International Economics

TOPIC 2
Foundations of Modern Trade Theories

Topic 2 Outline

Trade basis, Trade terms and Trade gains Trade models Analytical tools Discussion Assignment

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A Case for Debate

I do not know much about economics, But I do know this: if I buy a Good at home for a dollar, both the good and the dollar will stay at home. But if I buy the good from a foreigner, I will get the good and he will get the dollar! Its Good or Bad---

Who Was Wrong?

Export is good Import is bad ------

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Questions:
Why nations choose to trade? Whom a nation chooses to trades with? At what condition Nations trade with each other? Is trade logic also valid for commercial services ? Which nations gains more ?
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1. Theoretical analysis
Trade Theory in History
Mercantilism (1500-1800):zero-sum game Adam Smith: positive sum game
The Wealth of Nations (1776) The Chinese have little respect for foreign trade! P644-645

Ricardian Model: comparative advantage Assumptions: One factor world;rational behaviour; no tech barriers and change; perfect competition;labour mobility within home
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Ricardian Theory :2*2Model

Comparative advantage as basis for trade
Home Foreign Cheese 1 hour per p 6 Wine 2 hour pre p 3

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What can be created? One factor input Production in a closed economy under given labour force Open with trade needs specialization The key to Trade refers More advantageous, Less disadvantageous Gains from Trade __(Principle)
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Trade Pattern
Home 1 Foreign 6 Gains: Home: 1+2>3 Foreign:1+2>3 2 3

Analytical Tools measuring the supply side:

Opportunity Cost,Production Possibility Frontier (under conditions of Constant and increasing cost )
W tot

PPF C
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New concepts
ToT, the Slope of PPF, 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)

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Marginal Rate of Transformation, MRT

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Production possibilities schedules under constant opportunity costs

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Supply schedules: constant opportunity costs

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Trading under constant opportunity costs

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Production gains from specialization:

constant opportunity costs
Before Specialization
Autos Wheat US Canada World 40 40 80 40 80 120

After Specialization
Autos Wheat 120 0 120 0 160 160

Net Gain (Loss)

Autos Wheat 80 -40 40 -40 80 40

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Consumption gains from trade:

constant opportunity costs
Before Trade
Autos Wheat US Canada World 40 40 80 40 80 120 60 60 120

After Trade
Autos Wheat 60 100 160

Net Gain (Loss)

Autos Wheat 20 20 40 20 20 40

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Production possibilities schedule under increasing costs

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Trading under increasing costs: US

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Trading under increasing costs: Canada

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Production gains from specialization:

increasing opportunity costs
Before Specialization
Autos Wheat US Canada World 5 17 22 18 6 24

After Specialization
Autos Wheat 12 13 25 14 13 26

Net Gain (Loss)

Autos Wheat 7 -4 3 -4 7 3

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Consumption gains from trade:

increasing opportunity costs
Before Trade
Autos Wheat US Canada World 5 17 22 18 6 24 5 20 25

After Trade
Autos Wheat 21 6 27

Net Gain (Loss)

Autos Wheat 0 3 3 3 0 3

Product units comparison

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Measuring Trade Possibility

Trade Triangle(Home & Foreign)

US
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CANNADA
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Trade Triangle
Refers to Desirable trading(X,M)at a given common price Defined by the absolute value of the slope of the hypotenuse of the triangle

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Other variables
Wage rate: money price of labor factor differs,may change the prediction about trade. Non-tradables: reasons lie on
A multi-factor model that changes specialization Targeted distortion from industrial policies Transportation cost Natural quality
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Questions
Both Smith and Ricardo contended that the world trade pattern is determined solely by supply conditions. How will you explain? What has been assumed for the trade logic? What is meant by the term of Triangle? What makes you aware of the real reason why the nations trade with each other?
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Case Study
Forconn produced about 40% of the world total comcumer electronics .IM&EX amounted to 214.7m USD

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Worker in Foxcoon 300 hours a month Labor cost only ocupied 6% of total iPhone value chain of which 2.5% earned by China,the rest 3.5% profits going to other labor force Question:What is the comparative advantage of 27 Apple and Foxcoon?

Further Reading Suggestion

Adam Smith: The wealth of nations, pp644-645 Rudiger Dornbusch, Stanley Fisher, Paul Samuelson.Comparative advantage,Trade and payment in a Recardian model, AER, Dec.1977,pp823-839 Robert.Carbaugh,pp29-73
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Further Reading Suggestion

Bhagwati, J. and R. Hudec, eds. Fair Trade and Harmonization: Prerequisites for Free Trade? Cambridge, MA: MIT Press, 1997. Batra, R. The Myth of Free Trade. New York: Scribner, 1993. Bowen, H., et al. Applied International Trade Analysis. Ann Arbor, MI: The University of Michigan Press, 1998.

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Fuss, M., and L.Waverman, Costs and Productivity in Automobile Production. New York: Cambridge University Press, 1992. Ghosh, B. Gains from Global Linkages. New York: St. Martins, 1997. Lazonick, W. Competitive Advantage on the Shop Floor. Cambridge, MA: Harvard University Press, 1991.

2010-05-10

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