lec 1: introduction - chiang mai...

Copyright ©2000, South-Western College Publishing

Lec 1:

Introduction

Trade

Theory

Subject Outline

FinanceTrade

Policy

International

Economics

Trade

TheoryStudy Guide 1

Mercantilism

Absolute Advantage

Comparative Advantage

Heckscher-Ohlin Stolper-Samuelson

Factor Price Equalisation

Rybzcynski

Immiserising Growth

Trade

Theory

• Theory used to explain and predict.

• What is International Trade?

• Why do nations trade?

• What are the gains from trade?

• Who gains from trade?

Trade Theory

Trade

Policy

Tools of the Trade Policy Analysis

Tariffs

Other TradePolicies Regional Trade

Agreements

International ResourceMovements

Finance

Study Guide 3

Weeks 9-12

Exchange Rates

Exchange ratetheorems

Interest Arbitrage

Current AccountDeficit

Trade

TheoryStudy Guide 1

Comparative Advantage

Heckscher-Ohlin Stolper-Samuelson

Factor Price Equalisation

RybzcynskiTrade

Theory

Mercantilism

Absolute Advantage

Week 1

Immiserising Growth

• Mercantilism - zero sum game - one nation gains at the expense of the other.

• Adam Smith - both nations can gain from trade.

• Absolute Advantage - each nation should specialise in production of the good which it is most efficient at producing.

Trade Theory Why do Nations Trade?

• Perfect Competition in Product and Factor Markets (P=MC)

• Each Country has a fixed endowment of resources that are fully used and are homogeneous

• Technology is Unchanging

• No Transportation Costs or barriers to trade

• Factors of Production are perfectly mobile between industries but are immobile between countries

• 2x2x1


Assumptions


Mercantilism

The way for a nation to become rich

and powerful is to export more than

to import

Thomas Munn (1571-1641)

Trade Theory

Imports

Exports

Imports

Exports

ENGLAND FRANCE

Why do Nations Trade?

Mercantilism

Introduction

Adam Smith (1723-1790)

Introduction

David Ricardo (1772-1823)


International EconomicsBy Robert J. Carbaugh

7th Edition

Chapter 2:

Foundations of modern trade theory

Carbaugh, Chap. 2 15

Historical development of trade theory

• Mercantilism

• positive trade balance

• Absolute advantage (Adam Smith)

• Countries benefit from exporting what they make cheaper than anyone else

• Comparative advantage (David Ricardo)

• Nations can gain from specialization, even if they lack an absolute advantage

Foundations of trade theory

International Trade Theories:

Mercantilism (1500 – 1750):

1. International trade is a zero-sum game:

Static view of world resources:

One’s gains = Other’s losses

2. Wealth: Acquisition of precious metals—gold or silver

Well-being = Accumulating gold

3. Economic growth =Enhancement of power with strong

army, strong navy and merchant marine, and enlargement

of foreign colonies.

4. Productive = maintaining and increasing the power

5. Regulations or restrictions on importable activities

6. Favorable positive trade balance:

Exports > Imports Inflows of specie (gold)

Money supply increases

Stimulates output and

employment

Economic growth

Mercantilism :

Role of the government and

domestic economic policy

• Control the use and exchange of precious metals (Bullionism)

•High tariffs, quotas on imports of consumption goods

•Tax exemptions and subsidies to exports

•Allows trade monopolies and monopsonies

•Pursues low wage policies

•Encourage large family, providing financial incentives for

marriage and stimulate population growth

•Emphasis the important of the merchant class

David Hume (1752):

Price-Specie-Flow Mechanism

Accumulate specie with internal automatic repercussions.

Assumptions:

1. Link between money and price:

MV = PV; Full employment; Fixed velocity of money

2. Demand for trade goods is price elastic:

Stable equilibrium in trade sector.

3. Perfect competition: product and factor markets

Link between prices and wages (W).

4. Gold standard exists:

Gold is directly linked to money and specie.

Price-Specie-flow Mechanism:

Trade surplus vis-à-vis Trade Deficit

Exports > Imports Exports < Imports

Step 1 : Net inflow of specie Net outflow of specie

Step 2 : Money supply increase Money supply decrease

Step 3 : Prices and wages

increase

Prices and wages

decrease

Step 4 : Increase in imports &

Decrease in exports

Decrease in imports and

Increase in exports

until until

Exports = Imports Exports = Imports

Country A Country B

Adam Smith (1723 – 1790)

Laissez faire and free trade is a positive-sum game:

Nation’s wealth production capacity not

holdings of gold

Economic growth free environment and self-interest

and competition

Productivity gains division of labor and specialization

of labor

Mutual beneficial exchange and free trade


2

Foundations of modern trade theory


Historical development of trade theory• Mercantilism

• positive trade balance

• Absolute advantage (Adam Smith)

• Countries benefit from exporting what they make cheaper than anyone else

• Comparative advantage (David Ricardo)

• Nations can gain from specialization, even if they lack an absolute advantage

Foundations of trade theory


Absolute & Comparative Advantage

Comparative advantage

Absolute advantage: each nation is more efficient in

producing one good

Output per labor hour

Nation Wine Cloth

United States 5 bottles 20 yards

United Kingdom 15 bottles 8 yards

Comparative advantage: the US has an absolute

advantage in both goods

Output per labor hour

Nation Wine Cloth

United States 40 bottles 40 yards

United Kingdom 20 bottles 10 yards


Ricardo’s Comparative Advantage in money prices


Cloth (yards) Wine (bottles)

Nation Labor Wage Quant. Price Quant. Price

US 1 hr $20/hr 40 $0.50 40 $0.50

UK 1 hr £5/hr 10 £0.50 20 £0.25

UK 1 hr $8 10 $0.80 20 $0.40

(at $1.6 = £1)


Transformation schedules

• Generalizes theory to include all factors, not just labor

• Shows combinations of products that can be made if all factors are used efficiently

• Slope, or marginal rate of transformation, shows the opportunity cost of making more of one good (how much of one good must be given up to make more of another)



Marginal Rate of TransformationComparative advantage

0

10

20

30

40

50

60

70

0 20 40 60 80 100 120 140

Autos

A

B

C

Slope = MRT = 0.5

Wh

eat


Transformation schedules: constant opportunity costs

United States

0

20

40

60

80

100

120

140

160

0 40 80 120

Autos

Canada

0

20

40

60

80

100

120

140

160

0 40 80 120

Autos


Slope = 0.5 = MRT

Slope = 2.0 = MRT

Wh

eat

Wh

eat


Supply schedules: constant opportunity costs

0

0.5

1

1.5

2

2.5

3

0 40 80 120 160

Autos


S Canada

0

0.5

1

1.5

2

2.5

3

0 20 40 60 80 10

0

12

0

14

0

16

0

Wheat

S US

S US

S Canada

Bu

sh

els

of

wh

eat

per

au

to

Au

tos p

er

bu

sh

el o

f w

heat


Trading under constant opportunity costs

United States

0

20

40

60

80

100

120

140

160

0 20 40 60 80 10

0

12

0

14

0

16

0

Autos


A

B

C

D

E

F

Trading

possibilities line

(terms of trade 1:1)

Canada

0

20

40

60

80

100

120

140

160

0 20 40 60 80 10

0

12

0

14

0

16

0

Autos

A’

B’

C’D’

Trading

possibilities line

(terms of trade 1:1)

Wh

eat

Wh

eat


Production gains from specialization: constant opportunity costs


Autos Wheat Autos Wheat Autos Wheat

US 40 40 120 0 80 -40

Canada 40 80 0 160 -40 80

World 80 120 120 160 40 40

Before After Net Gain

Specialization Specialization (Loss)


Consumption gains from trade: constant opportunity costs


Autos Wheat Autos Wheat Autos Wheat

US 40 40 60 60 20 20

Canada 40 80 60 100 20 20

World 80 120 120 160 40 40

Before After Net Gain

Specialization Specialization (Loss)


Complete specialization under constant opportunity costs

0

0.5

1

1.5

2

2.5

3

0 40 80 120 160

Autos


S Canada

0

0.5

1

1.5

2

2.5

3

0 40 80 120 160

Wheat

S US

S US

S Canada

Aw

Aa

Aa’

Aw’

Bu

sh

els

of

wh

eat

per

au

to

Au

tos p

er

bu

sh

el o

f w

heat


Changing comparative advantage

United States

0

100

0 50 100 150

Computers

MRT = 1.0

Japan

0

80

0 40 80 120 160

Computers

MRT = 2.0


MRT = 0.67MRT = 0.5

Au

tos

Au

tos

lec 1: introduction - chiang mai...

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