1. School of International Trade and Economics
国际贸易
Lectured by Yuanfen Tu
School of International Trade and Economics

2. International Economics By Robert J. Carbaugh 13th Edition
Chapter 2:
Foundations of Modern Trade Theory

3. Introduction Basis for trade Terms of trade
Why do nations export and import?
Terms of trade
Gains from international trade
Specific to production and consumption

4. Historical Development Of Modern Trade Theory
The Mercantilists（ ）
Concern: Regulation of domestic and international affairs to promote national interests
Solution: Strong foreign-trade sector
Favorable trade balance
Advocated government regulation of trade
Tariffs, quotas and other commercial polices were proposed

5. Historical Development
Continued
Criticism of Mercantilist policies
David Hume’s price-specie-flow doctrine
Favorable trade balance possible only in the short run; over time it would automatically be eliminated
Adam Smith’s “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 output

6. 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 cost
Such productivities are based on natural and acquired advantages.
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 requirements

7. Why Nations Trade? Principle of absolute advantage
Continued
Principle of absolute advantage
Only when one nation has an absolute cost of advantage in one good
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)

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9. Why Nations Trade? David Ricardo: Comparative advantage
Continued
David Ricardo: Comparative advantage
Mutually beneficial trade can occur whether or not countries have any absolute advantage.
Less efficient nation: Specialize in and export the good in which 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)

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11. Why Nations Trade? Assumptions of Ricardo’s model:
Continued
Assumptions of Ricardo’s 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 between 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 used

12. Why Nations Trade? Assumptions of Ricardo’s model (cont.):
Continued
Assumptions of Ricardo’s model (cont.):
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 nations
Comparative-advantage principle (Table 2.3)

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14. Production Possibilities Schedules
Used to explain comparative advantage
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 possibilities schedules for the U.S and Canada: (Figure 2.1)

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16. Trading Under Constant-Cost Conditions
Principle of comparative advantage under 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 quality

17. Trading Under Constant-Cost Conditions
Continued
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 States
2 bushels of wheat for Canada
Direction of trade
United States specializing in and exporting autos
Canada specializing in and exporting wheat

18. Trading Under Constant-Cost Conditions
Continued
Production gains from specialization
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)

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20. Trading Under Constant-Cost Conditions
Continued
Consumption gains from trade (Figure 2.1)
Specialization and trade
Achieve consumption points outside domestic production possibilities schedules
Terms of trade: Rate at which its export product is traded for the other country’s export product
Determines the set of post-trade 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 countries

21. Trading Under Constant-Cost Conditions
Continued
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 (along 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)

22. Trading Under Constant-Cost Conditions
Comparative advantage
Trading Under Constant-Cost Conditions
Complete specialization
Both countries’ unit production costs remain constant, which leads to complete specialization.
Exception: One of the countries is too small to supply the other with all of its needs

23. Trading Under Constant-Cost Conditions
Continued
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 better than or equal to the rate defined by domestic price line
Region of mutually beneficial trade is bounded by cost ratios

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25. Trading Under Constant-Cost Conditions
Continued
Equilibrium terms of trade
Mill’s 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 country’s demand for the other country’s product (Figure 2.2)
Importance of being unimportant
Larger nation attains fewer gains from trade while the smaller nation attains most of the gains

26. Terms-of-trade estimates
International equilibrium
Terms-of-trade estimates
Commodity terms of trade (barter terms 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)

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28. Dynamic Gains from Trade
Dynamic gains from international trade
Effect of trade on country’s growth rate and volume of additional resources made available to, or utilized by, trading country
Dwarf static gains from trade

29. Dynamic Gains from Trade
Dynamic gains from international trade include:
More efficient use of an economy’s resources
Higher output and income
More saving, more investment
Higher rate of economic growth
Higher productivity
Economies of large-scale production
Increased competition

30. Global Competition Productivity gains for US Iron Ore workers
Increased competitive pressure on U.S. iron ore producers in the 1980s
Workers agreed to changes in work rules that enhanced labor productivity

31. Changing Comparative Advantage
Comparative advantage can vanish if productivity growth lags
Production possibilities schedules, for computers and automobiles, of the U.S. and Japan under constant opportunity cost (Figure 2.3)
Pressure on producers to reinvent themselves
Case: Semiconductor industry in the U.S.

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33. Trading Under Increasing-Cost Conditions
Increasing opportunity costs
Concave production possibilities schedule
Bowed outward from the diagram’s origin
Inputs are imperfect substitutes for one another
Principle of diminishing marginal productivity（边际生产力递减）
MRT rises along slope of production possibilities schedule

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35. Increasing-Cost Trading Case
Process of specialization continues in both nations (Figure 2.5) until:
The relative cost of autos is identical in both nations
U.S. exports of autos precisely equal Canada’s imports of autos, and conversely for wheat
Production gains from specialization (Figure 2.6a)
Consumption gains from trade (Figure 2.6b)

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38. Partial Specialization
Reason for partial specialization
Increasing costs constitute a mechanism that forces costs in two trading nations to converge
Unit costs rise as both nations produce more of their commodities.
When cost differentials are eliminated, the basis for further specialization ceases to exist
Highly probable that both nations will produce some of each good

39. Impact of Trade on Jobs Standard 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 employment

40. Impact of Trade on Jobs Principle of comparative advantage
Continued
Principle 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)

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42. Comparative Advantage Extended to Many Products
More than two products
Rank goods by degree of comparative cost (Example: Figure 2.7)
Each country exports the product(s) in which it has the greatest comparative advantage
Each country 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 products

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44. 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 trading 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 productivity

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46. Exit Barriers In an open trading system
Resources channeled from low productivity to high productivity uses
Competition forces high cost plants to exit, leaving low cost plants to operate in long run
Exit barriers hinder market adjustments that would occur through comparative advantage

47. Exit Barriers (2 of 2) Exit barriers in U.S. steel industry caused by:
Relatively fixed cost of union-negotiated wages & benefits
Antiquated plants with no other use; contract termination fines; environmental problems
Exit barriers associated with:
Overcapacity (caused by imports, reduced demand, productivity-improving technology)

48. Empirical Evidence on Comparative Advantage
Empirical support for Ricardo’s theory
British economist G.D.A. MacDougall (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) and trade (Figure 2.9)

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50. Empirical Evidence on Comparative Advantage
Continued
Ricardo’s theory: Limitations
Labor is not the only factor input
Allowance should be made for production and distribution costs where appropriate
Differences in product quality also explain trade patterns in certain industries

51. Does Comparative Advantage Apply in the Face of Job Outsourcing
Ricardian theory assumes production cannot move to other nations
Today, labor, technology, capital, ideas all shift around globe
Today, many goods supplied by global supply chains, international production networks that allow firms to move goods and services efficiently across national borders

52. Does Comparative Advantage Apply in the Face of Job Outsourcing
Movement 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 capital
American workers will encounter direct world competition at almost every job category

53. Advantages of Outsourcing
Reduced costs and increased competitiveness
Creation of new export requirements
Repatriated （寄钱回国）earnings
Other contentions（争论）:
U.S. companies will become less competitive if they cannot outsource jobs
This will weaken the economy and threaten more jobs
Job losses tend to be temporary
Creation of new industries and products leading to more lucrative jobs for Americans

54. Outsourcing and the U.S. Automobile Industry
Ford Motor Company
Early days: Assembly line
Emergence of competition and increased sophistication requirements
Number of tasks outgrew number of operations in a plant
Outsourcing of non-core tasks
External suppliers contribute about 70 percent of a Ford vehicle
Reduction in costs and improvement in quality

55. Burdens of Outsourcing
Loss of jobs
Declining demand for low-skilled American workers
Shift of demand for high-skilled workers to cheaper substitutes in Asia
Risks to wages
Declining wages of low-skilled workers both in real terms and relative to the wages of skilled workers
Measures to lessen the adverse effects of people suffering job losses