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Trade model extensions and applications


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this slide explain about Trade model extensions and applications. this topic taken from international economics book by Robert J. Carbaugh.

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Trade model extensions and applications

  1. 1. International Economics By Robert J. Carbaugh 8th Edition Chapter 4: Trade Model Extensions and Applications
  2. 2. Factor endowment theory (Heckscher-Ohlin) Comparative advantage is explained entirely by different national supply conditions, especially resource endowments Nations export products that use inputs which are relatively abundant (cheap) at home, and import products which need inputs which are relatively scarce (expensive) at home Why relative price differentials?
  3. 3. Factor endowment theory: assumptions Nations all have the same tastes and preferences (same indifference curves) They use factor inputs which are of uniform quality They all use the same technology Why relative price differentials?
  4. 4. Comparative advantage according to factor endowment theory Factor endowment model Autarky equilibrium
  5. 5. Comparative advantage according to factor endowment theory Factor endowment model Post-trade equilibrium
  6. 6. Factor endowment theory: implications Factor price equalization  The shift within each nation towards use of cheaper factors, and away from expensive ones, leads to more equal factor prices Distribution of income  Trade changes domestic distribution of income as demand for different factors changes Factor endowment model
  7. 7. Economies of scale & specialization Economies of scale provide incentives for specialization, since per unit costs go down as production increases Trade provides a larger potential market for products, making higher production levels possible Bringing theory closer to reality
  8. 8. Economies of scale as basis for trade Economies of scale
  9. 9. Trade & specialization under decreasing costs Economies of scale
  10. 10. Other extensions of the theory Overlapping demands  Factor endowment theory has considerable explanatory power for trade in primary products and agricultural goods.  The main force influencing manufactured-good trade is domestic demand conditions.  Firms’ incentive is large market  foreign buyers have similar taste  firms begin to export. Taste = f(Y)  High income country will demand high quality manufactured goods, nation with low per capita incomes demand lower-quality goods Rich country will likely trade with other rich countries, poor countries will trade with other poor countries. overlapping demand  Could not rule out all trade in manufactured goods between rich and poor countries. Bringing theory closer to reality
  11. 11. Other extensions of the theory (cont.) Intra-industry trade  Involves two ways trade in a similar commodity  Could be intensively found in advanced nations  with similar resource endowments. Ex: Us exports IBM computers and imports Hitachi computers from Japan  Involves flows of goods with similar factor requirements. Firms that produce these goods tend to be oligopolies  Includes trade in homogenous as well as differentiated products  Reason for intra-industry trade in homogenous goods:  Transportation costs  Seasonal factor & differentiation in time  Reason for intra-industry trade in differentiated products:  Taste. Domestic firms supply majority taste and nation imports to fulfill minority taste  Overlapping demand  similar taste  Economies of scale  focusing on a few variety and style of a product
  12. 12. Other extensions of the theory (cont.) Product cycles  So far, the basis of trade was attributed to such factors as differing labor productivities, factor endowments and national demand structures. Now, technological change plays an important role in determining trade.  Technological innovations result in:  New methods of producing existing commodities  Production of new commodities  Commodity improvements  Stages that many manufactured goods follow in terms of product cycle:  Manufactured good is introduced to home market  Domestic industry shows export strength  Foreign production begins  Domestic industry loses competitive advantage  Import competition begins  Trade cycle is complete when the production process becomes so standardized that it can be easily used by other nations.
  13. 13. Other extensions of the theory (cont.) Dynamic comparative advantage - industrial policy  Comparative advantage theory implies that nations are better off by promoting free trade and allowing competitive markets to determine what should be produced and how.  specialization and reallocation of existing resource found domestically  Criticism: Static theory  Overlook the fact that additional resources can be made available to the trading nation because they can be created or imported  Increasing cost.  short run not in the long run (decreasing cost). Possible partly because firms learn to be more efficient and partly because of economies of large-scale production  Dynamic comparative adv. Thorugh government policies (industrial policy). Ex: Japan with picking winners policy  Antitrust immunity, tax incentives, R&D subsidies. Loan guarantees, low-interest-rate loans, and trade protection
  14. 14. Free trade under increasing costs Transportation costs No transportation costs
  15. 15. Free trade under increasing costs Transportation costs Transportation costs of $2000 per auto
  16. 16. Specific factor theory Looks at the income distribution effects of trade in the short run, when some factor inputs are not mobile among sectors Indicates that workers may be better or worse off, depending on preferences Predicts that owners of factors used in export industries gain from trade, while owners of factors used in import-competing industries will lose from trade Bringing theory closer to reality
  17. 17. Relative prices and the specific factor model Bringing theory closer to reality