1. Trade patterns and their evolution © 2015 Melvin Jameson

2. Reasons to study international trade: To better understand the international economic environment including: the dynamics by which it changes, and its impact on the politics of trade policy, and thus the political/regulatory environment. To help identify international business opportunities and to understand why they exist. © 2015 Melvin Jameson

3. 1. What drives trade? When is Trade is Profitable? © 2015 Melvin Jameson Trade results from international differences in supply and demand.

4. U.S. In Isolation Supply and Demand © 2015 Melvin Jameson SupplyDemandprice 535$2,000 634$2,050 733$2,100 832$2,150 931$2,200 1030$2,250 1129$2,300 1228$2,350 1327$2,400 1426$2,450 1525$2,500 1624$2,550 1723$2,600 1822$2,650 1921$2,700 20 $2,750 2119$2,800 2218$2,850 2317$2,900 2416$2,950 2515$3,000

5. U.S. In Isolation Supply and Demand © 2015 Melvin Jameson SupplyDemandprice 535$2,000 634$2,050 733$2,100 832$2,150 931$2,200 1030$2,250 1129$2,300 1228$2,350 1327$2,400 1426$2,450 1525$2,500 1624$2,550 1723$2,600 1822$2,650 1921$2,700 20 $2,750 2119$2,800 2218$2,850 2317$2,900 2416$2,950 2515$3,000

6. Rest-of-the-World In Isolation © 2015 Melvin Jameson priceSupplyDemand $2,000180220 $2,050184216 $2,100188212 $2,150192208 $2,200196204 $2,250200 $2,300204196 $2,350208192 $2,400212188 $2,450216184 $2,500220180 $2,550224176 $2,600228172 $2,650232168 $2,700236164 $2,750240160 $2,800244156 $2,850248152 $2,900252148 $2,950256144 $3,000260140

7. If prices differ when markets are isolated, trade is will occur when it becomes possible. It will continue until the price difference (less any trading costs) is eliminated. To understand why trade occurs, we must ask why prices would differ without it. © 2015 Melvin Jameson

8. Results of unimpeded trade © 2015 Melvin Jameson U.S. rest of the world ImportSupplyDemandpriceSupplyDemandExport 30535$2,000180220-40 28634$2,050184216-32 26733$2,100188212-24 24832$2,150192208-16 22931$2,200196204-8 201030$2,250200 0Autarky; world 181129$2,3002041968 Free trade161228$2,35020819216Free trade 141327$2,40021218824 121426$2,45021618432 101525$2,50022018040 81624$2,55022417648 61723$2,60022817256 41822$2,65023216864 21921$2,70023616472 Autarky U.S.020 $2,75024016080 -22119$2,80024415688 -42218$2,85024815296 -62317$2,900252148104 -82416$2,950256144112 -102515$3,000260140120 Desired export = Desired import U.S. price = world price

9. Costly trade: $250/unit transportation © 2015 Melvin Jameson U.S. rest of the world ImportSupplyDemandpriceSupplyDemandExport 30535$2,000180220-40 28634$2,050184216-32 26733$2,100188212-24 24832$2,150192208-16 22931$2,200196204-8 201030$2,250200 0Autarky; world 181129$2,3002041968Costly trade Free trade161228$2,35020819216Free trade 141327$2,40021218824 121426$2,45021618432 101525$2,50022018040 Costly trade81624$2,55022417648 61723$2,60022817256 41822$2,65023216864 21921$2,70023616472 Autarky U.S.020 $2,75024016080 -22119$2,80024415688 -42218$2,85024815296 -62317$2,900252148104 -82416$2,950256144112 -102515$3,000260140120 Desired export = Desired import U.S. price (importer) = world price + trade cost

10. Results of trade: Traded Goods Prices of traded goods converge worldwide. Production is reallocated internationally Because of the differences between countries, reallocating production to increase specialization increases total world output. A net welfare improvement results. © 2015 Melvin Jameson

11. 2. Which prices matter? © 2015 Melvin Jameson Relative prices – that is price relative to other traded goods Absolute vs. comparative advantage in production costs

12. Absolute Advantage (Adam Smith) A country will export those products it can produce more efficiently than anyone else. © 2015 Melvin Jameson

13. Example: absolute advantage Output per hour of labor BeefCloth United States50 lbs./hour20 yards/hour United Kingdom25 lbs/hour40 yards/hour © 2015 Melvin Jameson

14. Absolute Advantage In this example: US is more efficient at producing beef 50 lbs./hr. Vs. 25 lbs./hr. UK is more efficient at producing cloth 40 yards/hr. vs. 20 yards/hr. therefore: US will export beef(import cloth) UK will export cloth (import beef) © 2015 Melvin Jameson

15. Absolute Advantage Problem: What if one country has an absolute advantage at both products? Does this mean the other should do nothing? Comparative advantage: A country exports the products it produces with greatest relative efficiency. © 2015 Melvin Jameson

16. Comparative Advantage The key is not factor productivity © 2015 Melvin Jameson But marginal rate of transformation

17. Example: Comparative advantage Output per hour of labor BeefCloth United States50 lbs./hour40 yards/hour United Kingdom25 lbs/hour30 yards/hour © 2015 Melvin Jameson Thus cloth is cheaper in the UK (0.83 lbs. vs. 1.25 lbs.)

18. Comparative advantage With frictionless markets, the MRT can be expressed as a price ratio. © 2015 Melvin Jameson Thus cloth is cheaper in the UK (0.83 lbs. vs. 1.25 lbs.)

19. MRT = tradeoff between two products Product price = tradeoff between product and “all-other- goods” i.e. relative efficiency (location of supply curve.) What leads countries to differ wrt relative efficiency of production? © 2015 Melvin Jameson

20. Some Examples of Comparative Advantage Country Canada Jamaica Mexico Saudi Arabia Japan South Korea Nevada Product Lumber Aluminum ore Tomatoes Oil Automobiles Steel, ships ?? © 2015 Melvin Jameson

21. Discussion: Nevada’s exports Nevada’s comparative advantages © 2015 Melvin Jameson United States Census Bureau: International Trade Data

22. Export support in Las Vegas © 2015 Melvin Jameson http://www.trade.gov/cs/services.asp

23. 3. Why do local prices differ? or Why does specialization in production occur? © 2015 Melvin Jameson

24. Sources of Comparative Advantage What gives each of these countries its particular comparative advantage? What kinds of differences can lead to greater relative efficiency in particular products? © 2015 Melvin Jameson

25. Models of Trade Model Classical Comparative Advantage Factor Proportions Heckscher-Ohlin Technology-based models (product life-cycle model) Difference Natural Resource endowments Factor endowments (capital/labor ratio) Human capital: skilled (educated) vs unskilled labor © 2015 Melvin Jameson

26. Models of Trade (continued) Model Intra-Industry Trade seasonal transportation costs product differentiation Economies of Scale (Krugman) internal external Difference seasonal productivity location © 2015 Melvin Jameson

27. Economies of Scale Internal EOS (increasing returns to scale) Producing on a very large scale lowers average costs The low-cost product can be exported Even absent comparative-advantage differences External EOS (Clusters) All firms in a region (cluster) enjoy lower average cost due to a concentration of specialized resources Large pool of workers with specialized human capital Specialized inputs/subcontractors Shared information and knowledge Similar average cost reduction given scale of the region © 2015 Melvin Jameson

28. Intra-industry trade: Simultaneous import and export of what appears to be the same product Possible explanations product differentiation seasonal differences transportation costs © 2015 Melvin Jameson

29. Technology: The Product Cycle Product life-cycle 1. Newly introduced product is highly innovative- Highly educated human resources are required. 2. Manufacture becomes standardized – a skilled work force is required. 3. The product becomes commoditized – low-cost labor is well-suited to production. Comparative advantage changes over the life-cycle of the product. © 2015 Melvin Jameson

30. Product life-cycle examples: Radio, TV manufacture: U.S. and Japan computer manufacture: U.S. – Taiwan – China © 2015 Melvin Jameson

31. Trade: Examples and Applications 1. Comparative advantage based on natural resource endowment: - Example: Saudi oil 2. Factor endowments - relative amounts of capital & labor Manufacturing in China © 2015 Melvin Jameson

32. Discussion: Manufacturing in China © 2015 Melvin Jameson

33. Discussion: China Factor endowments and trade Compare US and China on availability of Labor vs. capital Unskilled vs. skilled labor Factor endowment theory predicts a country exports products that use intensively those factors with which it is well endowed. © 2015 Melvin Jameson

34. Discussion: China China exports to the United States Apparel, footwear, toys, and the final assembly of electronic machinery and equipment Products intensive in unskilled labor United States exports to China Aircraft, software, pharmaceuticals, and high-tech components of electrical machinery and equipment Products intensive in skilled labor and technology © 2015 Melvin Jameson

35. Discussion: China Manufacture, especially of unskilled labor intensive products, migrated to China. Consider the impact on World output of manufactured goods Demand for raw materials (commodities) Price of manufactured products in the US Wages in China © 2015 Melvin Jameson

36. 4. Further results of trade: Non-traded goods © 2015 Melvin Jameson

37. Factor-Price Equalization Trade leads to increased demand for the cheap (abundant; comparative advantage creating) factor its price rises decreased demand for the expensive (scarce; comparative disadvantage creating) factor its price falls © 2015 Melvin Jameson

38. Results of trade: Non-traded goods Prices of traded goods converge worldwide. Factor prices converge (“factor price equalization”) Prices of non-traded substitutes for traded goods converge. © 2015 Melvin Jameson

39. Discussion: China (continued) Trends in Chinese wages and manufacturing Impact on world trade patterns Background reading: © 2015 Melvin Jameson The Economist Intelligence Unit: Report on trends in Chinese workforce August 26, 2014 “China Hand: More with less” “Why You May Soon See More Goods Labeled ‘Made in Vietnam’” WSJ October 19, 2015 p. B1 Link Link or see separate pdf

40. Limits to Factor-Price Equalization Transportation costs and other barriers limit the amount of trade. Real factor productivity varies due to international differences in capital stock, technology, education, legal and economic institutions etc. © 2015 Melvin Jameson

41. Dynamics of comparative advantage Some sources of comparative advantage are long lasting favorable climate vast oil reserves Others are more transient low-cost labor © 2015 Melvin Jameson