Transcript International Trade - Shanghai University

International Trade
Cheng Ming 程铭
School of Economics, Shanghai University
Chapter One
Comparative Advantage
--- The Ricardian Model
1. The Concept of Comparative Advantage
Two basic reasons for International Trade
 Countries can benefit from doing things they
do well
 Reaching economies of scale in production
• David Ricardo, in his 1817 book “The Political
Economy and Taxation” put forward the theory
of Comparative Advantage
• A company has a comparative advantage in
producing a good if the opportunity cost in
terms of other goods is lower.
• Each country can benefit from the exporting
the goods in which it has a comparative
advantage.
2. A One-factor Economy
 In Ricardian model, international trade is
SOLELY due to the differences in the
productivity of labor
 An Economy – Home
Two Goods – Wine & Cheese
One Factor – Unit labor requirement
 We define:
aLW – unit labor requirement in wine
aLc – unit labor requirement in cheese
L – total labor supply
Production Possibility
Slop: opportunity cost
of cheese in terms of
wine
aLC/aLW
Production Possibility
Frontier
Relative Prices and Supply
• PPF illustrates the mixture of goods the
economy can produce
• The actual production mix is based on the
relative prices (no profits in One-factor model)
• If Pc/Pw > aLC/aLW, specialize in the production
in cheese
• If Pc/Pw = aLC/aLW, both goods will be
produced
• The economy will produce cheese if the relative
price exceeds it opportunity cost
3. Trade in a One-factor World
We assume: Home country is less productive than
Foreign in Wine, but more productive in Cheese
Therefore:
aLC/aLW < a*LC/a*LW
Or, equivalently, that
aLC/a*LC < aLW/ a*LW
Therefore, Home country has comparative advantage
in Cheese
Determining the Relative Price
after Trade
Relative price
of Cheese
a*LC/a*L
Rs
1
2
aLC/aL
R
RD
Q
L/aL
L/a*LW
Relative Quantity
of Cheese
 Point 1, the intersection of demand curve R
and RS curve, where the relative price of
cheese is between the two countries’ pretrade
prices. Each country will specialize in the
production of the good in which it has a
comparative advantage.
 Point 2, the world relative price after trade is
the same as the opportunity cost of cheese in
terms of wine in Home, Home economy need
not specialize, while Foreign does specialize in
producing wine.
The Gains from Trade
 The First Way
-- to think of trade as an indirect method of
production, i.e. Home can produce wine
directly and trade with Foreign for cheese
(produce indirectly)
-- for an hour of labor, direct production 1/aLW
wine, or 1/aLC cheese and be trade with wine
-- if (1/aLC)(PC/PW) > 1/aLW, or PC/PW > aLC/aLW
trade will be beneficial
 The second way – how trade will affect the
possibilities for consumption.
Trade Expands Consumption Possibilities
Quantity
of wine, Qw
Quantity
of wine, Qw
T
F
P
F
P
T
Quantity
Quantity
of cheese, Qc
(a) Home
of cheese, Qc
(b) Foreign
Relative Wages
 Political discussion of international trade often
focus on comparisons of wage rates in
different countries.
Unit Labor Requirements
Cheese
Wine
aLC = 1hr per pound aLW = 2hr per gallon
Foreign a*LC = 6 hr
a*LW = 3hr
Home
• Since, aLC/aLW < a*LC/a*LW
• So, Home will produce Cheese, Foreign produce Wine
• Suppose a unit of cheese and wine both sell for $12,
Home worker will earn $12 per hour, while Foreign
worker will earn $4
• As long as the relative price of cheese to wine is 1, the
wage of Home workers will be 3 times that of Foreign
workers.
• Home still has a comparative advantage in producing
cheese since this wage rate lies between the ratios of
the two countries productivities in the two countries.
4. Misconceptions about
Comparative Advantage
 Productivity and Competitiveness
Myth 1: Free trade is beneficial only if your country is
strong enough to stand up to foreign competition.
 The Pauper Labor Argument
Myth 2: Foreign competition is unfair and hurts other
countries when it is based on low wages.
 Exploitation
Myth 3: Trade exploits a country and makes it worse off if
its workers receive much lower wages than workers in
othernations.
5.Comparative Advantage with many goods
• With many goods, we label aLi and a*Li as labor
requirement for Home and Foreign, and rearranged
as:
aL1/a*L1< aL2/a*L2 < aL3/a*L3 < …< aLN/a*LN
• Let w and w* be the wage rate per hour in Home
and Foreign, respectively
• We know that it would produce cheaper in Home if
waLi < w*a*Li, and it can be rearranged to yield
a*Li/aLi > w/w*
Home and Foreign Unit Labor Requirements
Relative Home
Good
Home Unit Labor Foreign Unit Labor Productivity
Requirements(aLi) Requirements(a*Li) Advantage(a*Li/aLi)
Apples
Bananas
Caviar
Dates
Enchiladas
1
5
3
6
12
10
40
12
12
9
10
8
4
2
0.75
6. Adding Transport Cost
and Nontraded Goods
There are three reasons why specialization in
the real international economy is not the
extreme:
 The existence of more than one factor
 Countries sometimes protest industries from
foreign competitions
 It is costly to transport goods and services. i.e.
because of the transport cost, there exists
nontraded goods
Chapter Two
Specific
Factors and
Income
Distribution
1.The Specific Factors Model
• Although international trade is beneficial to
both of the countries, it is, however, has
strong effects on the distribution of income.
While trade may benefit a nation as a whole,
it often hurts significant groups within the
country, at least in the short run.
• We use the specific factors model to explain.
• Assumption of the Model:
-- an economy produce two goods:
manufactures and food.
-- three factors: labor(L), capital(K), and
land(T)
-- labor is the Mobil factor, while K and T are
specific factors for manufactures and food,
respectively
-- so, QM = Q M(K,LM)
QF = QF(T,LF)
LM + LF = L
Production Possibilities
The Production Function for Manufactures
Output, QM
The more labor input,
the larger the output.
Because of the
diminishing returns,
the successive input
will has less output.
Reflected by a flatter
Curve.
QM=QM(K,LM)
Labor
Input,LM
The Marginal Product of Labor
The marginal product
of labor equal to the
slop of the production
function
Marginal product
of labor, MPLM
MPLM
Labor
Input,LM
The Production Possibility Frontier
in the Specific Factors Model
Output of food, QF, (increasing )
QF=QF(T,LF)
1’
QF
L
Labor input
In food, LF
(increasing
QM
LF
1
)
LM
Economy’s
Production
Possibility
Frontier(PPF)
PP
Output of
Manufactures,
QM
(increasing )
L
Labor input
In manufacturers, LM
(increasing )
OM=QM(K,LM)
 In the Specific Factors Model, the PPF is an
convex line (reflecting diminishing returns to
labor), while in the Ricardian Model, it is a
straight line (reflecting constant returns)
 The slop of the production possibility curve
= - MPLF/MPLM
 The slop represents the opportunity cost for
manufactures in terms of food.
Price, Wages, and Labor Allocation
 Each sector will hire labor to the point until to
the point where the value produced by an
additional person-hour equals to the cost of
employing that hour. In manufacturing sector,
for instance:
 MPLM хPM = W, because of the diminishing
returns, MPLM is a downward curve, giving
the constant price of the manufactures.
 We can also consider the above equation as the
demand curve.
•
•
•
•
Since
MPLM хPM = MPLF хPF = w, therefore,
- MPLF/MPLM = - PM/PF
The result tells us that at the production point
the production possibility frontier QF
Slop =
must be tangent to a line whose
-(PM/PF)
slop is minus the price of
manufactures divided by
that of food.
QM
An equal proportional increase in the prices
of manufactures and food
Wage
Rate, w
2
PF хMPLF
1
10%
Wage
increase
w2
PF хMPLF
PM
Increase
10%
PF Increase 10%
2
2
PM хMPLM
w1
1
Labor used in
Manufactures, LM
1
PM хMPLM
Labor used
In food,LF
 If both goods’ prices increase by 10%, the labor
demand curves will both shift up by 10%. The
allocation of labor between the sectors and the
outputs of the two goods do not change.
 So it generates a general principle: changes in
the overall price level have no real effects, that is,
do not change any physical quantities in the
economy. Only changes in relative prices -- affect
welfare or the allocation of resources.
A change in relative prices
Wage
Rate,w
1
PF хMPLF
7% upward
Shift in labor
demand
2
W1
2
PMхMPLM
Wage rate
Rises by
Less than w2
7%
1
1
PM хMPLM
Labor used in
Manufactures,
LM
Amount of labor
shifted from food
to manufactures
Labor used
In food,
LF
 Two important facts about the results of the
shift of the labor in the above diagram
 First, although the wage rate rises, it rises by
less than the increase in the price of
manufactures.
 Second, when only PM rises, in contrast to the
case of a simultaneous rise in PM and PF, labor
shifts from the food sector to the
manufacturing sector and the output of
manufactures rises while that of food falls.
(This is why w dose not rise as much as PM:
because manufacturing employment rises, the
marginal product of labor in that sector falls.
Relative prices and the distribution of Income
 Let’s discuss the the results of the shifts of
labor for the incomes of three groups:
 1) Workers – their wage rate has risen, but less
than in the proportion to the rise in PM. Thus,
their real wage in terms of manufactures (w/PM)
falls, while (w/PF) rises.
 So, the warfare of workers are uncertain,
depending upon their preferences of
consumption.
 2) Owners of capital, are definitely better off.
The real wage rate in terms of manufactures
has fallen, so that the profits of capital owners
in terms of what whey produce rises.
 3) Owners of land are definitely worse off.
The lose for two reason:
--- the real wage in terms of food rises,
squeezing their income, and
--- the rise in manufactures prices reduces the
purchasing power of any given income.
2. International Trade in
the Specific Factors Model
 We know that an increase in the supply of
manufactures (or land) would increase
manufactures (food) output and reduce the
food (manufactures) output.
 Now we suppose that American has a larger
supply of land than Japan; while Japan has a
larger supply of capital than American.
 We also suppose that under any PM/PF, the
demand of two countries is the same, i.e. trade
is occurred only because of the difference of
the relative supply
 Therefore, the relative price of manufactures
is determined by the world relative supply
RSworld and world relative demand Rdword.
Relative price
Of manufactures, PM/PF
RSA
RSworld
(PM/PF)A
RSj
(PM/PF)world
(PM/PF)j
RDworld
Relative quantity
Of manufactures,
QM/QF
Trade pattern and Budget constraint
 In a closed economy, output equals to
consumption, so
DM = QM, DF = QF
 Although trade makes it possible for a country
to consume the different mix of manufactures
and food, the value of consumption must be
equal to the value of production, so
PM хDM + PF хDF = PM хQM + PF хQF, or
DF – QF = (PM/PF) х(QM – DM)
The budget constraint for a trading economy
Consumption of food, DF
Output of food, QF
Point 1 represents the economy’s
Production. The economy’s consumption must lie along a line that
Passes through point 1 and has a
Slope equal to minus the relative
1
Price of manufacturers.
Budget constraint
(slope = - PM/PF)
1
QF
Production
Possibility
frontier
1
QM
Consumption of
Manufacturers,DM
Output of
Manufacturers, QM
3. Income distribution and the gains from trade
 After trade, it leads to a convergence of relative
prices.
 Trade benefits the factor that is specific to the
export sector of each country but hurts the factor
specific to the import-competing sectors, with
ambiguous effects on mobile factors.
 Do the gains outweight the losses? Through the
diagram in the next page, we find that trade
potentially benefits a country since it expends the
economy’s choices of consumption.
Trade expands the economy’s consumption possibilities
Consumption of food, DF
Output of food, QF
Before trade, economy’s production and consumption were
at Point 2 on its production
possibilities frontier (PP).
After trade, The economy can
consume at any point on its
budet constraint in the colored
region consists of feasible
posttrade consumption choices
with consumption of both
goods higher than at the
pretrade point 2.
2
1
QF
1
Budget constraint
(slope = - PM/PF)
PP
1
QM
Consumption of
Manufacturers, DM
Output of
Manufacturers, QM
4. The political economy of trade: a
preliminary review
 Optimal trade policy
In spite of the real importance of income
distribution, most economists remain strongly in
favor of more or less free trade, reasons are:
a. Income distribution effects are not specific to
international trade.
b. It is always better to allow trade and compensate
those whose who are hurt by it than to prohibit the
trade.
• c. Those who stand to lose from increased
trade are typically better organized than
those who stand to gain. This imbalance
creates a bias in the political process that
requires a counterweight
 Income distribution and trade politics
in most of the countries, including the U.S.A.,
those who want trade limited are more
effective politically than those who want it
extended. Typically, those who gain from
trade in any particular product are a much
less concentrated, informed, and organized
group than those who lose.
Chapter Three: Resources and Trade –
The Heckscher-Ohlin Model
1. A model of Two-factor Economy
 The economy produce two goods – cloth and food
 Two factors – labor and land
aTC = acres of land used to produce one unit of cloth
aLC = hours of labor used to produce one unit of cloth
aTF = acres of land used to produce one unit of food
aLF = hours of labor used to produce one unit of food
 L and T = supply of labor and land
Input Possibilities in food production
Unit land input aTF,
in acres
A farmer can
Produce a unit of
Food with less land
If he or she uses more
Labor,and vice versa.
Input combinations
that produce one unit
of food
II
Unit land input
aLF,in hours
 What he or she will actually use?
 It depends on the relative cost of land and labor
-- factor prices: w/r (wage rate per hour of
labor/ cost of one unit of land)
 It is represented by the Figure as the curve FF.
 There is a corresponding relationship between
w/r and the land-labor ratio in cloth production.
As showed by the curve CC.
 Curve CC lies to the left of FF, indicating
production of food uses a higher ratio of land to
labor than the production of cloth.
Factor prices and input choices
Wage-rental
ratio, w/r
在每个部门，生产中所使用的土
地与劳动的比例取决于劳动与土
地的相对价格，即w/r。图中的
FF曲线表示在粮食生产中的土
地-劳动比的选择，CC曲线则表
示在棉布生产中的土地-劳动比
率。对于任何一个给定的工资租金比，粮食生产会使用较高的
土地-劳动比率。在这种情况下，
我们称粮食生产为土地密集型
(land intensive)，棉布生产为劳
动密集型(labor intensive).
CC
FF
Land-labor
Ratio, T/L
Factor prices and goods prices
Relative price
of Cloth, PC/PF
SS
由于棉布生产是劳动密集型的,粮
食生产是土地密集型的,要素相对
价格w/r与商品相对价格PC/PF存
在着一 一对应的关系. 劳动的相
对成本越高,劳动密集型产品的相
对价格就越高. 图中的SS曲线显
示了这种关系.
Wage-rental
ratio, w/r
从商品价格到要素投入的选择
From Goods Prices to Input Choices
Relative
Price of cloth
PC/PF
CC
FF
2
w/r
1
w/r
2
PC/PF
1
PC/PF
Increasing
1
2
1
TC/LC TC/LC TF/LF
Increasing
2
TF/LF LandLabor
Ratio
T/L
给定棉布的相对价格,工资与地租
的比例一定等于(w/r)1. 对应于这一工资—地租比例,棉布和粮
食生产中的土地与劳动比例分别是(TC/LC)1和(TF/LF)1. 如果棉
布的相对价格上升到(PC/PF)2, 工资—地租比就一定会上升到
(w/r)2,从而造成两个部门生产中使用的土地– 劳动比例提高.
The allocation of resources
Increasing
Labor used in food
production
OC
C
1
F
Increasing
Land used in food
production
Land used in
cloth production
OF
Labor used in cloth production
Increasing
 What will be happen, if the economy resources
change, say, by increasing the offer of land.
 We notice that an increase the economy’s
supply of land will lead to a fall in the output
of the labor intensive good, with the rise of the
output of the land intensive good.
 That is, there is a biased expansion of
production possibilities.
Resources and Production Possibilities
Output of food,QF
资源供给的变动对生产可能
Slope= -PC/PF
2
2
性的偏向性效应是理解资源 QF
差异如何导致国际贸易的关
键. 土地供给的增加使一国
的生产可能性向偏向于粮食
Slope=
生产的方向扩张,而劳动的
-PC/PF
增加使生产可能性向偏于棉
TT2
1
布生产的方向扩张. 因此, 土
1
地对劳动的相对供给比较高 QF
的国家在生产粮食生产上具
TT1
有相对优势.一般说来,一个
1
2
国家生产本国相对充裕资源
QC Output of cloth, QC
QC
密集型的产品具有比较优势.
-- known as the “Rybcznski effect” (罗布津斯基效应)
2. Effects of International Trade Between
Two-Factor Economies
 Relative prices and the Pattern of Trade
-- since Home is the labor-intensive economy,
Home tends to produce a higher ratio of cloth
to food.
-- When Home and Foreign trade, their relative
prices converge.
-- Since Home is abundant in labor, cloth
production uses a higher ratio of labor to land
in its production than food, that is cloth is
labor-intensive, Home will export cloth and
import food.
Trade Leads to a Convergence of Relative Prices
贸易前,点1是本国的均衡 Relative price
点,即本国的相对需求曲线 of cloth, PC/PF
RD和相对供给曲线RS的
交点. 同理,点3是外国贸易
前的均衡点. 贸易后, 世界
相对价格位于贸易前两国
均衡点之间,如点2所示.
RS*
RS
3
.2
RD
1
Relative quantity
of cloth, QC+QC*
QF+QF*
Trade and Distribution of Income
 Owners of a country’s abundant factors gain
from trade, but owners of a country’s scarce
factors lose.
 We find that factors of production that are
“stuck” in an import-competing used
intensively by the import-competing industry
are hurt by the opening of trade.
 The distinction between income distribution
effects due to immobility and those due to
differences in factor intensity also reveals that
there is frequently a conflict between shortterm and long-term interests in trade.
Factors Price Equalization
 There is a tendency toward the equalization of
factor prices.
 However, we find the assumption do not meet
the the real world: reasons --- we assume countries produce both goods
-- countries have the same technologies
-- factor price equalization depends on the
complete convergence of the prices of the goods
which is not the fact.
3.Empirical Evidence on the H-O Model
 Leontief Paradox
 H-O model has been less successful at
explaining the actual patterns of
international trade than one might hope, it
remains vital for understanding the effects of
trade, especially its effects on the income
distribution.
Chapter Four
The Standard Trade Model
 Ricardian Model has conveyed the essential
idea of comparative advantage, but difficult
for discussing the distribution of income.
 The Specific Model is effective in explaining
the income distribution, however, awkward for
discussing the trade pattern.
 The H-O Model is helpful in deeper
understanding of the trade pattern due to the
differences of resources.
1. A Standard Model of Trading Model
 All of the above models can be viewed as
special cases of a more general model of a
trading economy.
 The Standard Model is much more effective in
explaining the issues such as:
-- the effects of shifts in world supply resulting
from economic growth;
-- shifts in world demand resulting from foreign
aid;
-- simultaneous shifts in supply and demand
resulting from tariffs and export subsidies.
Production Possibilities and Relative Supply
 The basic assumption of the model: two goods
– food (F) and cloth (C), with a smooth
PPF(TT).
 We know that the actual mix of production is
determined by the relative price PC/PF.
 Any economy will maximize the value of
output: V = PCQC + PFQF, or
QF = V/PF – (PC/PF)QC
 Isovalue lines – lines along which the value of
output is constant.
Relative Prices Determine the Economy’s Output
Food
Production, QF
An economy whose
Production possibility
frontier is TT will
produce at Q, which
is on the highest
possible isovalue
line.
Isovalue lines
.Q
TT
Cloth
Production, QC
Relative Prices and Demand
• Giving any economy,
• PCQC + PFQF = PCDC + PFDF = V
• The economy’s choice of a point on the
isovalue line depends on the tastes of its
consumers – represented by a series of
indifference curves.
• Please note the three characteristics of the
indifference curves (P95)
How an Increase in the Relative Price of
Cloth Affects Relative Supply
Food
Production, QF
The isovalue lines become
steeper when the relative
price of cloth rises from
VV1(PC/PF)1 to
VV2(PC/PF)2. As a result ,
the economy produces
more cloth and less food
and the equilibrium output
shifts form Q1 to Q2
Q1
.
Q2 .
VV1(PC/PF)1
VV2(PC/PF)2
Cloth
Production,QC
Production,Consumption, and Trade
in the Standard Model
The economy produces at
QF
point Q, where the
production possibility
frontier is tangent to the
Food
highest possible isovalue
line. It consumes at point D, import
where that isovalue line is
tangent to the highest
possible indifference curve.
The economy produces
more cloth than it
consumes and therefore
export cloth;
correspondingly, it
consumes more food than it
produces and therefore
imports food.
Indifference curves
.
D
.Q
Isovalue lines
TT
QC
Cloth
exports
Effects of a Rise in the
Relative Prices of Cloth
QF
The slop of the isovalue lines
is equal to minus the
relative price of cloth PC/PF,
so when that relative prices
rises all isovalue lines
become steeper. In
particular, the maximumvalue line rotates from VV1
to VV2. Production shifts
from Q1 to Q2,
consumption shifts from D1
to D2.
.
D1
.
D2
.
Q1
.
Q2
TT
VV1(PC/PF)1
VV2(PC/PF)2
QC
The Welfare Effect of Changes in the Terms of Trade
 When PC/PF increases, a country that initially
exports cloth is made better off, since its
consumption moved from D1 to D2.
 The general conclusion: a rise in the terms of
trade increases a country’s welfare, while a
decline in the terms of trade reduces its welfare.
 Economic growth(represented by the shift of
the RS curve) vs. welfare – is economic growth
in other countries good or bad for Home? And
is growth in a country more or less valuable
when that nation is part of a closely integrated
world economy?
Growth and the PPF
 Economic growth means an outward shift of a
country’s PPF.
Q
 International trade
effects of growth
results from the
.
fact that such growth
.
has a bias.
F
TT1
TT2
QC
Growth biased toward cloth
Relative Supply and the Terms of Trade
Suppose Home has a
growth strongly biased
toward cloth, so the
World as a whole the
relative output of cloth
to food will rise,
resulting a decrease in
the relative price of
cloth. Export-biased
growth tends to worsen
a growing country’s
terms of trade, to the
benefit of the rest of the
World.
PC/PF
RS1
RS2
1
(PC/PF)1
.
2
(PC/PF)2
.
Cloth –biased growth
RD
QC+QC*
QF+QF*
Immiserizing Growth
 Some analysts suggested that the growth in
poorer nations would actually be self-defeating.
The export-biased growth would worsen their
terms of trade.
 Jagdish Bhagwati of Columbia University
argued that such perverse effects of growth
can in fact arise within a rigorously specified
economic model. It can be occurred when the
export-biased growth combined with very
steep RS and RD curves, so that the change in
the terms of trade is large enough to offset the
initial favorable effects of an increase in a
country’s productivity capacity.
2. International Transfers of Income
-- effects on a transfer on the terms of trade
 If Home makes a transfer of its income to Foreign,
Home’s income is reduced, and Foreign’s
expenditure is increased.
 It would lead to a shift in world relative demand
and thus affect the terms of trade.
 The shift of the RD curve is the only effect of a
transfer of income. The RS curve does not change.
 However, the terms of trade is also depended on the
allocation of the spending.
Effects of a transfer on the terms of trade
If Home has a
PC/PF
higher propensity to
spend on cloth than
Foreign, a transfer
of income by Home
to Foreign shifts the
RD curve left from (PC/PF)1
RD1 to RD2,
(PC/PF)2
reducing the
equilibrium relative
price of cloth.
1
2
.
.
Qc+QC*
QF+QF*
 therefore, a transfer worsens the donor’s
terms of trade if the donor has a higher
marginal propensity to spend on its export
good than the recipient.
 Since the actual spending patterns of each
country seems to have a relative preference
for its own goods, and also there exists the
nontrade goods, as well as the effect of
barriers to trade, most international
economists believe that the transfer of
income worsens the donor’s terms of trade.
3. Tariffs and export subsides:
simultaneous shifts in RS and RD
• If Home imposes a certain percentage of tariff on
the value of food, say, 20%, the internal price of
food relative to cloth faced by Home producers
and consumers will be 20% higher than the
external relative price of food on the world
market
 At any given world relative price of cloth, Home
will face a lower relative cloth price, and then will
produce less cloth and more food. So the world
relative supply of cloth will fall, while the relative
demand for cloth will rise.
 Therefore, Home’s terms of trade will improve at
the expense of Foreign.
Effects of a tariff on the terms of trade
Relative price
Of cloth,PC/PF
An import tariff
imposed by Home will
both reduces the
relative supply of
cloth and increase the
(PC/PF)2
relative demand of
cloth. As result, the
relative price of cloth
(PC/PF)1
must rise. Home’s
terms of trade will
improve.
RS2
RS1
2
RD2
1
RD1
Relative quantity
Of cloth, QC+QC*
QF+QF*
Effects of an export subsidy
• If Home offers a 20% subsidy on the value of
any cloth exported. For any given world prices
this subsidy will raise Home’s internal price of
cloth relative to food by 20%.
 Therefore, Home will produce more cloth and
less food, while leading Home consumers to
substitute food for cloth.
 A Home export subsidy worsens Home’s terms
of trade and improves Foreign’s.
Chapter Five: Economies of Scale,Imperfect
Competition,and International Trade
1. Economies of scale and international trade:
-- an overview
 Economies of scale, also referred to as
increasing returns, exists in many industries.
Therefore, production is more efficient in the
larger scale.
 Classification of economies of scale:
-- External economies of scale
-- Internal economies of scale
2. The theory of imperfect competition
 Perfect vs. imperfect competition
-- perfect competition: there are many buyers and
sellers, none of whom represents a large of part of
the market, so firms are price takers.
-- imperfect competition: only a few major
producers in an industry, firms will view
themselves as price setters.
 Two characteristics of imperfect competition
-- in an industry, there are only a few major
producers, and
-- each producer’s product is seen by consumers
as strongly differentiated from those of rival
firms.
Monopolistic Pricing and Production Decision
一个具有垄断地位的厂商
Cost, C
会选择这样一个产量: 在该
and
产量上, 边际收益等于边际
Price, P
成本。这个利润最大化的
产量就在图中的点QM，
与QM对应的价格为PM。
PM
由于边际收益总是低于
AC
价格，因此边际收益曲线
MR位于需求曲线D的下方。
垄断利润等于阴影的长
方形面积，即等于价格与
平均成本之差乘以产量QM。
Monopoly profit
AC
D
MC
MR
QM
Quantity,Q
Monopolistic Competition Model
• Two key assumptions:
 Each firm is assumed to be able to
differentiate its product from that of its rivals.
 Each firm is assumed to take the prices
charged by its rivals as given – that is, it
ignores the impact of its own price on the
prices of other firms.
-- assumption of the model
_
Q = S х[1/n – b х(p – p)]
Equilibrium in a monopolistically competition
Cost C, and
垄断竞争市场里的厂商数以
Price, P
及各厂商的定价由两个关系
所决定: 一方面,市场中的厂
商数越多,则它们的竞争越激
AC3
烈,相应地定价也较低.这一关 P1
系由曲线PP反映.另一方面,厂 P2,AC2
商数越多,各厂商的销售量也
AC1
越少,因而平均成本较高.这一
关系由曲线CC表示.如果价格 P3
高于平均成本,该行业就会赢
利,更多的厂商进入该行业,反
之,亦然. 当平均成本与价格相
n1 n2
等时(E)点,形成均衡的价格与
厂商数.
CC
.
PP
n3 Number
Of firms,n
Limitations of the Monopolistic Competition Model
• There are two kinds of behavior arises in the
general oligopoly setting that are excluded by
assumption from the monopolistic model:
 First is the collusive behavior – through
explicit agreements between firms, or through
tacit coordination strategies, such as price
leader.
 Second is the strategic behavior – through
some of the behavior that may affect the
competitors.
3.Monopolistic Competition and Trade
• Since,
• AC = F/Q + c = n хF/S + c
• International trade will increase in total sales
S, reducing the average costs for any given
number of firms n. Therefore, the CC curve in
the larger market will be below that in the
smaller market.
• P = c + 1/(b хn)
• The size of the market does not enter into the
equation, so an increase in S does not shift the
PP curve.
Effects of a larger market
Cost, C and
Price P
在其他条件不变的
情况下,随着市场
规模的扩张,各厂商
能生产更多的产品,
平均成本也随之下降, P1
结果是厂商数目的
P2
增加,可获取的商品
种类也因之而丰富,
各种商品的价格下跌.
CC1
CC2
1
2
PP
n1 n2
Number of
Firms,n
Economies of scale and Comparative advantage
 The difference between this model and the factor
proportional model is that manufacturers is not a
perfectly competitive industry in which a number of
firms all produce differentiated products.
 Because of economies of scale, neither country is able
to produce the full range of manufactured products by
itself; thus, although both countries may produce some
manufactures, they will be producing different things.
 If we assume the manufacture is a monopolistic
competitive sector, Home will be a net exporter of
manufacture and an importer of food.
Home
(capital abundant)
Manufactures Food
Trade in a World
Without Increasing
Foreign
Returns
(labor abundant)
Trade with
Increasing Returns
and Monopolistic
Competition
Home
(capital abundant)
Foreign
(labor abundant)
Manufactures Food
Interindustry
trade
Intraindustry
trade
Four points about this pattern of trade
 Interindustry trade(manufactures and food) –
due to comparative advantage.
 Intraindustry trade(manufactures for
manufactures) – due to economies of scale
 The pattern of intraindustry trade itself is
unpredictable.
 The relative importance of intraindustry and
interindustry trade depends on how similar
countries are. The importance of intraindusty
trade equals to
exports – imports
I=1exports + imports
4. Dumping and Reciprocal Dumping
Cost, C and
Price,P
PDOM
PFOR
MC
3
1
2
DFOR=MRFOR
DDOM
MRDOM
QDOM
Domestic Sales
QMONOPOLY
Exports
Total Output
Quantities produced
and demanded, Q
5. The Theory of External Economies
 Economies of scale apply at the level of the
industry rather than at the level of the
individual firms.
 Three main reasons why a cluster of firms
may be more efficient than an individual firm
in isolation:
-- Specialized Suppliers
-- Labor Market Pooling
-- Knowledge Spillovers
External Economies and International Trade
As this model
Price, Cost (per watch)
shows, external
economies
potentially give a C0
strong role to
historical accident
in determine who
1
produce what, and
P1
may allow
established
2
patterns of
specialization to
persist even they
run counter to
Q1
comparative
advantage.
ACSWISS
ACTHAI
D
Quantity of Watches
Produced and demand
Trade and Welfare with External Economies
Clearly in this
situation trade
leaves Thailand
worse off than
it would be in
the absence of
trade
Price,Cost (per watch)
Co
P1
P2
1
ACSWISS
2
ACTHAI
DWORLD
DTHAI
Quantity of watches
Produced and demanded
Dynamic increasing returns
 External economies arising from the
accumulation of knowledge differ something
form the external economies considered above
 Dynamic increasing returns -- learning curve
is determined by the cumulative output of the
industry to date.
 While for ordinary external economies, the
cost of the industry is determined by the
prevailing production quantity.
Chapter Six:
International Factor Movements
• 1. International Labor Mobility
• A One- good Model without factor mobility
Output, Q
Marginal Product
Of labor, MPL
Q (T,L)
Rents
Real
wage Wages
Labor, L
MPL
Labor, L
Causes and Effects of International Labor Mobility
MPL
MPL*
Marginal product
of labor
B
A
MPL*
Q Home
employment
C
L2
L1
Migration of labor
From Home to Foreign
Total world labor force
MPL
Foreign Q*
Employment
2. International Borrowing and Lending
 When we speak of capital flow in this part, we
refer to it as a financial transaction – that is one
country make loan to another.
 International borrowing and lending can be
interpreted as a kind of trade – intertemporal trade
 Any economy will produce and consume its output
either at present or in the future, therefore, it
involves a trade-off between present and future
production of the consumption good.
 We can summarize by drawing an intertemporal
production possibility frontier.
The Intertemporal Production Possibility Frontier
A country can
trade current
consump-tion for
future consumption
in the same way
that it can produce
more of one good
by producing less
of another.
Future
consumption
Present
consumption
 The shape of intertemporal PPF will differ
among countries
 Let suppose Home’s PPFs are biased toward
current consumption, while Foreign toward
future
 Without international borrowing and lending,
Home will have a higher relative price of future
product consumption than in Foreign
 Therefore, Home will export present
consumption and import future consumption
 The relative price of future consumption is
determined by interest rate --- 1/(1+r)
 Let’s assume that Home’s intertemporal PPF is biased
toward present production – therefore Home has a
comparative advantage in present production – a low
relative price of present consumption.
 A country has a comparative advantage in future
production of consumption goods is one that in the
absence of borrowing and lending would have a low
relative price of future consumption – a high real
interest rate.A high interest rate means a high return to
diverting resources from current production to future
 So countries that borrow in the international market
will be those where highly productive investment
opportunities are available relative to current
productive capacity. (lenders are actually export their
current consumption ).
3. Direct Foreign Investment and
Multinational Firms
 Another important form of capital movement is
direct foreign investment (FDI)
 A distinctive feature of FDI is that it involves
not only a transfer of resources but also the
acquisition of control
 The point is that while multinational firms
sometimes act as a vehicle for international
capital flows is to allow the formation of
multinational organizations – the extension of
control is the essential purpose.
The theory of Multinational Firms
 Location – why should a firm to produce the same product in
different countries
-- differences of resources / transportation costs / government
restrictions
 Internalization – why is production in different location done
by the same firm in stead of a different country?
-- it turns out to be more effective and profitable to carry out
transactions within a firm rather than between firms,
because:
a) technology transfer – difficult to determine the price
b) vertical integration – upstream and downstream often get
into conflicts, these problems can be reduced or avoided
through a single vertically integrated firm.
Chapter Seven
The Instrument of Trade Policy
• 1. Basic tariffs analysis
 Supply, demand, and trade in a single industry
-- without tariffs, the world Price, P
XS
price is determined by
Home import demand P
(MD) and Foreign export
MD
supply (XS)
W
QW
Quantity,Q
Effects of a Tariff
Home Market
Price,P
S
World Market
Foreign Market
Price,P
Price,P
2
PT
XS
S*
1
t
PW
PT*
3
D
Quantity,Q
MD
QT QW
Quantity,Q
D*
Quantity,Q
A tariff raises the price in Home while lowering the
price in Foreign. The volume traded declines.
 Note, the increase in the price in Home is less
than the amount of the tariff, because part of
the tariff is reflected in a decline in Foreign’s
export price
 Therefore, Home has the effect of the
improvement of trade terms
 If Home is a “small country”, where it cannot
affect foreign export price. As a result of the
tariff, imports fall in the country imposing the
tariff, while price raises equal to the tariff
imposed. (see next diagram)
A tariff in a small country
When a country is
small, a tariff it
imposes cannot
lower the foreign
price of the good it
imports. As a result,
the price of the
import rises and
the quantity of
imports demanded
falls
Price,P
S
PW+t
PW
D
S1
S2
D1 D2
Imports after tariff
Imports before tariff
Quantity,Q
Measuring the amount of protection
 Nominal rate of protection – arithmetic average
 Actual rate of protection – weighted average
 Effective rate of protection
d
w
Vj – Vj
ERP =
w
Vj
2.Costs and Benefits of a tariff
The costs and
benefits to
different
groups can
be
represented
as sums of
the five areas
a, b, c, d and
e
Price，P
PT
Pw
PT*
a
S
c
b
d
e
D
S1 S2
D 1 D2
QT
Quantity, Q
 Consumers surplus loss: a + b + c + d
 Domestic producers gain: a
 Government revenue gain through tariff: c + e
 e represents the terms of trade gain
 Production distortion loss: b
 Consumption distortion loss: d
 Efficiency loss: b + d
 The net cost of a tariff:
= (a + b + c + d) – a – (c + e)
=b+d–e
Net welfare effects of a tariff
Terms of
Trade
gain
d
Consumption
distortion
loss
Production
distortion
loss
e
3. Others instruments of trade policy
 Export subsidies
Price,P
PS
Subsidy
PW
a
S
b
e
c
f
g
PS*
D
Producer gain:a+b+c
Consumer loss:a+b
Government subsidy:
b+c+d+e+f+g
Consumption and production loss:b and d
Additional terms of
trade loss:e+f+g
Quantity,Q
Exports
 Import quota – U.S. Import Quota on Sugar
Price, $/ton
Supply
Consumer loss: a+b+c+d
Producer gain: a
Quota rents: c
a
b
c
d
Demand
5.14 6.32 8.45 9.26
Import quota
2.13 million tons
Quantity of
Sugar million
tons
 Voluntary Export Restraints (VER) – or
Orderly Market Agreements (OMA)
 Local Content Requirements
-- no strict limit on imports, it allows firms to
import as long as it by more domestically, so
the effective price of inputs of the firms is an
average of the price of imported and
domestically produced inputs. This differences
of prices pass on to consumers.
 Export credit subsidies
 National procurement
 Red-tap barriers – War of Poitiers
Comparing a Tariff and a Quota
Price,P
A quota
Pq
leads
To lower
PW+t
domestic
output and a PW
higher price
than a tariff
that yields
the same
level of
imports.
MC
D
MRq
Qq Qt
Dq
Quantity,Q
4. The effects of trade policy: A summary
Tariff
Export
subsidy
Import
quota
VER
Producers
surplus
Increases
Increases
Increases
Increases
Consumers
surplus
Falls
Falls
Falls
Falls
Government
Revenue
Increases
Falls (gov.
spending
rises)
Overall
national
welfare
Ambiguous
(fall for small
country)
Falls
No change No change
(rents to
(rents to
holders) foreigners)
Ambitious
Falls
Chapter Eight
The Political Economy of Trade Policy
• 1. The case for Free Trade
 Free Trade and Efficiency
-- a free trade would remove both production and
consumption distortions and increases national
welfare
 Additional Gains From Free Trade
-- economies of scale
-- providing entrepreneurs with an incentive to seek new
ways to export or compete with imports, since free
trade offers more opportunities for learning and
innovation than are provided by a system of “managed”
trade.
 Political Argument for Free Trade
-- it reflects the fact that a political commitment to
free trade may be a good idea in practice even
though there may be better policies in principle.
1) The conventionally measured costs of deviating
from free trade are large.
2) There are other benefits from free trade that add
to the costs of protectionist policies.
3) Any attempt to pursue sophisticated deviations
from free trade will be subverted by the political
process.
2. National Welfare Arguments
Against Free Trade
 The terms of trade argument for a tariff
-- a sufficiently small
Tariff the terms of trade
1
benefits must
outweight the costs.
Optimal Prohibitive Tariff Rate
tariff,t0 Tariff, tp
 The Domestic Market Failure Argument Against
Free Trade
-- the basic theoretical case for free trade rested on
cost-benefit analysis using the concepts of
consumer and producer surplus.
-- some economists argue that these concepts do not
properly measure the benefits of producing a good.
-- since labor in a sector may be unemployed or
underemployed, the existence of defects in the
capital and labor market may prevent the transfer,
the possibility of technological spillovers from
industries – domestic market failure
Distortion from
tariff a and b,
however, the
calculation
overlooks an
additional
benefit that
may make the
tariff preferable
to free trade.
Since the
increase in
production
yields a social
benefit
Price,P
s
PW+t
PW
b
D
Dollars S1 S2
c
S1 S2
D2 D1
Quantity,Q
Marginal
Social
benefit
Quantity,Q
 The social benefit is derived from the experience of
production that improve the technology of the economy
as a while but that the firms in the sector cannot
appropriate this benefit and therefore do not take it into
account in deciding how much to produce.
 The marginal social benefit is the additional production
that is not captured by the producer surplus measure.
 We can prove that as the economy impose a sufficient
small tariff, the extra social benefit (c) would
outweight the distortions (a) and (b).
 The domestic market failure argument against free
trade in a particular case of a more general concept
known in economies as the theory of the second best.
3. Income Distribution and Trade Policy
-- the discussion so far is confined to the national
warfare, when we look at the reality, there is
always individual’s desire reflected in the
objectives of the government.
-- in the following model we will assume the
governments are trying to maximize political
success rather than the abstract measurement of
national welfare.
 Electoral Competition
-- the so-called median voter.
选民被依照其偏好
的关税税率的高低
Preferred tariff rate
而排成一条直线。
如果一个党派提出 tA
高关税A, 那么另一 tB
个党派就可能提出
通过一个较低的关
税税率B而赢得大部 tM
分选票。政治竞争
迫使两个党派对提
出接近于M的关税
率， 其中M是中点
Median
选民所偏好的关税
Voter
税率。
Political support
Voters
 however, this model doest not work well, in fact,
it makes an almost precisely wrong prediction.
 According to this model, a policy should be
chosen on the basis of how many voter it pleases.
A policy that inflicts large losses on a few people
but but benefits a large number of people should
be a political winner.
 What is the reality?
 Collective Action
- there is a problem of collective action: while it is in
the interests of the group as a whole to press for
favorable policies, it is not in any individual’s
interests to do so.
 Modeling the Political Process
- politicians may win the elections partly because
they advocate popular policies – need money. So
the relevant policies favoring the group that
offering sufficient financial contribution will be
put forward. Some people therefore envision the
trade policy as a sort of auction – in which interest
groups “buy” policies.
4. International Negotiations and Trade Policy
The Advantages of Negotiation
 Helps mobilize support for free trade
 Helps governments avoid getting caught in
destructive trade wars.
Intentional Trade Agreements: A Brief History
 GATT – in 1947
 WTO – 1995
 Free Trading Agreements/Customs
Union/Common Market/Economic Union
Chapter Nine
Trade Policy in Developing
and Developed Countries
1. Trade Policy in Developing Countries
 Import-substitution Industrialization
-- The Infant Industry Argument
Pitfalls of the Infant Industry Arguments
a. It is not always good to try to move today into the
industries that will have a comparative advantage
in the future
b. Protecting manufacturing does no good unless the
protection itself helps make industry competitive.
c. The implementation of the policy is costly and
time consuming to build up an industry.
Justifications for Infant Industry Protection: -two reasons why infant industry should be
protected:
a. Imperfect capital market: infant industry in
developing countries does not have a set of
financial institutions, through protection, it allows
more rapid growth – as a second best policy
b. The problem of appropriability – the idea is that
firms in new industry generate social benefits for
which they are not compensated.
-- Promoting Manufacturing Through Protection, in
most developing countries, the basic strategy for
industrialization has been to develop industries
oriented toward the domestic market by using
trade restrictions such as tariffs and quotas to
encourage the replacement of imported
manufactures by domestic products.
As a strategy of promoting manufactures, the
import-substituting industrialization has worked.
The problem is :has the strategy promoted the
growth of economic development.
The Problems of the Dual Economy
 The division of a single economy into two sectors
that appear to be at very different levels of
development is referred to a economic dualism.
 The presence of economic dualism is often used to
justify tariffs that protect the apparently efficient
manufacturing sector.
 Some economists have argued that importsubstitution policies have actually helped to create
the dual economy or at least aggravate some of its
symptoms.
Export-oriented industrialization
 Those countries adopting the policies have
achieved spectacular economic growth. The so
called HPAEs – high performance Asian
economies.
 Some people argue that there is a correlation
between rapid growth in exports and rapid overall
economic growth, and the relatively low rates of
protection in the HPAEs helped them to growth.
 The miracle can be contributed to : high trade ratio,
high saving rate and rapid growth of education
level
2. Strategic Trade Policies
in Advanced Countries
• Arguments for strategic trade policy
 Technology and Externalities – firms can
appropriate some of the benefits of their own
investment in knowledge, while other firms can
benefit through “reverse engineer”
 Imperfect Competition and Strategic Trade Policy–
since there exists the market failure that justifies
the government intervention in the lack of perfect
competition.
The Brander-Spencer Analysis
• Effects of a subsidy to Airbus
Airbus
Boeing
Produce
Don’t produce
-5
0
-5
100
100
0
0
0
 however, the problems of the strategic policies
would face foreign retaliation. Since the policies
are beggar-thy-neighbor policies that increase the
welfare at the expense of other countries’ .
 We should note that strategic policy cannot be
judged by asking whether the targeted industries
grew. Although some of the industries finally
grow and achieve substantial market share, but
this does not mean that the policies accelerated
economic growth, because an interventionist
policy will not accelerated economic growth
unless it corrects a market failure.