1. International Economics Eleventh Edition
CHAPTER T H R E E 3
International Economics Eleventh Edition
The Standard Theory
Of International Trade
Dominick Salvatore
John Wiley & Sons, Inc.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

2. Learning Goals:
Understand how relative commodity prices and the comparative advantage of nations are determined under increasing costs.
Show the basis and the gains from trade under increasing costs.
Explain the relationship between international trade and deindustrialization in the U.S. and other advanced nations.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

3. The Production Frontier with Increasing Costs
Increasing Opportunity Costs
A nation must give up more and more of one commodity to release just enough resources to produce each additional unit of another commodity.
Increasing cost production possibilities frontier is concave to the origin (not a straight line).
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

4. FIGURE 3-1 Production Frontiers of Nation 1 and Nation 2 with Increasing Costs.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

5. The Production Frontier with Increasing Costs
The marginal rate of transformation (MRT) increases as more units of good X are produced.
The marginal rate of transformation is another name for opportunity cost.
The value of MRT is given by the slope of the PPF.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

6. Community Indifference Curves
A community indifference curve shows combinations of two commodities that yield equal satisfaction to the community or nation.
Represent measure of taste and preference.
Characteristics of community indifference curves:
The higher the curve, the greater the utility.
Negative slope, convex to the origin.
Different curves do not cross.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

7. FIGURE 3-2 Community Indifference Curves for Nation 1 and Nation 2.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

8. Community Indifference Curves
The marginal rate of substitution (MRS) falls as more of good X is consumed.
The MRS of X for Y in consumption is the amount of Y that a nation could give up for one extra unit of X and still remain on the same indifference curve.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

9. Equilibrium in Isolation
Interaction of forces of demand (community indifference curves) and supply (production possibilities frontier) determine equilibrium for a nation in the absence of trade (autarky).
Nations seek the highest possible indifference curve, given the production constraint.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

10. FIGURE 3-3 Equilibrium in Isolation.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

11. Equilibrium in Isolation
The equilibrium-relative commodity price in isolation = slope of tangency between PPF and indifference curve at autarky point of production and consumption.
Relative prices are different in Nation 1 and Nation 2 because of different shape and location of PPF’s and indifference curves.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

12. Basis for and Gains from Trade with Increasing Costs
Relative commodity price differentials between two nations reflect comparative advantages, and form basis for mutually beneficial trade.
Each nation should specialize in the commodity they can produce at the lowest relative price.
Specialization will continue until relative prices equalize between nations.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

13. FIGURE 3-4 The Gains from Trade with Increasing Costs.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

14. Basis for and Gains from Trade with Increasing Costs
Equilibrium-relative commodity price with trade = common relative price at which trade is balanced.
Balanced trade: quantity of X (Y) Nation 1(2) wants to export = quantity of X(Y) Nation 2(1) wants to import.
Any other relative price could not persist because trade would be unbalanced.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

15. Basis for and Gains from Trade with Increasing Costs
Under constant cost conditions, specialization is complete.
Under increasing cost conditions, specialization is incomplete:
As production moves along PPF toward comparative advantage good, relative costs change, thus changing basis and gains from trade.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

16. FIGURE 3-5 The Gains from Exchange and from Specialization.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

17. Trade Based on Differences in Taste
Even if two nations have identical PPFs, basis for mutually beneficial trade will still exist if tastes, or demand preferences, differ.
Nation with relatively smaller demand for X will have a lower autarky relative price for, and comparative advantage, in X.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

18. FIGURE 3-6 Trade Based on Differences in Tastes.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

19. Case Study 3-1 Comparative Advantage of the Largest Advanced and Emerging Economies
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

20. Case Study 3-2 Specialization and Export Concentration in Selected Countries
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

21. Case Study 3-3 Job Losses in High Import-Competing Industries
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

22. Case Study 3-4 International Trade and Deindustrialization in the United States, the European Union, and Japan
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

23. Appendix to Chapter 3
Production Functions, Isoquants, Isocosts and Equilibrium
Production Theory with Two Nations, Two Commodities, and Two Factors
The Edgeworth Box and Production Frontiers
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

24. FIGURE 3-7 Isoquants, Isocosts, and Equilibrium.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

25. FIGURE 3-8 Production with Two Nations, Two Commodities, and Two Factors.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

26. FIGURE 3-9 Derivation of the Edgeworth Box Diagram and Production Frontier for Nation 1.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

27. FIGURE 3-10 Derivation of the Edgeworth Box Diagram and Production Frontier for Nation 2.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

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Need to add tables from the 4 cases studies.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.