1、Copyright 2007 South-Western, a division of Thomson Learning. All rights reserved. Chapter 2Foundations of ModernTrade Theory: Comparative AdvantageCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. Introduction Basis for trade Why do nations export and import? Terms
2、of trade Gains from international trade Specific to production and consumptionCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. Modern Trade Theory Historical Development The Mercantilists Concern: Regulation of domestic and international affairs to promote national
3、interests Solution: Strong foreign-trade sector Favorable trade balance Advocated government regulation of tradeCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. Historical Development Criticism of Mercantilist policies David Humes price-specie-flow doctrine Favorabl
4、e trade balance possible only in the short run; over time it would automatically be eliminated Adam Smiths “The Wealth of Nations” Challenged the static view of wealth Dynamic view International trade increases the level of productivity within a country, which in turn increases world outputContinued
5、Copyright 2007 South-Western, a division of Thomson Learning. All rights reserved. Why Nations Trade?Absolute Advantage Adam Smith Free trade and international division of labor Cost differences govern movement of goods Productivities of factor inputs represent the major determinant of production co
6、st Determination of competitiveness from the supply side of the market Concept of cost: Labor theory of value Labor is the only factor of production and is homogeneous Cost depends on labor requirementsCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. Why Nations Tra
7、de? Principle of absolute advantage Import goods in which a nation has an absolute cost disadvantage Export those goods in which it has an absolute cost advantage (Example: Table 2.1)ContinuedCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. BackCopyright 2007 South-
8、Western, a division of Thomson Learning. All rights reserved. Why Nations Trade? David Ricardo: Comparative advantage Mutually beneficial trade can occur even when one nation is absolutely more efficient in the production of all goods Less efficient nation: Specialize in and export the good in which
9、 it is relatively less inefficient More efficient nation: Specialize in and export that good in which it is relatively more efficient Examples of comparative advantages (Table 2.2)ContinuedCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. BackCopyright 2007 South-Wes
10、tern, a division of Thomson Learning. All rights reserved. Why Nations Trade? Assumptions of Ricardos model: World consists of two nations, each using a single input to produce two commodities Labor is the only input Labor can move freely among industries within a nation but is incapable of moving b
11、etween nations Level of technology is fixed for both nations Costs do not vary with level of production and are proportional to the amount of labor usedContinuedCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. Why Nations Trade? Assumptions of Ricardos model (cont.)
12、: Perfect competition prevails in all markets Free trade occurs between nations Transportation costs are zero Firms make production decisions to maximize profits; consumers maximize satisfaction through consumption decisions There is no money illusion Trade is balanced, no flows of money between nat
13、ions Comparative-advantage principle (Table 2.3)ContinuedCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. BackCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. Production Possibilities Schedules Used to explain comparative advantage
14、Shows production combinations of two goods when all factor inputs are used most efficiently Illustrates the maximum output possibilities Marginal rate of transformation (MRT) Amount of one product a nation must sacrifice to get one additional unit of the other product Hypothetical production possibi
15、lities schedules for the U.S and Canada: (Figure 2.1) Copyright 2007 South-Western, a division of Thomson Learning. All rights reserved. BackCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. Trading Under Constant-Cost Conditions Principle of comparative advantage un
16、der constant opportunity costs Basis for trade and direction of trade Gains from trade Two reasons for constant costs: Factors of production are perfect substitutes for each other All units of a given factor are of the same qualityCopyright 2007 South-Western, a division of Thomson Learning. All rig
17、hts reserved. Trading Under Constant-Cost Conditions Basis for trade and direction of trade Relative costs (Figure 2.1) Point A U.S: 40 autos and 40 bushels of wheat Point Al Canada: 40 autos and 80 bushels of wheat Relative cost of producing an additional auto 0.5 bushels of wheat for the United St
18、ates 2 bushels of wheat for Canada Direction of trade United States specializing in and exporting autos Canada specializing in and exporting wheatContinuedCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. Trading Under Constant-Cost Conditions Production gains from s
19、pecialization Refer (Figure 2.1) United States moves from production point A to B, totally specializing in auto production Canada totally specializes in wheat production by moving from Al to Bl Summary of production gains (Table 2.4a)ContinuedCopyright 2007 South-Western, a division of Thomson Learn
20、ing. All rights reserved. BackCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. Trading Under Constant-Cost Conditions Consumption gains from trade (Figure 2.1) Specialization and trade Achieve consumption points outside domestic production possibilities schedules Te
21、rms of trade: Rate at which its export product is traded for the other countrys export product Determines the set of posttrade consumption points Defines the relative prices at which two products are traded Trading possibilities line: Line tt represents the international terms of trade for both coun
22、triesContinuedCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. Trading Under Constant-Cost Conditions Consumption gains from trade (Figure 2.1) Trade triangle: The triangle BCD (Bl Cl Dl for Canada) showing the U.S. Exports (along the horizontal axis), Imports (alon
23、g the vertical axis), and Terms of trade (the slope) Consumption gains from trade for each country and the world as a whole (Table 2.4b) Complete specialization Exception: One of the countries is too small to supply the other with all of its needsContinuedCopyright 2007 South-Western, a division of
24、Thomson Learning. All rights reserved. Trading Under Constant-Cost Conditions Distributing the gains from trade Domestic cost conditions (Figure 2.2) Domestic cost ratios set the outer equilibrium terms of trade Domestic cost-ratio line: The no-trade boundary International terms of trade has to be b
25、etter than or equal to the rate defined by domestic price line Region of mutually beneficial trade is bounded by cost ratiosContinuedCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. BackCopyright 2007 South-Western, a division of Thomson Learning. All rights reserve
26、d. Trading Under Constant-Cost Conditions Equilibrium terms of trade Mills theory of reciprocal demand Within the outer limits of the terms of trade, the actual terms of trade is determined by the relative strength of each countrys demand for the other countrys product (Figure 2.2) Importance of bei
27、ng unimportant Larger nation attains fewer gains from trade while the smaller nation attains most of the gainsContinuedCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. Trading Under Constant-Cost Conditions Terms-of-trade estimates Commodity terms of trade (barter t
28、erms of trade) Improvement: Rise in export prices relative to import prices over a time period Deterioration: Rise in import prices relative to export prices over a time period Commodity terms of trade for selected countries (Table 2.5)ContinuedCopyright 2007 South-Western, a division of Thomson Lea
29、rning. All rights reserved. BackCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. Dynamic Gains from Trade Effect of trade on growth rate and thus on the volume of additional resources Higher output and income resulting in savings and consequent investments Better su
30、pplier match for imports Economies of large-scale production Increased competition Impact on productivity, quality, and pricesCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. Global Competition Productivity gains for US Iron Ore workers Increased competitive pressur
31、e on U.S. iron ore producers in the 1980s Workers agreed to changes in work rules that enhanced labor productivityCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. Changing Comparative Advantage Comparative advantage can vanish if productivity growth lags Pressure on
32、 producers to reinvent themselves Case: Semiconductor industry in the U.S. Production possibilities schedules, for computers and automobiles, of the U.S. and Japan under constant opportunity cost (Figure 2.3) Copyright 2007 South-Western, a division of Thomson Learning. All rights reserved. BackCopy
33、right 2007 South-Western, a division of Thomson Learning. All rights reserved. Trading Under Increasing-Cost Conditions Increasing opportunity costs Concave production possibilities schedule (Figure 2.4) Principle of diminishing marginal productivity Supply factors as well as demand factors have to
34、be consideredCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. BackCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. Increasing-Cost Trading Case Process of specialization continues in both nations (Figure 2.5) until: The relative cos
35、t of autos is identical in both nations U.S. exports of autos precisely equal Canadas imports of autos, and conversely for wheat Production gains from specialization (Figure 2.6a) Consumption gains from trade (Figure 2.6b) Copyright 2007 South-Western, a division of Thomson Learning. All rights rese
36、rved. BackCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. BackCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. Partial Specialization Reason for partial specialization Increasing costs constitute a mechanism that forces costs in tw
37、o trading nations to converge When cost differentials are eliminated, the basis for further specialization ceases to exist Highly probable that both nations will produce some of each goodCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. Impact of Trade on Jobs Standa
38、rd trade theory Extent to which an economy is open: Influences the mix of jobs Can cause dislocation in certain areas or industries Has little effect on the overall level of employmentCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. Impact of Trade on Jobs Principle
39、 of comparative advantage Trade influences the mix of jobs Shifting of workers and capital to more productive industries Data suggests little impact on the overall number of jobs (Figure 2.6)ContinuedCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. BackCopyright 200
40、7 South-Western, a division of Thomson Learning. All rights reserved. Comparative Advantage Extended to Many Products More than two products Rank goods by degree of comparative cost (Example: Figure 6.7) Each country exports the product(s) in which it has the greatest comparative advantage Each coun
41、try imports the product(s) in which it has greatest comparative disadvantage Cutoff point between exports and imports Depends on the relative strength of international demand for the various productsCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. BackCopyright 2007
42、 South-Western, a division of Thomson Learning. All rights reserved. Comparative Advantage Extended to Many Countries More than two Countries Advantageous for a country to enter into multilateral trading relationships (Figure 2.8) Surpluses with trading partners that buy its exports Deficits with tr
43、ading partners that supply low-cost items imported Bilateral agreements that balance exports and imports would: Reduce volume of trade and specialization Hinder movement of resources to their highest productivityCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. BackC
44、opyright 2007 South-Western, a division of Thomson Learning. All rights reserved. Exit Barriers Exit barriers hinder the necessary market adjustments Various cost conditions make lengthy exit a rational response Case: U.S. steel industry Nature of labor costs and benefits Penalties for terminating c
45、ontracts Expenses associated with writing off assets Environmental costs Low realization on sale of assetsCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. Empirical Evidence on Comparative Advantage Empirical support for Ricardos theory British economist G.D.A. MacD
46、ougall (1951) Tested the prediction that nations export goods in which their labor productivity is relatively high 20 of 25 industries fit the predicted pattern Studies by Balassa and Stern Stephen Golub Examined the relationship between relative unit labor costs (the ratio of wages to productivity)
47、 and trade (Figure 2.9)Copyright 2007 South-Western, a division of Thomson Learning. All rights reserved. BackCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. Empirical Evidence on Comparative Advantage Ricardos theory: Limitations Labor is not the only factor input
48、 Allowance should be made for production and distribution costs where appropriate Differences in product quality also explain trade patterns in certain industriesContinuedCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. Comparative Advantage: Job Outsourcing Movemen
49、t of factors of production around the globe Weakens comparative advantage Developments that caused major changes: Strong educational systems produce skilled workers in developing nations, who work at lower cost Internet technology New political stability that permits free movement of technology and
50、capital American workers will encounter direct world competition at almost every job categoryCopyright 2007 South-Western, a division of Thomson Learning. All rights reserved. Advantages of Outsourcing Reduced costs and increased competitiveness Creation of new export requirements Repatriated earnin
