ECW3121 International Trade and Finance Lecture 4

1
ECW3121International Trade and FinanceLecture 4
2
Heckscher-Ohlin
Stolper-Samuelson
Factor Price Equalisation
Comparative Advantage
Trade Theory Study Guide 1
Rybzcynski
Absolute Advantage
Immiserising Growth
Mercantilism
International Trade and Finance
Balance Of Payments
Foreign Exchange Markets
Non Tariff Barriers
Interest Arbitrage
TradeBlocs
Tariffs
Finance Study Guide 3
Trade Policy Study Guide 2
International Resource Movements
Tools of the Trade Policy Analysis
Exchange rate theorems
3
Trade Theory
Stolper- Samuelson theorem
O
L
L
L
Y
Increase in the price for X causes increase in
the production of X by the labour abundant Nation
1. This will cause increase in w/r ratio (or
increase in wage in the units of capital
rent) Specialisation of nation 2 in good Y
causes increase of r/w ratio.
Nation 2
K
A
K
L
O
F
Y
B
Nation 1
F
B
K
A
L
Ox
4
Trade Theory
Stolper- Samuelson theorem

• In a Labour Abundant Nation, which exports a
  Labour Intensive Commodity,
• wages will increase relative to rental and the
  Labour force will be the winners......
• capital owners the losers when free trade is
  opened.
• In a Capital Abundant Nation, which exports a
  Capital Intensive Commodity,
• rental will increase relative to wages and the
  Capital Owners will be the winners......
• labour owners the losers when free trade is
  opened.
• Because Each Nation gains from free trade, the
  winner will gain enough to fully compensate the
  losers......
• the result being a net gain

5
Trade Theory
Factor-Price Equalisation

• The end result of free trade
• The wage- rental ratio will be the same in
  each nation corresponding to an equal commodity
  price ratio.
• This result shows that even with the assumption
  of factor immobility between nations, factor
  prices will still adjust as though the factors
  were mobile.
• The factor prices (wages, rental) are embedded in
  the commodity price.
• Free trade is a substitute for factor mobility.

6
Trade Theory
Factor-Price Equalisation
O
Y
Nation 2
A
O
Y
B
Nation 1
F
F
A
B
Ox
Nation 2
Nation 1
7
Trade Theory
Factor-Price Equalisation
O
Y
Nation 2
A
O
Y
B
Nation 1
F
F
A
B
Ox
Points B and B are points of stable Equilibrium,
free trade will tend towards these points.
B
Nation 2
B
Nation 1
8
Reading
Trade Theory
Economic growth

• Salvatore, Chapters 7
• The Reader - the articles by T.M.
  Rybchinski and J. Bhagwati.

9
Trade Theory
Economic growth

• Economic Growth - Increase in National Output
  over time.
• Change in GDP from one year to the next.
• Real GDP can only increase
• if a nation acquires more factors of production
  (extensive growth) or
• as a result of technical progress - the existing
  factors of production may be used to produce a
  higher level of output (intensive growth) .

10
In international trade theory
Trade Theory
Economic growth

• Small economy/country - does not affect world
  prices (the price for a particular commodity)
• Large economy/country - affects world prices (the
  price for a particular commodity).

11
Trade Theory
Economic growth
Extensive growth, no technical progress
Rybczynski theorem Small Country

• At constant commodity prices, an increase in the
  endowment of one factor will cause, by a greater
  proportion, an increase in the commodity
  intensive in that factor and will reduce the
  output of the other commodity.

12
Trade Theory
Economic growth
Extensive growth, no technical progress
Rybczynski theorem Small Country
Increase in the endowment of one factor (labour)
expands the Edgeworth box along the L-side and
PPF - along the axis X. Relative prices for the
commodities remain unchanged. Therefore,
relative capital/labour ratio remains unchanged
(w/r)A
0y
0y
y
K
(w/r)A
y
x
x
0x
L
Y
A
y1
A
PA
PA
0
x1
X
13
Trade Theory
Economic growth
Extensive growth, no technical progress
Rybczynski theorem Small Country
The output of the product X increases. The output
of the product Y decreases.
(w/r)A
0y
0y
y
K
(w/r)A
y
x
x
0x
L
Y
A
y1
A
y2
PA
PA
0
x2
x1
X
14
Trade Theory
Economic growth
Extensive growth, no technical progress
Immiserising Growth Large Country

• Increase in the output of exported commodity by a
  large nation can deteriorate nations welfare.

15
Trade Theory
Economic growth
Immiserising Growth Large Country

• If the production possibility of the commodity X
  increases (corresponding factor endowment
  increases)
• PPF expands along the axis X and becomes flatter
  at the same level of output
• or
• the same level of output of the product X
  becomes relatively cheaper.

Y
E
Yec
Ybp
B
Pb
0
Xec
X
Xbp
16
Trade Theory
Economic growth
Immiserising Growth Large Country
If the production possibility of the commodity X
increases (corresponding factor endowment
increases), at a new equilibrium point the
country Produces Xcpgt Xbp of the product X and
Ycplt Ybp of the product Y (why the output of Y
decreases?)
Y
E
Yec
C
B
Pc
Ybp
Pb
0
Xec
X
Xbp
Xcp
17
Trade Theory
Economic growth
Immiserising Growth Large Country
If the production possibility of the commodity X
increases (corresponding factor endowment
increases), at a new equilibrium consumption
point F, the country consumes XFClt XEC of the
product X and YFClt YEC.
Y
E
Yec
YFC
F
C
Ybp
B
Pc
Pb
0
XFC
Xec
X
Xbp
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Trade Theory
Economic growth
Technical progress
Neutral technical progress

• Increases productivity of labour and capital in
  the same proportion.
• No change in relative prices for factors.
• Equivalent to proportional increase in the
  endowment both factors
• No factor substitution

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Trade Theory
Economic growth
Technical progress
Labour-saving technical progress

• Increases productivity of capital proportionately
  more than labour.
• Equivalent to increase in capital endowment.
• Capital is substituted for labour.

20
Trade Theory
Economic growth
Technical progress
Capital-saving technical progress

• Increases productivity of labour proportionately
  more than capital.
• Equivalent to increase in capital endowment.
• Labour is substituted for capital.

21
Trade Theory
Economic growth
Neutral technical progress. Small country
Y
E
Yec
E
Yec
Ybp
B
B
Ybp
Pb
0
Xec
Xec
X
Xbp
Xbp
22
Trade Theory
Economic growth
Neutral technical progress. Small country
Y
E
Yec
E
Yec
Ybp
B
B
Ybp
Pb
0
Xec
Xec
X
Xbp
Xbp
23
Trade Theory
Economic growth
Labour saving technical progress. Small labour
abundant country
Y
E
Yec
B
Ybp
Pb
0
Xec
X
Xbp
24
Trade Theory
Economic growth
Capital saving technical progress. Small labour
abundant country
Y
E
Yec
B
Ybp
Pb
0
Xec
X
Xbp