offer curves will shift, changing
volume and/or terms of trade.
 A shift of the offer curve toward the axis measuring
the export commodity will increase trade at constant
prices and improve terms of trade.
 An opposite shift of the offer curve will reduce
volume of trade at constant prices and improve
terms of trade.
FIGURE 7-8 Growth and Trade in Both Nations.
Case Study 7-1 Growth in the Capital Stock
per Worker of Selected Countries
Case Study 7-2 Growth in Output per Worker
from Capital Deepening, Technological
Change, and Improvements in Efficiency
Case Study 7-3 Growth and the Emergence of
New Economic Giants
Case Study 7-4 Growth, Trade, and Welfare in
the Leading Industrial Countries
Appendix to Chapter 7
 Graphical Proof of the Rybczynski Theorem

 Growth with the Specific-Factors Model
 Hicksian Neutral, L-Saving, and K-Saving
Technical Progress
FIGURE 7-9 Graphical Proof of the Rybczynski Theorem.
FIGURE 7-10 Growth with the Specific-Factors Model.
FIGURE 7-11 Hicksian Neutral, L-Saving, and K-Saving
Technical Progress.
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CHAPTER S E V E N

Economic Growth and

 Most trade theory discussed so far is static in

 Increases in labor (L) and capital (K) shift the

 Increases in labor (L) and capital (K) shift the

 The Rybczynski Theorem

 The Rybczynski Theorem

 All technical progress reduces the amount of

 Three different types of Hicksian technical

 The same rate of neutral technical progress in

 A “small country” is too small to affect the

 Production is protrade if:

 Consumption is protrade if:

 What happens to the volume of trade in the

FIGURE 7-4 Factor Growth and Trade: The Small-Country Case.

 A “large country” is sufficiently large to affect

 Terms of trade effect

FIGURE 7-5 Growth and Trade: The Large-Country Case.

FIGURE 7-7 Growth That Improves Nation 1’s Terms

 With balanced growth and neutral technical

 With growth and/or change in tastes in both

 Graphical Proof of the Rybczynski Theorem

 All rights reserved. Reproduction or translation of this work beyond

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