© Randall W. Stone, 2002 Review of International Trade Theory Commerce and Coalitions

© Randall W. Stone, 2002 Comparative Advantage 1. Comparative advantage –› trade 2. Gains from trade in an industry 3. Effects of a tariff

© Randall W. Stone, Comparative Advantage → → Trade Different productivity Different technology Different factor endowments Definition: Lower relative price (not necessarily absolute)

© Randall W. Stone, 2002 Comparative Advantage Technology : 1 K + 2 L = 1 Textile2 K + 1 L = 1 Iron Factor endowments : –Australia has 4 K and 2 L (2 iron or 1 tex) –Bulgaria has 2 K and 4 L (2 tex or 1 iron) Example: Common technology, different factor endowments:

© Randall W. Stone, 2002 Comparative advantage Iron Textiles A B W P A : Iron = 1/2 Textile P B : Iron = 2 Textile P World : 1 Iron = 1 Textile

© Randall W. Stone, 2002 Conclusions : Trade improves welfare because higher indifference curves become reachable Trade lowers price of Textiles in capital- rich country A, hurting laborers Trade lowers price of Iron in labor-rich country B, hurting capital owners Intuition: Scarcity → High price. Trade reduces scarcity

© Randall W. Stone, Gains from trade in an industry I mporting country (P D > P W ) Q P S D PDPD QDQD PWPW Q CW Q PW P D : Domestic price P W : World price

© Randall W. Stone, Gains from trade in an industry I mporting country (P D > P W ) Q P S D PDPD QDQD PWPW Q CW Q PW Value of imports

© Randall W. Stone, Gains from trade in an industry I mporting country (P D > P W ) Q P S D PDPD QDQD PWPW Q CW Q PW Consumer gains:Q D (P D - P W ) +1/2 (Q CW - Q D )(P D - P W ) Consumer gain

© Randall W. Stone, Gains from trade in an industry I mporting country (P D > P W ) Q P S D PDPD QDQD PWPW Q CW Q PW Producer loss:Q PW (P D - P W ) +1/2(Q D - Q PW )(P D - P W ) Welfare Gains > Losses Producer loss

© Randall W. Stone, Gains from trade in an industry Exporting country (P D < P W ) Q P S D PDPD QDQD PWPW Q PW Q CW Value of exports P D : Domestic price P W : World price

© Randall W. Stone, Gains from trade in an industry Exporting country (P D < P W ) Q P S D PDPD QDQD PWPW Q PW Q CW Producer gain:Q D (P W - P D ) +1/2(Q PW - Q D )(P W - P D ) Producer gains

© Randall W. Stone, Gains from trade in an industry Exporting country (P D < P W ) Q P S D PDPD QDQD PWPW Q PW Q CW Consumer loss:Q CW (P W - P D ) +1/2(Q D - Q CW )(P W - P D ) Consumer loss Welfare Gains > Losses

© Randall W. Stone, Gains from trade in an industry Conclusions:- Trade increases welfare - Winners and losers - Compensation? Importing country Exporting country P P QQ SD S D P l C g CgCg PgPg C l P g

© Randall W. Stone, Effects of a tariff Q P SD PDPD PWPW Q CW Q PW P D : Domestic price P W : World price Imports with no tariff PTPT P T : Price with tariff Q PT Q CT Imports with tariff

© Randall W. Stone, Effects of a tariff Q P SD PDPD PWPW Q CW Q PW Consumer loss: A + B + C + D Imports with no tariff PTPT Q PT Q CT Imports with tariff ABCD

© Randall W. Stone, Effects of a tariff Q P SD PDPD PWPW Q CW Q PW Imports with no tariff PTPT Q PT Q CT Imports with tariff Gains: Producer gains: A A Government gains: C C Welfare loss: BD B + D

© Randall W. Stone, 2002 Why not compensate the losers? Concentrated costs, diffuse benefits Incentives to defect Economic change shifts political power Bargaining Why bother?

© Randall W. Stone, 2002 Stolper-Samuelson Intuition: scarcity -> high price Factors of production that are more scarce domestically than globally have a higher price in the absence of trade Domestically abundant factors are more valuable if there is trade Domestic coalitions should depend on which factors are abundant

© Randall W. Stone, 2002 Trade and Cleavages Change occurs when: –Trade increases (transport costs decrease) –Relative factor endowments change (development: K increases) Land-Labor ratio Low K High K High (land)Low (land) (class conflict) (urban- rural) (urban- rural) (class conflict)