International Trade

1
International Trade

• Cheng Ming ??
• School of Economics, Shanghai University

2
Chapter OneComparative Advantage--- The
Ricardian Model

• The Concept of Comparative Advantage
• Two basic reasons for International Trade
• Countries can benefit from doing things they do
  well
• Reaching economies of scale in production

3

• David Ricardo, in his 1817 book The Political
  Economy and Taxation put forward the theory of
  Comparative Advantage
• A company has a comparative advantage in
  producing a good if the opportunity cost in
  terms of other goods is lower.
• Each country can benefit from the exporting the
  goods in which it has a comparative advantage.

4
2. A One-factor Economy

• In Ricardian model, international trade is SOLELY
  due to the differences in the productivity of
  labor
• An Economy Home
• Two Goods Wine Cheese
• One Factor Unit labor requirement
• We define
• aLW unit labor requirement in wine
• aLc unit labor requirement in cheese
• L total labor supply

5
Production Possibility
Qw
Slop opportunity cost of cheese in terms of wine
L/a
LW
aLC/aLW
Qc
L/a
LC
Production Possibility Frontier
6
Relative Prices and Supply

• PPF illustrates the mixture of goods the economy
  can produce
• The actual production mix is based on the
  relative prices (no profits in One-factor model)
• If Pc/Pw gt aLC/aLW, specialize in the production
  in cheese
• If Pc/Pw aLC/aLW, both goods will be produced
• The economy will produce cheese if the relative
  price exceeds it opportunity cost

7
3. Trade in a One-factor World

• We assume Home country is less productive than
• Foreign in Wine, but more productive in Cheese
• Therefore
• aLC/aLW lt aLC/aLW
• Or, equivalently, that
• aLC/aLC lt aLW/ aLW
• Therefore, Home country has comparative advantage
  
• in Cheese

8
Determining the Relative Price after Trade
Relative price of Cheese
Rs
aLC/aL
1
2
aLC/aL
R
RD
L/aL
Q
Relative Quantity of Cheese
L/aLW
9

• Point 1, the intersection of demand curve R and
  RS curve, where the relative price of cheese is
  between the two countries pretrade prices. Each
  country will specialize in the production of the
  good in which it has a comparative advantage.
• Point 2, the world relative price after trade is
  the same as the opportunity cost of cheese in
  terms of wine in Home, Home economy need not
  specialize, while Foreign does specialize in
  producing wine.

10
The Gains from Trade

• The First Way
• -- to think of trade as an indirect method of
  production, i.e. Home can produce wine directly
  and trade with Foreign for cheese (produce
  indirectly)
• -- for an hour of labor, direct production 1/aLW
  wine, or 1/aLC cheese and be trade with wine
• -- if (1/aLC)(PC/PW) gt 1/aLW, or PC/PW gt aLC/aLW
• trade will be beneficial

11

• The second way how trade will affect the
  possibilities for consumption.

Trade Expands Consumption Possibilities
Quantity of wine, Qw
Quantity of wine, Qw
T
F
P
F
P
T
Quantity of cheese, Qc
Quantity of cheese, Qc
(a) Home
(b) Foreign
12
Relative Wages

• Political discussion of international trade often
  focus on comparisons of wage rates in different
  countries.

Unit Labor Requirements
Cheese Wine
Home aLC 1hr per pound aLW 2hr per
gallon Foreign aLC 6 hr aLW
3hr
13

• Since, aLC/aLW lt aLC/aLW
• So, Home will produce Cheese, Foreign produce
  Wine
• Suppose a unit of cheese and wine both sell for
  12, Home worker will earn 12 per hour, while
  Foreign worker will earn 4
• As long as the relative price of cheese to wine
  is 1, the wage of Home workers will be 3 times
  that of Foreign workers.
• Home still has a comparative advantage in
  producing cheese since this wage rate lies
  between the ratios of the two countries
  productivities in the two countries.

14
4. Misconceptions about Comparative Advantage

• Productivity and Competitiveness
• Myth 1 Free trade is beneficial only if your
  country is strong enough to stand up to foreign
  competition.
• The Pauper Labor Argument
• Myth 2 Foreign competition is unfair and hurts
  other
• countries when it is based on low wages.
• Exploitation
• Myth 3 Trade exploits a country and makes it
  worse off if its workers receive much lower wages
  than workers in othernations.

15
5.Comparative Advantage with many goods

• With many goods, we label aLi and aLi as labor
  requirement for Home and Foreign, and rearranged
  as
• aL1/aL1lt aL2/aL2 lt aL3/aL3 lt lt aLN/aLN
• Let w and w be the wage rate per hour in Home
  and Foreign, respectively
• We know that it would produce cheaper in Home if
• waLi lt waLi, and it can be rearranged to
  yield
• aLi/aLi gt w/w

16

• Home and Foreign Unit Labor Requirements
• 
  Relative Home
• Good Home Unit Labor Foreign Unit Labor
  Productivity
• Requirements(aLi)
  Requirements(aLi) Advantage(aLi/aLi)
• Apples 1
  10 10
• Bananas 5
  40 8
• Caviar 3
  12 4
• Dates 6
  12 2
• Enchiladas 12
  9 0.75

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6. Adding Transport Cost and Nontraded Goods

• There are three reasons why specialization
  in the real international economy is not the
  extreme
• The existence of more than one factor
• Countries sometimes protest industries from
  foreign competitions
• It is costly to transport goods and services.
  i.e. because of the transport cost, there exists
  nontraded goods

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Chapter Two

• Specific Factors and Income Distribution

19
1.The Specific Factors Model

• Although international trade is beneficial to
  both of the countries, it is, however, has strong
  effects on the distribution of income. While
  trade may benefit a nation as a whole, it often
  hurts significant groups within the country, at
  least in the short run.
• We use the specific factors model to explain.

20

• Assumption of the Model
• -- an economy produce two goods manufactures and
  food.
• -- three factors labor(L), capital(K), and
  land(T)
• -- labor is the Mobil factor, while K and T are
  specific factors for manufactures and food,
  respectively
• -- so, QM Q M(K,LM)
• QF QF(T,LF)
• LM LF L

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Production Possibilities

• The Production Function for Manufactures

Output, QM
The more labor input, the larger the output.
Because of the diminishing returns, the
successive input will has less output. Reflected
by a flatter Curve.
QMQM(K,LM)
Labor Input,LM
22
The Marginal Product of Labor
Marginal product of labor, MPLM
The marginal product of labor equal to the slop
of the production function
MPLM
Labor Input,LM
23
The Production Possibility Frontier in the
Specific Factors Model

Output of food, QF, (increasing )
Economys Production Possibility Frontier(PPF)
QFQF(T,LF)
1
QF
L
QM
PP
LF
Labor input In food, LF (increasing )
Output of Manufactures, QM (increasing )
1
LM
L
OMQM(K,LM)
Labor input In manufacturers, LM (increasing )
24

• In the Specific Factors Model, the PPF is an
  convex line (reflecting diminishing returns to
  labor), while in the Ricardian Model, it is a
  straight line (reflecting constant returns)
• The slop of the production possibility curve
• - MPLF/MPLM
• The slop represents the opportunity cost for
  manufactures in terms of food.

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Price, Wages, and Labor Allocation

• Each sector will hire labor to the point until to
  the point where the value produced by an
  additional person-hour equals to the cost of
  employing that hour. In manufacturing sector, for
  instance
• MPLM ?PM W, because of the diminishing returns,
  MPLM is a downward curve, giving the constant
  price of the manufactures.
• We can also consider the above equation as the
  demand curve.

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• Since
• MPLM ?PM MPLF ?PF w, therefore,
• - MPLF/MPLM - PM/PF
• The result tells us that at the production point
  the production possibility frontier
• must be tangent to a line whose
• slop is minus the price of
• manufactures divided by
• that of food.

QF
Slop -(PM/PF)
QM
27
An equal proportional increase in the prices of
manufactures and food
Wage Rate, w
2
PF ?MPLF
1
PF ?MPLF
PM Increase 10
PF Increase 10
w2
10 Wage increase
2
2
PM ?MPLM
w1
1
1
PM ?MPLM
Labor used In food,LF
Labor used in Manufactures, LM
28

• If both goods prices increase by 10, the labor
  demand curves will both shift up by 10. The
  allocation of labor between the sectors and the
  outputs of the two goods do not change.
• So it generates a general principle changes in
  the overall price level have no real effects,
  that is, do not change any physical quantities in
  the economy. Only changes in relative prices --
  affect welfare or the allocation of resources.

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A change in relative prices
Wage Rate,w
1
PF ?MPLF
7 upward Shift in labor demand
2

W1 w2
2
Wage rate Rises by Less than 7
PM?MPLM
1
1
PM ?MPLM
Labor used in Manufactures, LM
Labor used In food, LF
Amount of labor shifted from food to manufactures
30

• Two important facts about the results of the
  shift of the labor in the above diagram
• First, although the wage rate rises, it rises by
  less than the increase in the price of
  manufactures.
• Second, when only PM rises, in contrast to the
  case of a simultaneous rise in PM and PF, labor
  shifts from the food sector to the manufacturing
  sector and the output of manufactures rises while
  that of food falls. (This is why w dose not rise
  as much as PM because manufacturing employment
  rises, the marginal product of labor in that
  sector falls.

31
Relative prices and the distribution of Income

• Lets discuss the the results of the shifts of
  labor for the incomes of three groups
• 1) Workers their wage rate has risen, but less
  than in the proportion to the rise in PM. Thus,
  their real wage in terms of manufactures (w/PM)
  falls, while (w/PF) rises.
• So, the warfare of workers are uncertain,
  depending upon their preferences of consumption.

32

• 2) Owners of capital, are definitely better off.
  The real wage rate in terms of manufactures has
  fallen, so that the profits of capital owners in
  terms of what whey produce rises.
• 3) Owners of land are definitely worse off. The
  lose for two reason
• --- the real wage in terms of food rises,
  squeezing their income, and
• --- the rise in manufactures prices reduces
  the purchasing power of any given income.

33
2. International Trade in the Specific Factors
Model

• We know that an increase in the supply of
  manufactures (or land) would increase
  manufactures (food) output and reduce the food
  (manufactures) output.
• Now we suppose that American has a larger supply
  of land than Japan while Japan has a larger
  supply of capital than American.

34

• We also suppose that under any PM/PF, the demand
  of two countries is the same, i.e. trade is
  occurred only because of the difference of the
  relative supply
• Therefore, the relative price of manufactures is
  determined by the world relative supply RSworld
  and world relative demand Rdword.

35
Relative price Of manufactures, PM/PF
RSA
RSworld
RSj
(PM/PF)A
(PM/PF)world
(PM/PF)j
RDworld
Relative quantity Of manufactures, QM/QF
36
Trade pattern and Budget constraint

• In a closed economy, output equals to
  consumption, so
• DM QM, DF QF
• Although trade makes it possible for a country to
  consume the different mix of manufactures and
  food, the value of consumption must be equal to
  the value of production, so
• PM ?DM PF ?DF PM ?QM PF ?QF, or
• DF QF (PM/PF) ?(QM DM)

37
The budget constraint for a trading economy
Consumption of food, DF Output of food, QF
Point 1 represents the economys Production. The
economys con- sumption must lie along a line
that Passes through point 1 and has a Slope
equal to minus the relative Price of
manufacturers.
Budget constraint (slope - PM/PF)
1
1
QF
Production Possibility frontier
1
QM
Consumption of Manufacturers,DM Output of
Manufacturers, QM
38
3. Income distribution and the gains from trade

• After trade, it leads to a convergence of
  relative prices.
• Trade benefits the factor that is specific to the
  export sector of each country but hurts the
  factor specific to the import-competing sectors,
  with ambiguous effects on mobile factors.
• Do the gains outweight the losses? Through the
  diagram in the next page, we find that trade
  potentially benefits a country since it expends
  the economys choices of consumption.

39
Trade expands the economys consumption
possibilities
Consumption of food, DF Output of food, QF
Before trade, economys pro- duction and
consumption were at Point 2 on its production
possibilities frontier (PP). After trade, The
economy can consume at any point on its budet
constraint in the colored region consists of
feasible posttrade consumption choices with
consumption of both goods higher than at the
pretrade point 2.
2
Budget constraint (slope - PM/PF)
1
QF
1
PP
Consumption of Manufacturers, DM Output
of Manufacturers, QM
1
QM
40
4. The political economy of trade a preliminary
review

• Optimal trade policy
• In spite of the real importance of income
  distribution, most economists remain strongly in
  favor of more or less free trade, reasons are
• a. Income distribution effects are not specific
  to international trade.
• b. It is always better to allow trade and
  compensate those whose who are hurt by it than to
  prohibit the trade.

41

• c. Those who stand to lose from increased trade
  are typically better organized than those who
  stand to gain. This imbalance creates a bias in
  the political process that requires a
  counterweight
• Income distribution and trade politics
• in most of the countries, including the
  U.S.A., those who want trade limited are more
  effective politically than those who want it
  extended. Typically, those who gain from trade in
  any particular product are a much less
  concentrated, informed, and organized group than
  those who lose.

42
Chapter Three Resources and Trade The
Heckscher-Ohlin Model

• 1. A model of Two-factor Economy
• The economy produce two goods cloth and food
• Two factors labor and land
• aTC acres of land used to produce one unit of
  cloth
• aLC hours of labor used to produce one unit of
  cloth
• aTF acres of land used to produce one unit of
  food
• aLF hours of labor used to produce one unit of
  food
• L and T supply of labor and land

43
Input Possibilities in food production
Unit land input aTF, in acres
Input combinations that produce one unit of food
A farmer can Produce a unit of Food with less
land If he or she uses more Labor,and vice versa.
II
Unit land input aLF,in hours
44

• What he or she will actually use?
• It depends on the relative cost of land and labor
• -- factor prices w/r (wage rate per hour of
  labor/ cost of one unit of land)
• It is represented by the Figure as the curve FF.
• There is a corresponding relationship between w/r
  and the land-labor ratio in cloth production. As
  showed by the curve CC.
• Curve CC lies to the left of FF, indicating
  production of food uses a higher ratio of land to
  labor than the production of cloth.

45
Factor prices and input choices
Wage-rental ratio, w/r
CC
FF
?????,????????????????????????????,?w/r????FF?????
????????-??????,CC??????????????-????????????????-
???,????????????-???????????,?????????????(land
intensive),??????????(labor intensive).
Land-labor Ratio, T/L
46
Factor prices and goods prices
Relative price of Cloth, PC/PF
SS
?????????????,???????????,??????w/r???????PC/PF???
? ??????. ?????????,???????????????.
???SS?????????.
Wage-rental ratio, w/r
47
?????????????From Goods Prices to Input Choices

• Relative
• Price of cloth
• PC/PF

CC
FF
2
w/r
1
w/r
Land- Labor Ratio T/L
1
1
2
2
1
2
PC/PF
PC/PF
TC/LC
TC/LC
TF/LF
TF/LF
Increasing
Increasing
?????????,????? ???????(w/r)1. ???????????,??????
?????????????(TC/LC)1?(TF/LF)1.
????????????(PC/PF)2, ????????????(w/r)2,????????
???????? ??????.
48
The allocation of resources
Increasing Labor used in food production
OF
Increasing Land used in food production
Land used in cloth production
Increasing
C
1
F
OC
Labor used in cloth production Increasing
49

• What will be happen, if the economy resources
  change, say, by increasing the offer of land.
• We notice that an increase the economys supply
  of land will lead to a fall in the output of the
  labor intensive good, with the rise of the output
  of the land intensive good.
• That is, there is a biased expansion of
  production possibilities.

50
Resources and Production Possibilities
Output of food,QF
?????????????????????????????????????.
?????????????????????????????,????????????????????
????. ??, ??????????????????????????????.????,????
??????????????????????.
Slope -PC/PF
2
2
QF
Slope -PC/PF
TT2
1
1
QF
TT1
1
2
Output of cloth, QC
QC
QC
-- known as the Rybcznski effect (???????)
51
2. Effects of International Trade Between
Two-Factor Economies

• Relative prices and the Pattern of Trade
• -- since Home is the labor-intensive economy,
  Home tends to produce a higher ratio of cloth to
  food.
• -- When Home and Foreign trade, their relative
  prices converge.
• -- Since Home is abundant in labor, cloth
  production uses a higher ratio of labor to land
  in its production than food, that is cloth is
  labor-intensive, Home will export cloth and
  import food.

52
Trade Leads to a Convergence of Relative Prices
Relative price of cloth, PC/PF
???,?1?????? ?,?????????? RD???????RS? ??.
??,?3????? ?????. ???, ?? ??????????? ?????,??2??.
RS
RS
3
.2
RD
1
Relative quantity of cloth, QCQC
QFQF
53
Trade and Distribution of Income

• Owners of a countrys abundant factors gain from
  trade, but owners of a countrys scarce factors
  lose.
• We find that factors of production that are
  stuck in an import-competing used intensively
  by the import-competing industry are hurt by the
  opening of trade.
• The distinction between income distribution
  effects due to immobility and those due to
  differences in factor intensity also reveals that
  there is frequently a conflict between short-term
  and long-term interests in trade.

54
Factors Price Equalization

• There is a tendency toward the equalization of
  factor prices.
• However, we find the assumption do not meet the
  the real world reasons --
• -- we assume countries produce both goods
• -- countries have the same technologies
• -- factor price equalization depends on the
  complete convergence of the prices of the goods
  which is not the fact.

55
3.Empirical Evidence on the H-O Model

• Leontief Paradox
• H-O model has been less successful at explaining
  the actual patterns of international trade than
  one might hope, it remains vital for
  understanding the effects of trade, especially
  its effects on the income distribution.

56
Chapter FourThe Standard Trade Model

• Ricardian Model has conveyed the essential idea
  of comparative advantage, but difficult for
  discussing the distribution of income.
• The Specific Model is effective in explaining the
  income distribution, however, awkward for
  discussing the trade pattern.
• The H-O Model is helpful in deeper understanding
  of the trade pattern due to the differences of
  resources.

57
1. A Standard Model of Trading Model

• All of the above models can be viewed as special
  cases of a more general model of a trading
  economy.
• The Standard Model is much more effective in
  explaining the issues such as
• -- the effects of shifts in world supply
  resulting from economic growth
• -- shifts in world demand resulting from foreign
  aid
• -- simultaneous shifts in supply and demand
  resulting from tariffs and export subsidies.

58
Production Possibilities and Relative Supply

• The basic assumption of the model two goods
  food (F) and cloth (C), with a smooth PPF(TT).
• We know that the actual mix of production is
  determined by the relative price PC/PF.
• Any economy will maximize the value of output V
  PCQC PFQF, or
• QF V/PF (PC/PF)QC
• Isovalue lines lines along which the value of
  output is constant.

59
Relative Prices Determine the Economys Output
Food Production, QF
An economy whose Production possibility frontier
is TT will produce at Q, which is on the highest
possible isovalue line.
Isovalue lines
. Q
TT
Cloth Production, QC
60
Relative Prices and Demand

• Giving any economy,
• PCQC PFQF PCDC PFDF V
• The economys choice of a point on the isovalue
  line depends on the tastes of its consumers
  represented by a series of indifference curves.
• Please note the three characteristics of the
  indifference curves (P95)

61
How an Increase in the Relative Price of Cloth
Affects Relative Supply
Food Production, QF
The isovalue lines become steeper when the
relative price of cloth rises from VV1(PC/PF)1 to
VV2(PC/PF)2. As a result , the economy produces
more cloth and less food and the equilibrium
output shifts form Q1 to Q2
.
Q1
.
VV1(PC/PF)1
Q2
VV2(PC/PF)2
Cloth Production,QC
62
Production,Consumption, and Trade in the
Standard Model
The economy produces at point Q, where the
production possibility frontier is tangent to the
highest possible isovalue line. It consumes at
point D, where that isovalue line is tangent to
the highest possible indifference curve. The
economy produces more cloth than it consumes and
therefore export cloth correspondingly, it
consumes more food than it produces and therefore
imports food.
QF
Indifference curves
.
D
Food import
.
Q
Isovalue lines
TT
QC
Cloth exports
63
Effects of a Rise in the Relative Prices of Cloth
QF
The slop of the isovalue lines is equal to minus
the relative price of cloth PC/PF, so when that
relative prices rises all isovalue lines become
steeper. In particular, the maximum-value line
rotates from VV1 to VV2. Production shifts from
Q1 to Q2, consumption shifts from D1 to D2.
.
D2
.
D1
.
Q1
.
VV1(PC/PF)1
Q2
VV2(PC/PF)2
TT
QC
64
The Welfare Effect of Changes in the Terms of
Trade

• When PC/PF increases, a country that initially
  exports cloth is made better off, since its
  consumption moved from D1 to D2.
• The general conclusion a rise in the terms of
  trade increases a countrys welfare, while a
  decline in the terms of trade reduces its
  welfare.
• Economic growth(represented by the shift of the
  RS curve) vs. welfare is economic growth in
  other countries good or bad for Home? And is
  growth in a country more or less valuable when
  that nation is part of a closely integrated world
  economy?

65
Growth and the PPF

• Economic growth means an outward shift of a
  countrys PPF.
• International trade
• effects of growth
• results from the
• fact that such growth
• has a bias.

QF
.
.
TT1
TT2
QC
Growth biased toward cloth
66
Relative Supply and the Terms of Trade
Suppose Home has a growth strongly biased toward
cloth, so the World as a whole the relative
output of cloth to food will rise, resulting a
decrease in the relative price of cloth.
Export-biased growth tends to worsen a growing
countrys terms of trade, to the benefit of the
rest of the World.
PC/PF
RS1
RS2
.
1
(PC/PF)1
.
2
RD
(PC/PF)2
QCQC QFQF
Cloth biased growth
67
Immiserizing Growth

• Some analysts suggested that the growth in poorer
  nations would actually be self-defeating. The
  export-biased growth would worsen their terms of
  trade.
• Jagdish Bhagwati of Columbia University argued
  that such perverse effects of growth can in fact
  arise within a rigorously specified economic
  model. It can be occurred when the export-biased
  growth combined with very steep RS and RD curves,
  so that the change in the terms of trade is large
  enough to offset the initial favorable effects of
  an increase in a countrys productivity capacity.

68
2. International Transfers of Income-- effects
on a transfer on the terms of trade

• If Home makes a transfer of its income to
  Foreign, Homes income is reduced, and Foreigns
  expenditure is increased.
• It would lead to a shift in world relative demand
  and thus affect the terms of trade.
• The shift of the RD curve is the only effect of a
  transfer of income. The RS curve does not change.
• However, the terms of trade is also depended on
  the allocation of the spending.

69
Effects of a transfer on the terms of trade
If Home has a higher propensity to spend on cloth
than Foreign, a transfer of income by Home to
Foreign shifts the RD curve left from RD1 to RD2,
reducing the equilibrium relative price of cloth.
PC/PF
1
.
(PC/PF)1
.
2
(PC/PF)2
QcQC QFQF
70

• therefore, a transfer worsens the donors terms
  of trade if the donor has a higher marginal
  propensity to spend on its export good than the
  recipient.
• Since the actual spending patterns of each
  country seems to have a relative preference for
  its own goods, and also there exists the nontrade
  goods, as well as the effect of barriers to
  trade, most international economists believe that
  the transfer of income worsens the donors terms
  of trade.

71
3. Tariffs and export subsides simultaneous
shifts in RS and RD

• If Home imposes a certain percentage of tariff on
  the value of food, say, 20, the internal price
  of food relative to cloth faced by Home producers
  and consumers will be 20 higher than the
  external relative price of food on the world
  market
• At any given world relative price of cloth, Home
  will face a lower relative cloth price, and then
  will produce less cloth and more food. So the
  world relative supply of cloth will fall, while
  the relative demand for cloth will rise.
• Therefore, Homes terms of trade will improve at
  the expense of Foreign.

72
Effects of a tariff on the terms of trade
Relative price Of cloth,PC/PF
RS2
An import tariff imposed by Home will both
reduces the relative supply of cloth and increase
the relative demand of cloth. As result, the
relative price of cloth must rise. Homes terms
of trade will improve.
RS1
2
(PC/PF)2
RD2
1
(PC/PF)1
RD1
Relative quantity Of cloth, QCQC
QFQF
73
Effects of an export subsidy

• If Home offers a 20 subsidy on the value of any
  cloth exported. For any given world prices this
  subsidy will raise Homes internal price of cloth
  relative to food by 20.
• Therefore, Home will produce more cloth and less
  food, while leading Home consumers to substitute
  food for cloth.
• A Home export subsidy worsens Homes terms of
  trade and improves Foreigns.

74
Chapter Five Economies of Scale,Imperfect
Competition,and International Trade

• 1. Economies of scale and international trade
• -- an overview
• Economies of scale, also referred to as
  increasing returns, exists in many industries.
  Therefore, production is more efficient in the
  larger scale.
• Classification of economies of scale
• -- External economies of scale
• -- Internal economies of scale

75
2. The theory of imperfect competition

• Perfect vs. imperfect competition
• -- perfect competition there are many buyers
  and sellers, none of whom represents a large of
  part of the market, so firms are price takers.
• -- imperfect competition only a few major
  producers in an industry, firms will view
  themselves as price setters.
• Two characteristics of imperfect competition
• -- in an industry, there are only a few major
  producers, and
• -- each producers product is seen by
  consumers as strongly differentiated from those
  of rival firms.

76
Monopolistic Pricing and Production Decision
??????????? ????????? ?? ???, ???????? ??????????
? ????????QM, ?QM??????PM? ?????????? ??,????????
MR??????D???? ?????????? ????,?????? ??????????QM?

Cost, C and Price, P
Monopoly profit
PM AC
AC
D
MC
MR
QM
Quantity,Q
77
Monopolistic Competition Model

• Two key assumptions
• Each firm is assumed to be able to differentiate
  its product from that of its rivals.
• Each firm is assumed to take the prices charged
  by its rivals as given that is, it ignores the
  impact of its own price on the prices of other
  firms.
• -- assumption of the model
• Q S ?1/n b ?(p p)

_
78
Equilibrium in a monopolistically competition
Cost C, and Price, P
??????????????????????????? ???,?????????,???????
??,????????.???????PP??.????,?????,??????????,????
????.???????CC??.??????????,???????,??????????,??,
??. ???????????(E)?,???????????.
CC
AC3 P1 P2,AC2 AC1 P3
.
PP
n3
n1
n2
Number Of firms,n
79
Limitations of the Monopolistic Competition Model

• There are two kinds of behavior arises in the
  general oligopoly setting that are excluded by
  assumption from the monopolistic model
• First is the collusive behavior through
  explicit agreements between firms, or through
  tacit coordination strategies, such as price
  leader.
• Second is the strategic behavior through some
  of the behavior that may affect the competitors.

80
3.Monopolistic Competition and Trade

• Since,
• AC F/Q c n ?F/S c
• International trade will increase in total sales
  S, reducing the average costs for any given
  number of firms n. Therefore, the CC curve in the
  larger market will be below that in the smaller
  market.
• P c 1/(b ?n)
• The size of the market does not enter into the
  equation, so an increase in S does not shift the
  PP curve.

81
Effects of a larger market
Cost, C and Price P
???????? ???,???? ?????,??? ????????,
?????????, ???????? ??,?????? ????????, ?????????
.
CC1
CC2
1
P1 P2
2
PP
n1 n2
Number of Firms,n
82
Economies of scale and Comparative advantage

• The difference between this model and the factor
  proportional model is that manufacturers is not a
  perfectly competitive industry in which a number
  of firms all produce differentiated products.
• Because of economies of scale, neither country is
  able to produce the full range of manufactured
  products by itself thus, although both countries
  may produce some manufactures, they will be
  producing different things.
• If we assume the manufacture is a monopolistic
  competitive sector, Home will be a net exporter
  of manufacture and an importer of food.

83
Home (capital abundant)
Manufactures Food
Trade in a World Without Increasing Returns
Foreign (labor abundant)
Home (capital abundant)
Manufactures Food
Interindustry trade
Trade with Increasing Returns and Monopolistic
Competition
Intraindustry trade
Foreign (labor abundant)
84
Four points about this pattern of trade

• Interindustry trade(manufactures and food) due
  to comparative advantage.
• Intraindustry trade(manufactures for
  manufactures) due to economies of scale
• The pattern of intraindustry trade itself is
  unpredictable.
• The relative importance of intraindustry and
  interindustry trade depends on how similar
  countries are. The importance of intraindusty
  trade equals to
• exports imports
• exports imports

I 1 -
85
4. Dumping and Reciprocal Dumping
Cost, C and Price,P
MC
3
PDOM
1
2
DFORMRFOR
PFOR
DDOM
MRDOM
QMONOPOLY
QDOM
Quantities produced and demanded, Q
Domestic Sales
Exports
Total Output
86
5. The Theory of External Economies

• Economies of scale apply at the level of the
  industry rather than at the level of the
  individual firms.
• Three main reasons why a cluster of firms may be
  more efficient than an individual firm in
  isolation
• -- Specialized Suppliers
• -- Labor Market Pooling
• -- Knowledge Spillovers

87
External Economies and International Trade
As this model shows, external economies
potentially give a strong role to historical
accident in determine who produce what, and may
allow established patterns of specialization to
persist even they run counter to comparative
advantage.
Price, Cost (per watch)
C0
1
P1
ACSWISS
2
ACTHAI
D
Q1
Quantity of Watches Produced and demand
88
Trade and Welfare with External Economies
Price,Cost (per watch)
Clearly in this situation trade leaves
Thailand worse off than it would be in the
absence of trade
Co
1
P1 P2
ACSWISS
2
ACTHAI
DWORLD
DTHAI
Quantity of watches Produced and demanded
89
Dynamic increasing returns

• External economies arising from the accumulation
  of knowledge differ something form the external
  economies considered above
• Dynamic increasing returns -- learning curve is
  determined by the cumulative output of the
  industry to date.
• While for ordinary external economies, the cost
  of the industry is determined by the prevailing
  production quantity.

90
Chapter Six International Factor Movements

• 1. International Labor Mobility
• A One- good Model without factor mobility

Marginal Product Of labor, MPL
Output, Q
Q (T,L)
Rents
Real wage
MPL
Wages
Labor, L
Labor, L
91
Causes and Effects of International Labor Mobility
MPL
MPL
Marginal product of labor
B
A
MPL
MPL
C
Foreign Q Employment
L2 L1
Q Home employment
Migration of labor From Home to Foreign
Total world labor force
92
2. International Borrowing and Lending

• When we speak of capital flow in this part, we
  refer to it as a financial transaction that is
  one country make loan to another.
• International borrowing and lending can be
  interpreted as a kind of trade intertemporal
  trade
• Any economy will produce and consume its output
  either at present or in the future, therefore, it
  involves a trade-off between present and future
  production of the consumption good.
• We can summarize by drawing an intertemporal
  production possibility frontier.

93
The Intertemporal Production Possibility Frontier
A country can trade current consump-tion for
future consumption in the same way that it can
produce more of one good by producing less of
another.
Future consumption
Present consumption
94

• The shape of intertemporal PPF will differ among
  countries
• Let suppose Homes PPFs are biased toward current
  consumption, while Foreign toward future
• Without international borrowing and lending, Home
  will have a higher relative price of future
  product consumption than in Foreign
• Therefore, Home will export present consumption
  and import future consumption
• The relative price of future consumption is
  determined by interest rate --- 1/(1r)

95

• Lets assume that Homes intertemporal PPF is
  biased toward present production therefore Home
  has a comparative advantage in present production
  a low relative price of present consumption.
• A country has a comparative advantage in future
  production of consumption goods is one that in
  the absence of borrowing and lending would have a
  low relative price of future consumption a high
  real interest rate.A high interest rate means a
  high return to diverting resources from current
  production to future
• So countries that borrow in the international
  market will be those where highly productive
  investment opportunities are available relative
  to current productive capacity. (lenders are
  actually export their current consumption ).
  

96
3. Direct Foreign Investment and Multinational
Firms

• Another important form of capital movement is
  direct foreign investment (FDI)
• A distinctive feature of FDI is that it involves
  not only a transfer of resources but also the
  acquisition of control
• The point is that while multinational firms
  sometimes act as a vehicle for international
  capital flows is to allow the formation of
  multinational organizations the extension of
  control is the essential purpose.

97
The theory of Multinational Firms

• Location why should a firm to produce the same
  product in different countries
• -- differences of resources / transportation
  costs / government restrictions
• Internalization why is production in different
  location done by the same firm in stead of a
  different country?
• -- it turns out to be more effective and
  profitable to carry out transactions within a
  firm rather than between firms, because
• a) technology transfer difficult to determine
  the price
• b) vertical integration upstream and
  downstream often get into conflicts, these
  problems can be reduced or avoided through a
  single vertically integrated firm.

98
Chapter SevenThe Instrument of Trade Policy

• 1. Basic tariffs analysis
• Supply, demand, and trade in a single industry
• -- without tariffs, the world
• price is determined by
• Home import demand
• (MD) and Foreign export
• supply (XS)

Price, P
XS
PW
MD
Quantity,Q
QW
99
Effects of a Tariff
Foreign Market
Home Market
World Market
S
Price,P
Price,P
Price,P
S
XS
2
PT
1
t
PW
PT
3
D
MD
D
QT QW
Quantity,Q
Quantity,Q
Quantity,Q
A tariff raises the price in Home while
lowering the price in Foreign. The volume traded
declines.
100

• Note, the increase in the price in Home is less
  than the amount of the tariff, because part of
  the tariff is reflected in a decline in Foreigns
  export price
• Therefore, Home has the effect of the improvement
  of trade terms
• If Home is a small country, where it cannot
  affect foreign export price. As a result of the
  tariff, imports fall in the country imposing the
  tariff, while price raises equal to the tariff
  imposed. (see next diagram)

101
A tariff in a small country
Price,P
When a country is small, a tariff it imposes
cannot lower the foreign price of the good it
imports. As a result, the price of the import
rises and the quantity of imports demanded falls

S
PWt
PW
D
S1 S2 D1 D2
Quantity,Q
Imports after tariff
Imports before tariff
102
Measuring the amount of protection

• Nominal rate of protection arithmetic average
• Actual rate of protection weighted average
• Effective rate of protection
• Vj Vj
• Vj

d
w
ERP
w
103
2.Costs and Benefits of a tariff
The costs and benefits to different groups can
be represented as sums of the five areas a, b, c,
d and e
Price,P
S
PT Pw PT
c
b
a
d
e
D
S1 S2 D1 D2 QT
Quantity, Q
104

• Consumers surplus loss a b c d
• Domestic producers gain a
• Government revenue gain through tariff c e
• e represents the terms of trade gain
• Production distortion loss b
• Consumption distortion loss d
• Efficiency loss b d
• The net cost of a tariff
• (a b c d) a (c e)
• b d e

105
Net welfare effects of a tariff
Terms of Trade gain
d
b
e
Consumption distortion loss
Production distortion loss
106
3. Others instruments of trade policy

• Export subsidies

Price,P
S
PS PW PS
Producer gainabc Consumer lossab Government
subsidy bcdefg Consumption and
pro- duction lossb and d Additional terms of
trade lossefg
a
b
c
d
Subsidy
f
e
g
D
Quantity,Q
Exports
107

• Import quota U.S. Import Quota on Sugar

Price, /ton
Supply
Consumer loss abcd Producer gain a Quota
rents c
c
a
d
b
Demand
5.14 6.32 8.45 9.26
Quantity of Sugar million tons
Import quota 2.13 million tons
108

• Voluntary Export Restraints (VER) or Orderly
  Market Agreements (OMA)
• Local Content Requirements
• -- no strict limit on imports, it allows firms
  to import as long as it by more domestically, so
  the effective price of inputs of the firms is an
  average of the price of imported and domestically
  produced inputs. This differences of prices pass
  on to consumers.
• Export credit subsidies
• National procurement
• Red-tap barriers War of Poitiers

109
Comparing a Tariff and a Quota
Price,P
MC
A quota leads To lower domestic output and a
higher price than a tariff that yields the same
level of imports.
Pq PWt PW
D
Dq
MRq
Quantity,Q
Qq Qt
110
4. The effects of trade policy A summary
Tariff Export subsidy Import quota VER
Producers surplus Increases Increases Increases Increases
Consumers surplus Falls Falls Falls Falls
Government Revenue Increases Falls (gov. spending rises) No change (rents to holders) No change (rents to foreigners)
Overall national welfare Ambiguous (fall for small country) Falls Ambitious Falls
111
Chapter EightThe Political Economy of Trade
Policy

• 1. The case for Free Trade
• Free Trade and Efficiency
• -- a free trade would remove both production and
  consumption distortions and increases national
  welfare
• Additional Gains From Free Trade
• -- economies of scale
• -- providing entrepreneurs with an incentive to
  seek new ways to export or compete with imports,
  since free trade offers more opportunities for
  learning and innovation than are provided by a
  system of managed trade.

112

• Political Argument for Free Trade
• -- it reflects the fact that a political
  commitment to free trade may be a good idea in
  practice even though there may be better policies
  in principle.
• 1) The conventionally measured costs of
  deviating from free trade are large.
• 2) There are other benefits from free trade that
  add to the costs of protectionist policies.
• 3) Any attempt to pursue sophisticated
  deviations from free trade will be subverted by
  the political process.

113
2. National Welfare Arguments Against Free Trade

• The terms of trade argument for a tariff
• -- a sufficiently small
• Tariff the terms of trade
• benefits must
• outweight the costs.

National Warfare
1
Optimal Prohibitive Tariff Rate tariff,t0
Tariff, tp
114

• The Domestic Market Failure Argument Against Free
  Trade
• -- the basic theoretical case for free trade
  rested on cost-benefit analysis using the
  concepts of consumer and producer surplus.
• -- some economists argue that these concepts do
  not properly measure the benefits of producing a
  good.
• -- since labor in a sector may be unemployed or
  underemployed, the existence of defects in the
  capital and labor market may prevent the
  transfer, the possibility of technological
  spillovers from industries domestic market
  failure

115
Distortion from tariff a and b, however, the
calculation overlooks an additional benefit that
may make the tariff preferable to free trade.
Since the increase in production yields a social
benefit
Price,P
s
a
PWt PW
b
D
Quantity,Q
S1 S2 D2 D1
Dollars
Marginal Social benefit
c
Quantity,Q
S1 S2
116

• The social benefit is derived from the experience
  of production that improve the technology of the
  economy as a while but that the firms in the
  sector cannot appropriate this benefit and
  therefore do not take it into account in deciding
  how much to produce.
• The marginal social benefit is the additional
  production that is not captured by the producer
  surplus measure.
• We can prove that as the economy impose a
  sufficient small tariff, the extra social
  benefit (c) would outweight the distortions (a)
  and (b).
• The domestic market failure argument against free
  trade in a particular case of a more general
  concept known in economies as the theory of the
  second best.

117
3. Income Distribution and Trade Policy

• -- the discussion so far is confined to the
  national warfare, when we look at the reality,
  there is always individuals desire reflected in
  the objectives of the government.
• -- in the following model we will assume the
  governments are trying to maximize political
  success rather than the abstract measurement of
  national welfare.
• Electoral Competition
• -- the so-called median voter.

118
???????????????????????????????????A,
???????????????????????B?????????????????????????M
????, ??M??????????????
Preferred tariff rate
tA tB tM
Political support
Voters
Median Voter
119

• however, this model doest not work well, in fact,
  it makes an almost precisely wrong prediction.
• According to this model, a policy should be
  chosen on the basis of how many voter it pleases.
  A policy that inflicts large losses on a few
  people but but benefits a large number of people
  should be a political winner.
• What is the reality?

120

• Collective Action
• - there is a problem of collective action while
  it is in the interests of the group as a whole to
  press for favorable policies, it is not in any
  individuals interests to do so.
• Modeling the Political Process
• - politicians may win the elections partly
  because they advocate popular policies need
  money. So the relevant policies favoring the
  group that offering sufficient financial
  contribution will be put forward. Some people
  therefore envision the trade policy as a sort of
  auction in which interest groups buy policies.

121
4. International Negotiations and Trade Policy

• The Advantages of Negotiation
• Helps mobilize support for free trade
• Helps governments avoid getting caught in
  destructive trade wars.
• Intentional Trade Agreements A Brief History
• GATT in 1947
• WTO 1995
• Free Trading Agreements/Customs Union/Common
  Market/Economic Union

122
Chapter NineTrade Policy in Developing and
Developed Countries

• 1. Trade Policy in Developing Countries
• Import-substitution Industrialization
• -- The Infant Industry Argument
• Pitfalls of the Infant Industry Arguments
• It is not always good to try to move today into
  the industries that will have a comparative
  advantage in the future
• Protecting manufacturing does no good unless the
  protection itself helps make industry competitive.

123

• c. The implementation of the policy is costly and
  time consuming to build up an industry.
• Justifications for Infant Industry
  Protection -- two reasons why infant industry
  should be protected
• a. Imperfect capital market infant industry in
  developing countries does not have a set of
  financial institutions, through protection, it
  allows more rapid growth as a second best
  policy
• b. The problem of appropriability the idea is
  that firms in new industry generate social
  benefits for which they are not compensated.

124

• -- Promoting Manufacturing Through Protection, in
  most developing countries, the basic strategy for
  industrialization has been to develop industries
  oriented toward the domestic market by using
  trade restrictions such as tariffs and quotas to
  encourage the replacement of imported
  manufactures by domestic products.
• As a strategy of promoting manufactures, the
  import-substituting industrialization has worked.
  The problem is has the strategy promoted the
  growth of economic development.

125
The Problems of the Dual Economy

• The division of a single economy into two sectors
  that appear to be at very different levels of
  development is referred to a economic dualism.
• The presence of economic dualism is often used to
  justify tariffs that protect the apparently
  efficient manufacturing sector.
• Some economists have argued that
  import-substitution policies have actually helped
  to create the dual economy or at least aggravate
  some of its symptoms.

126
Export-oriented industrialization

• Those countries adopting the policies have
  achieved spectacular economic growth. The so
  called HPAEs high performance Asian economies.
• Some people argue that there is a correlation
  between rapid growth in exports and rapid overall
  economic growth, and the relatively low rates of
  protection in the HPAEs helped them to growth.
• The miracle can be contributed to high trade
  ratio, high saving rate and rapid growth of
  education level

127
2. Strategic Trade Policies in Advanced Countries

• Arguments for strategic trade policy
• Technology and Externalities firms can
  appropriate some of the benefits of their own
  investment in knowledge, while other firms can
  benefit through reverse engineer
• Imperfect Competition and Strategic Trade Policy
  since there exists the market failure that
  justifies the government intervention in the lack
  of perfect competition.

128
The Brander-Spencer Analysis

• Effects of a subsidy to Airbus

Airbus

Boeing


- 5
0
Produce Dont produce
- 5
100
0
100
0
0
129

• however, the problems of the strategic policies
  would face foreign retaliation. Since the
  policies are beggar-thy-neighbor policies that
  increase the welfare at the expense of other
  countries .
• We should note that strategic policy cannot be
  judged by asking whether the targeted industries
  grew. Although some of the industries finally
  grow and achieve substantial market share, but
  this does not mean that the policies accelerated
  economic growth, because an interventionist
  policy will not accelerated economic growth
  unless it corrects a market failure.