theories of international Trade Flashcards
the general effect of globalization
A general effect of globalization is a growing specialization of regions (countries) in production of distinct goods
How to explain this observed pattern of specialization and hence the pattern of interregional/international trade?
Economic research focuses on three influences:
− Absolute advantage (section 3.1)
− Comparative advantage (section 3.2)
− Economics of scale and head starts (section 3.3)
Absolute advantage of trade
A country has an absolute advantage over another one in the production of a good if it can produce it with fewer resources than the other country.
=In other words, higher absolute productivity in the production of a specific good is a reason for an absolute advantage of a specific country in the production of this good.
Absolute advantage and gains from trade
The gains from rice trade can be assessed using the consumer surplus and producer surplu
consumer surplus
Consumer surplus is an economic measurement of consumer benefits resulting from market competition. A consumer surplus happens when the price that consumers pay for a product or service is less than the price they’re willing to pay. It’s a measure of the additional benefit that consumers receive because they’re paying less for something than what they were willing to pay.
producer surplus
Producer surplus is the difference between how much a person would be willing to accept for a given quantity of a good versus how much they can receive by selling the good at the market price. The difference or surplus amount is the benefit the producer receives for selling the good in the market.
Absolute advantage gain (problem)
-The existence of gains (win win situation) from trade does not suggest that both countries will have the same level of gains from trade
-The total gains from trade for a country as a whole do not suggest that everyone within a country will gain from trade.
Autarky
is a situation in which a country does not trade with other countries.
In autarky, each country would have to produce all goods for its own demand
Absolute advantage and trade policy
The principle of absolute advantage is a policy suggestion that countries should import goods from other countries where they are produced more efficiently. These countries should then deploy scarce resources to produce goods that they can produce more efficiently.
Comparative advantage and trade
The model helps explain the pattern of specialization and trade between regions which benefits all trading partners.
–> based on comparative advantage in production
Explanation Comparative advantage
A country has a comparative advantage over another in the production of a good if it can produce it at a lower opportunity cost: i.e. if it has to forgo less of other goods than the other country.
opportunity cost
measures the net benefits you could have received by producing something else with the resources used
Ricardian model of international trade (example)
slide 84, 85 et 86
The Total Gains from International Trade
-trade can benefit each country
why does trade benefits each country (comparative advantage)
- they specialize in the production and exporting of goods in which they have a comparative advantage compared to the other country and
- The international trade ratio is between the pre-trade (autarky) relative prices. This is the law of comparative advantage.
Total Gains from Trade and the International Trade Ratio
-The general effect of specialization and trade is that each country can consume more than it did under autarky
-The gains from trade for countries involved are not the same in size
-The gains from trade depend on the international trade ratio. They are c.p. higher for a country involved when the international trade ratio for its export good is closer to the pre-trade price ratio of the import country
-When both countries fully specialize in the production of the good with a comparative advantage, the world production of both goods and the trade volume is the highest possible, and so are the total gains from trade for each country.
International trade ratio close to 2 (example P clothes/ P wheat)
consumption gains for the cloth-exporting country (DC) are c.p. higher and the consumption gains for the wheat-exporting country (LDC) are c.p. lower.
Who benefits the most (comparatif advantages) ?
Small Countries :
Smaller countries that open up to trade with larger partners have little ability to lower the relative price of their exports (their terms of trade) through higher supply or to raise the price of their imports through higher demand on the world market
consequence: their trade terms refer to the pre-trade exchange ratio of the largest trading partner
terms of trade
are defined as the ratio between the index of export prices and the index of import prices
–> show how many units of import goods can be purchased for one unit of export goods.
real life terms of trade
depend on the bargaining power of the partners in price negotiations.
–> There is, as usual in a market, a conflict of interests between the partners.
calculate Terms of trade
TOT = average price of all exports/ average price of all imports
Improvement (Deterioration) of terms of trade
If the ToT rise (fall), more (less) imports can now be purchased for any given quantity of exports.
the terms of trade for a country :
TOT = P exports (€ for one unity of exports) * exchange rate (USD for one €) / P imports (USD for one unit of imports)
Domestic Adjustments and Gains from Trade
-displaced workers (from one industry to another industry)
-more labor –> new workers can become as productive as the old ones, over time, the structural shift in the economy will make everybody better off
real-world adjustment
adjustment might take time and face opposition as people are not only consumers who profit from lower prices, but also producers who care about their current jobs.
short-rum (adjustment comparative advantage)
-the ability of factors to move between output sectors is limited
–> The workers, plants and equipment cannot switch instantaneously to the expanding export industry for reasons related their specific qualifications and spatial immobility
-factors of production which are specific for the import-competing industry experience a fall in real income and/or employment, whereas factors specific for the export industry win in real income
consequence (adjustment for comparative advantage)
-unemployment in some sectors
–> led to strengthening of employment protection, higher social benefits and other policies to protect households from shocks to income and employment.
relative labor Productivity
= opportunity cost
Comparative Advantage and the Relative Labor Productivity
-the key reason for international differences in opportunity costs are differences in relative (not absolute) labor productivity
in the reality why ricardian model (comparative advantages) are not applied
-Transportation costs reduce or prevent trade, which may cause each country to produce the same good or service. Due to high transportation costs (think about haircuts and auto repairs) non-traded goods and services exist.
-National trade policies allow import-competing industries to survive
-Sector-specific factors of production raise opportunity costs
why the concept of comparatives advantage is important
-There is broad empirical evidence (for various countries and periods) of the importance of relative productivity for international trade structure)
-The concept of comparative advantage helps explain why countries with overall low productivity develop strong exports in some industries
Are low wages a source of a comparative advantage?
lower wages abroad are not the source of comparative advantage, but rather the effect of lower labor productivity
–> in contrary wages rise as productivity rises
Labor productivity (calculate)
is measured by the value of GDP per worker, and wages are measured by the hourly compensation of the average worker.
The Heckscher-Ohlin Trade Theory
model of international trade based on comparative advantage due to international differences in factor endowments.
–> focuses on trade with many goods and on reasons why one country might be more productive than another in a particular line of production
factor endowments
The main economic factors of production are land (and other natural resources), labor, real capital, and human capital
donation factorielle : designe l’ensemble des capacités existante de production d’un pays
factor’s proportion theorem
The country that is abundant in a factor exports the good whose production is intensive in that factor.
The Stolper-Samuelson theorem
derived from the H-O model
It states that international trade changes distribution of income (in relation to autarky) in each trading country:
1. Owners of the country’s abundant factors of production gain higher relative and real income from trade, but owners of a country’s scarce factors lose
2. Factors of production that are used intensively by the import-competing industry are hurt by the opening to trade
Conflict of interest within countries
There is a considerable survey evidence that unskilled workers in rich countries are more protectionist than skilled workers and owners of capital, but unskilled workers in poor countries are more in favor of trade than skilled workers.
Empirical evidence on the HO model
-common technologies across countries
-countries producing the same set of goods with only 2 factors of production
-costless trade which equalizes prices of goods across countries
=direction for the prediction of HO
The International Product Life Cycle
He pointed out that many manufactured products go through a product life- cycle in which the input requirements and the location of production change over time
3 stage of international product life cycle
- early-stage = new product stage
–> the production takes place in an innovating firm’s country which is a (high-income) human-capital-abundant country. - middle stage = maturing product stage
–> The production shifts to other capital-abundant industrialized countries with high demand which become exporters - late stage = standardized product stage
–> competition from other firms selling similar products pressures companies to shift production to low-cost locations, mostly labor-abundant countries which export this good now to the rest of the world.
Shifting Comparative Advantage
implies that patterns of comparative advantage are not stable over time. Countries may lose and gain comparative advantage in different products.
Product Life Cycle (definition)
As products move from a stage of innovation to one of standardization, their factor-intensity changes. This shifts the pattern of comparative advantage. This may change the geography of production and the regional pattern of trade.
Economic Development:
As countries develop, their relative factor abundance changes towards higher relative abundance of skilled labor and real capital. This might be another reason for a shift in the pattern of comparative advantage, the geography of production and the regional pattern of trade.
China’s Export … (where ? )
Patterns to the USA
In the most recent years, the greatest share of exports is (china to USA)
In the most recent years, the greatest share of exports is transacted in the highest skill-intensity sectors, whereas exports were concentrated in the lowest skill-intensity sectors in the earlier years.
china’s grows
becomes relatively more skill-abundant, the concentration of exports in high-skill sectors steadily increases over time.
inter-industry trade
international exchange of products between two different industries (like cloth for wheat)
–> with comparative advantage
intra-industry trade
international trade of similar products made within the same industry (like domestic cars for foreign cars). This trade takes place between similar countries without comparative advantage.
the new trade theory
was developed by E. Helpman and P. Krugman
New trade theory (NTT) refers to modern economic theory that explains international trade based on economies of scale, network effects, and first-mover advantage
most of the world trade is intra or inter-industry ?
Intra industry
–> growing importance of intra- industry trade for industrialized developed countries
–> rapidly industrializing developing countries forced economists to elaborate a new set of models
economies of scale
The production of many goods, is characterized by decreasing average production costs
2 types of economies of scale
internal and external economies of scale
Internal economies of scale
A firm’s average cost of production decreases the more output it produces.
reason internal economies of scale ( A firm’s average cost of production decreases the more output it produces)
-the rent pay for the office, the building, energy cost: they do not double when we double the production
-fix cost: employees
-transportation cost per unit of output will become lower
–> related to the size
–> higher size of the experience, will improve the production
Internal Economies of Scale and Imperfect Competition
The presence of internal economies of scale is the reason why firms want to grow: size confers a competitive advantage.
Oligopoly
a handful of firms produce the entire market output, with each firm
formulating its strategies in response to those of its competitors
Monopolistic competition
each firm produces a slightly different product which is a (imperfect) substitute for another variety. Product differentiation ensures that each firm has a monopoly in its particular product variety within industry, but takes the prices charged by its rivals as given.
Unlike under pure monopoly, competition among many firms exists.
Internal economies of scale are important cause of international trade:
It pays to concentrate production in only a few locations, so each location has a large level of output. But that also means that production occurs in only a few locations/countries that export the good to other locations/countries
The Gains from International Trade with Internal Economies of Scale
International trade increases market size for exporting firms and improves the welfare of the individual nations for a number of reasons:
- Increase in consumer choices
2.Lower prices
3.Overall productivity gains
–> A smaller country tends to gain more from these integration effects than a larger country.
external economies of scale
are business-enhancing factors that occur outside a company but within the same industry.
when firms occur external economies of scale
They occur when firms become more productive (have lower average costs) as the size of the entire industry (number of firms or total industry output) increases, but not necessarily the size of any one firm.
A cluster
is a geographically proximate group of interconnected companies and associated institutions in a particular field, linked by commonalities and complementarities (external economies of scale)
origin of external economy of scale
dates back to Marshall (1890). Krugman (1991) stated that external economies of scale lead to regional concentration of firms (spatial clusters) and to international trade without comparative advantages.
example of spatial Clusters
-Tourism and wine
-Semiconductor industry and life science
-Silicon Valley
Reasons for External Economies of Scale
- Specialized suppliers
2.Labor market pooling
3.Knowledge spillovers (informal exchange of information, reverse-engineering and sharing ideas by workers of different firms become easier)
Dynamic External Economies of Scale Reinforce Regional Concentration
1.Geographical concentration may be self-reinforcing:
-The region with an initial small head start in attracting firms may over time
develop significant economies of scale before other regions.
-dynamic increasing returns to scale could arise if the average cost of production depends on the accumulation of knowledge and experience (learning), which depend on the production process over time.
2.a move toward clustering may cause a chain reaction, resulting in a massive industrial agglomeration
- An initial small head start may turn into a permanent competitive advantage for firms in one region over another.
Trade and Welfare with External Economies
1.gains to the world economy by concentrating production of
each industry with external economies
2.opening to trade will lead to specialization and prices that are lower than the prices in either country before trade.
3.Countries that start as large producers in certain industries with external economies tend to remain large producers and exporters even if another country could potentially produce more cheaply.
4.Each country wanting to reap the benefits of housing an industry with economies of scale creates trade conflicts.
