1. NS3040 Fall Term 2018 Trade Theories
Federal Reserve Bank of Chicago, Strong Dollar Weak Dollar

2. Comparative Advantage
The main theory of trade is comparative advantage
The idea that with different shaped production possibility curves, each country can transform resources into particular products at lower cost than other countries
Example:
wheat cloth
United States
England or
United States
England
The US must give up 36 units of wheat to produce 60 of cloth while UK only gives up 24 HOWEVER
England must give up 60 of cloth to produce 24 of wheat while US produces 36 of wheat with the same 60 of cloth

3. Heckscher-Ohlin Theory I
Basically the same idea as comparative advantage but easier to generalize:
Countries have comparative advantage in those products that use in their production relatively large amounts of the resources the country has in abundance
Example – Because of abundance of land, U.S. has a comparative advantage in wheat while Japan does not
Countries have a comparative disadvantage in those products that use relatively large amounts of the resources that country has shortages of.
Example the U.S. has a comparative disadvantage in textiles that use a lot of semi-skilled workers, while Indonesia has an advantage in textiles.
Free Trade will lead to factor price equalization

4. Heckscher-Ohlin Theory II

5. Example of Comparative Advantage

6. Comparative Advantage Steel

7. Comparative Advantage Wheat

8. Trade: Complete Picture

9. Problem With Immoble Resources

10. Leontief Paradox
When Heckscher-Ohlin first tested in 1947 by Harvard economist W. Leontief he discovered:
The U.S. exported labor intensive products and imported capital intensive
Explanations –
Measurement problems – capital inputs hard to measure precisely
Goods might be produced by different factor combinations in different countries. A U.S. capital intensive good, might be produced with much more labor in India
Data to aggregative – just man-hours and amounts of capital used. If introduce idea of human capital then paradox solved – US invests relatively large amounts in humans and this is a form of capital – an area the U.S. has traditionally had relatively large amounts.
Shortcomings of H-O Theory led to development of a variant approach -- comparative labor costs
Labor costs function of productivity of worker and the wage

11. Comparative Labor Costs
U.S. /UK Productivity Differential

12. Recent Patterns of Productivity

13. Other Variants of Comparative Advantage
Theory of Overlapping Demand
H-O emphasized supply side. Need demand considerations
Countries of similar levels of income will trade more with each other because of similar tastes and purchashing power
Explains why U.S. trades more with Canada than Mexico
Product Cycle Theory
Products go through various stages in their lives
New product – science, engineering important inputs
Mature product – management, finance important inputs
Standardized product – low wage semi-skilled assembly workers important input
Idea comparative advantage will shift from country to country depending on their factory endowments
Flying- Geese Patterns in East Asia
Transport Costs U.S retains some industries due to high-transport costs from foreign markets.

14. Linder Theory of Overlapping Demands

15. Product Cycle Phases

16. Product Life-Cycle Theory

17. Gravity Models and Brexit I
“Down to Earth,” Economist, October 1, 2016
U.K. planning new trade deals outside of Europe to replace EU trade when England leaves the EU
Might seem like a smart move
EU’s economy weak and demand for British exports has been depressed for years
Britain’s membership in EU had prevented it from making trade deals with fast growing economies like China and India
However likely that turning away from EU will only restrict U.K. trade

18. Gravity Models and Brexit II
Gravity model of trade will likely control U.K. trade patterns. The model states that
1. The bigger the GDP of the countries involved in a bilateral trading relationship, the more likely they will trade with each other
Larger economies have more demand for goods and services and
They offer more products supplying a broader range of consumers
2. The further away two countries are from each other the smaller the volume of trade
Partially related to transport costs
Cultural and linguistic differences also a factor