chapter 23 gains from international trade
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Chapter 23Gains from
International Trade
Chapter 23Gains from
International Trade
Pre-trade production and consumption possibilitiesPre-trade production and consumption possibilities
Cloth (metres m)
Whe
at (
kilo
s m
)
0
200
400
600
800
1000
0 200 400 600 800 1000
a
Less developedCountry, population 500
Less developed country Developed country
Wheat(kilos m)
Cloth(metres m)
Wheat(kilos m)
Cloth(metres m)
abcdef
1000 800 600 400 200 0
0100200300400500
ghIjklm
12001000 800 600 400 200 0
0 400 8001200160020002400
Cloth (metres m)
Less developed country Developed country
Wheat(kilos m)
Cloth(metres m)
Wheat(kilos m)
Cloth(metres m)
abcdef
1000 800 600 400 200 0
0100200300400500
ghIjklm
12001000 800 600 400 200 0
0 400 8001200160020002400
Whe
at (
kilo
s m
)
0
200
400
600
800
1000
0 200 400 600 800 1000
a
b Less developedcountry
Pre-trade production and consumption possibilitiesPre-trade production and consumption possibilities
Cloth (metres m)
Less developed country Developed country
Wheat(kilos m)
Cloth(metres m)
Wheat(kilos m)
Cloth(metres m)
abcdef
1000 800 600 400 200 0
0100200300400500
ghIjklm
12001000 800 600 400 200 0
0 400 8001200160020002400
Whe
at (
kilo
s m
)
0
200
400
600
800
1000
0 200 400 600 800 1000
a
b
c
d
e
f
Less developedcountry
Pre-trade production and consumption possibilitiesPre-trade production and consumption possibilities
Cloth (metres m)
Whe
at (
kilo
s m
)
0
200
400
600
800
1000
0 200 400 600 800 1000
Pre-trade production and consumption possibilitiesPre-trade production and consumption possibilities
This is just like an ordinary budget
constraint :
Remember if M=PxX+PYY
And the slope =-Px/Py
Cloth (metres m)
Whe
at (
kilo
s m
)
0
200
400
600
800
1000
0 200 400 600 800 1000
Pre-trade production and consumption possibilitiesPre-trade production and consumption possibilities
Except now it is the budget constraint of a
country.
GNP=2W+1C
And the slope= -PC/PW=-2/1
Cloth (metres m)
Whe
at (
kilo
s m
)
0
200
400
600
800
1000
0 200 400 600 800 1000
Pre-trade production and consumption possibilitiesPre-trade production and consumption possibilities
And just like with a consumer we can
represent a country’s tastes by indifference
curves (social indifference curves).
Cloth (metres m)
Less developed country Developed country
Wheat(kilos m)
Cloth(metres m)
Wheat(kilos m)
Cloth(metres m)
abcdef
1000 800 600 400 200 0
0100200300400500
ghIjklm
12001000 800 600 400 200 0
0 400 8001200160020002400
Whe
at (
kilo
s m
)
0
200
400
600
800
1000
0 200 400 600 800 1000
Pre-trade production and consumption possibilitiesPre-trade production and consumption possibilities
Cloth (metres m)
Less developed country Developed country
Wheat(kilos m)
Cloth(metres m)
Wheat(kilos m)
Cloth(metres m)
abcdef
1000 800 600 400 200 0
0100200300400500
ghIjklm
12001000 800 600 400 200 0
0 400 8001200160020002400
Whe
at (
kilo
s m
)
0
400
800
1200
1600
2000
2400
0 400 800 1200 1600 2000 2400
Whe
at (
kilo
s m
)
Cloth (metres m)
Less developedcountry
DevelopedCountry
Population300
Pre-trade production and consumption possibilitiesPre-trade production and consumption possibilities
0
200
400
600
800
1000
0 200 400 600 800 1000
Cloth (metres m)
0
400
800
1200
1600
2000
2400
0 400 800 1200 1600 2000 2400
Whe
at (
kilo
s m
)
Developedcountry
Pre-trade production and consumption possibilitiesPre-trade production and consumption possibilities
Similarly the “budget constraint” of this
country is :
GNP=4W+8C
And the slope=-PC/PW=-4/8=-1/2
Cloth (metres m)
0
400
800
1200
1600
2000
2400
0 400 800 1200 1600 2000 2400
Whe
at (
kilo
s m
)
Developedcountry
Pre-trade production and consumption possibilitiesPre-trade production and consumption possibilities
And again tastes in this country are represented by a social indifference
curve
0
200
400
600
800
1000
0 200 400 600 800 1000
Cloth (metres m)
Less developed country Developed country
Wheat(kilos m)
Cloth(metres m)
Wheat(kilos m)
Cloth(metres m)
abcdef
1000 800 600 400 200 0
0100200300400500
ghIjklm
12001000 800 600 400 200 0
0 400 8001200160020002400
Whe
at (
kilo
s m
)
a
b
c
d
e
f0
400
800
1200
1600
2000
2400
0 400 800 1200 1600 2000 2400
Whe
at (
kilo
s m
)
Cloth (metres m)
gh
ij
kl
m
Less developedcountry
Developedcountry
Slope -2/1 Slope -1/2
Pre-trade production and consumption possibilitiesPre-trade production and consumption possibilities
0
200
400
600
800
1000
0 200 400 600 800 1000
Cloth (metres m)
Whe
at (
kilo
s m
)
a
b
c
d
e
f0
400
800
1200
1600
2000
2400
0 400 800 1200 1600 2000 2400
Whe
at (
kilo
s m
)
Cloth (metres m)
gh
ij
kl
m
Less developedcountry
Developedcountry
Slope -2/1 Slope-1/2
Pre-trade production and consumption possibilitiesPre-trade production and consumption possibilities
Developed countries relative pre-trade price =Pc/Pw=1/2
Less-Developed countries relative pre-trade price =Pc/Pw= 2
0
200
400
600
800
1000
0 200 400 600 800 1000
Cloth (metres m)
Whe
at (
kilo
s m
)
a
b
c
d
e
f0
400
800
1200
1600
2000
2400
0 400 800 1200 1600 2000 2400
Whe
at (
kilo
s m
)
Cloth (metres m)
gh
ij
kl
m
Less developedcountry
Developedcountry
Slope -2/1 Slope -1/2
So C is relatively cheap in the Developed countries (it has a comparative advantage in cloth)
And relatively expensive in the Less-Developed countries where wheat is relatively cheaper (and it
has a comparative advantage in wheat)
0
200
400
600
800
1000
0 200 400 600 800 1000
Cloth (metres m)
Whe
at (
kilo
s m
)
a
b
c
d
e
f0
400
800
1200
1600
2000
2400
0 400 800 1200 1600 2000 2400
Whe
at (
kilo
s m
)
Cloth (metres m)
gh
ij
kl
m
Less developedcountry
Developedcountry
Slope -2/1 Slope -1/2
If we now allow free trade between the two countries, the free trade price must lie between the
two sets of AUTARKY prices
2
1
P
P2
TW
TC
0
200
400
600
800
1000
0 200 400 600 800 1000
Cloth (metres m)
Whe
at (
kilo
s m
)
a
b
c
d
e
f0
400
800
1200
1600
2000
2400
0 400 800 1200 1600 2000 2400
Whe
at (
kilo
s m
)
Cloth (metres m)
gh
ij
kl
m
Less developedcountry
Developedcountry
Slope -2/1 Slope -1/2
If we now allow free trade between the two countries, the free trade price must lie between the
two sets of AUTARKY prices
1P
PSuppose
TW
TC
0
200
400
600
800
1000
0 200 400 600 800 10000
400
800
1200
1600
2000
2400
0 400 800 1200 1600 2000 2400
Effect of trade on consumption possibilitiesEffect of trade on consumption possibilities
Cloth (metres m)
Whe
at (
kilo
s m
)
Whe
at (
kilo
s m
)
Cloth (metres m)
Less developed country Developed country
1P
PSuppose
TW
TC
Effect of trade on consumption possibilitiesEffect of trade on consumption possibilitiesW
heat
(ki
los
m)
0
200
400
600
800
1000
0 200 400 600 800 10000
400
800
1200
1600
2000
2400
0 400 800 1200 1600 2000 2400
Cloth (metres m)
Whe
at (
kilo
s m
)
Cloth (metres m)
Less developed country Developed country
Slope 1/1 Slope 1/1
Possibilities have clearly risen
So can’t be worse off!!
0
400
800
1200
1600
2000
2400
0 400 800 1200 1600 2000 2400
0
200
400
600
800
1000
0 200 400 600 800 1000
Effect of trade on consumption possibilitiesEffect of trade on consumption possibilities
Cloth (metres m)
Whe
at (
kilo
s m
)
Whe
at (
kilo
s m
)
Cloth (metres m)
Less developed country Developed country
Imports
600
Exports600
600
Imports
Exports
600
x
y
THE ADVANTAGES OF TRADETHE ADVANTAGES OF TRADE
• The law of comparative advantage
– specialisation as the basis for trade
– the gains from trade based on comparative advantage
A more solid and general way of looking at this is by looking at Production Possibility Frontiers:
• The law of comparative advantage
– specialisation as the basis for trade
– the gains from trade based on comparative advantage
A more solid and general way of looking at this is by looking at Production Possibility Frontiers:
Equilibrium before tradeEquilibrium before trade
O
Go
od
m
Good x
Previously could switch workers from cloth to
wheat at the same rate
e.g. in Developed Country at rate of 8 cloth to 4
wheat
Equilibrium before tradeEquilibrium before trade
O
Go
od
m
Good x
But more likely the productivity of workers would decline as more
and more were switched
From Cloth
(Export good x)
to wheat
(import good M)
Equilibrium before tradeEquilibrium before trade
O
Go
od
m
Good x
Productionpossibility curve
So rate declines as output of cloth falls and
wheat rises
So shape of country’s
production possibilities is
not a straight line but a curve
Equilibrium before tradeEquilibrium before trade
O
Go
od
m
Good x
Productionpossibility curve
Slope = -MCx / MCm = -MRT
O
Go
od
m
Good x
Socialindifference
curves
I3
I2
I1
Equilibrium before tradeEquilibrium before trade
O
Go
od
m
Good x
I3
I2
I1Autarky Price ratio
Slope = -Px / Pm
Equilibrium before tradeEquilibrium before trade
At P1C1
MCx Px MUx= =
MCm Pm MUm
O
Go
od
m
Good x
I3
I2
I1
P1C1
Equilibrium before tradeEquilibrium before trade
EquilibriumEquilibrium with with tradetrade
O
Go
od
m
Good x
I3
I2
World price ratio
P2
MCx PxT
= MCm Pm
T
P1C1
O
Go
od
m
Good x
I3
I2
World price ratio
MUx PxT
= MUm Pm
T
C2
P1C1
P2
EquilibriumEquilibrium with with tradetrade
O
Go
od
m
Good x
I3
I2
World price ratio
ImportsP1C1
P2
C2MC
MP D
EquilibriumEquilibrium with with tradetrade
O
Go
od
m
Good x
I3
I2
World price ratio
Imports
Exports
P1C1
P2
C2MC
MP
XC XP
D
EquilibriumEquilibrium with with tradetrade
O
Go
od
m
Good x
I3
I2
World price ratio
C2
P1C1
P2
Reason for tradeReason for trade
IF Prices Differ IF Prices Differ Then Trade Is Then Trade Is
Profitable for AllProfitable for All
Why might prices differ?Why might prices differ?
• Different technology or physical capabilitiesDifferent technology or physical capabilities– (Land/Minerals)(Land/Minerals)
• Differences in Factor EndowmentsDifferences in Factor Endowments– Labour/CapitalLabour/Capital
• Different tastes Different tastes – (same Technology & Factors)(same Technology & Factors)
• Differences in Taxes or competitionDifferences in Taxes or competition– (Monopoly pushes prices up)(Monopoly pushes prices up)
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