International Trade Theory and Policy

1
International Trade Theory and Policy

• School of Economics, Yunnan University
• Zhang Jianhua and Zhang Lin

2
Chap. 1 Introduction

• One. Course Outline
• Basic theory in Economics ( Analysis of commodity
  and factor mobility in open Macro economy by
  tools Microeconomics
• Contents
• Pure Theory in International Trade ( Reason and
  Influence of International Trade)
• Policy of International Trade (Policies aiming at
  limiting imports while encouraging exports)
• Institutions for International Trade(WTO
  Institutions )

3
Two Basic Concepts

• balance of trade
• Trade Surplus(ExportsgtImports,Favorable Balance
  of Trade)
• Trade Deficit (ExportsltImports,Unfavorable
  Balance of Trade)
• Trade Balance (Exports Imports)
• Trade Structure
• Commodity Structure
• Geographical Structure
• Dependency of Trade

2004?2005? ???????
2005??????????
2004?????????? ??70
4
Chap. 3 Comparative Cost and Classical Trade
Theorem

• In this chapter, we introduce theorem of
  international trade. We start such introduction
  looking at causes of international trade and its
  influences in the economy ( in Chap 3, 4, 5 and
  6), then we will analyze the influences of
  economics in trade.

One, Theory of Absolute Cost
Theory of absolute cost It is a theoretical
explanation to the cause of international
trade Introduced by Adam Smith in his Wealth of
Nations
5
Graph of Absolute Cost
Could countries have trade without absolute
differences in cost?
Each country produces goods absolutely low in
cost, in exchange for other countries goods
absolutely low in cost
Trade based on division of labor
Reason of trade is because of differences in
absolute cost
6
Chap 3. 2. Comparative Cost

• David Ricardo,1817
• Background

??????????
Cultivation of wheat expands, land of grass
shrinks, and price of wool goes up
??????
??????
???
Labor is more expansive
Food expend increases, end goods expend decreases
Revenge from other countries, export of end
products decrease
7
Case of Ricardian Model
Assumptions Two nations, two products, one
factor, fixed productivity, sufficient
employment, perfect competition, non-mobility of
factor, barter, no technological improvement, no
transportation cost
The absolute costs of both products in Britain is
lower than that in Portugal, why is there still
trade between these two countries
8
A necessary condition of international trade
Comparative cost difference
???????,???????
A sufficient condition of international trade
international exchange rate is between domestic
exchange rates in both countries.
There is benefit from trade
?
LimitationWhy there is comparative cost
9
Chap3. 3. Classical trade model based on
comparative cost
Used to explainReasons and influences of trade (
Price, Production, Consumption and Welfare.
Y
1, Analysis Tools
1) Production Possibility Curve The maximum
production when factors are fully employed.
A(0,100)
C(X1,Y1)
B(100,0)
O
X
10
Property of Production Possibility Curve
Slope of PPC is equal to marginal opportunity cost
Y
The cost of giving up one benefit for getting
another
A
5
B
4
O
X
3
4
Maximum cost may not be optimum production. We
have to introduce indifference curve in order to
get optimum production.
11
2, Indifference Curve
The different products combination that can bring
same satisfaction to consumers.
Y
UAUB

• Property of Indifference Curve
• There are many indifference curve
• Further from origin means more utility level
• Never cross with each other
• Concave
• Negative Slope

A(10,40)
B(25,15)
X
O
12
The combination of PPC and Indifference Curve
Equilibrium( Optimum ) Production and Consumption
Y
U2
U0
U1
Maximum production, but utility less than E
Impossible
B
C
Equilibrium point Maximum production, maximum
utility
A
E
ineffective
X
O
13
3, Exchange Rate ( Comparative price and Trade
condition
Y
?The exchange rate is equal to the slope of the
line ?The key of exchange rate line is its
slope, not the position. For example, AB and DE
is in different position but has same slope
1X 2Y
D
C
3X 3Y
B
X
O
A
E
1X 1Y
14
???????
???????,????????????
?????,???????????????,?????????
Y
T
????? ?????1X 2Y
B
X????,?? 1X 1.5Y
X????
X
O
A
??????? ???????1X 1Y
15
?????????????????????
Y
1X 1Y ???B???,X????
Y
1X 3Y ???A???,X????,Y????
B1
B
X
O
X
O
A
A1
A?
B?
16
Three, Classical Trade Model ( One Factor )
Y
Y
1X 3Y
T
C
National A
A
National B
T
X
X
O
O
B
D
1X 1Y
Price of X falls in international market, and
Price of Y also falls, finally reaches an
equilibrium price, say, T(1X2Y)
17
Influence of International Trade
X in nation B Production 0, consumption OX1(
Imports) Y in nation Production OC, Consumption
OY1, surplus Y1C
Consumption consumption combination is in
higher-position indifference curve, better trade
off
Y
Y
C
T
A
J
Y0
M
Y1
U1
F
E
U1
U0
U0
T
X
O
X
O
B
D
X0
X1
X in Nation A Production OB, Consumption OX0,
Surplus X0B( Export ) Y in Nation A Production
0, Consumption OY0 ( imports)
Price X ( more comparative advantage ) raised
ProductionProduction of X expanded ( Perfect
specialization )
18
Chap. 4, Mutual Demands Theory
Used to explain how exchange rate is fixed, and
how it varies.
One, Terms of Trade
Price Index of exports
PX
T

PM
Price Index of Imports
Improvement of trade condition each unit of
export can exchange for more imports
T
T
Deterioration of trade condition each unit of
export exchanges for less imports
19
Changes in Terms of Trade
Y
T3
Y
T0
T1
T2
Y3
T2
T1
T3
Y2
Y0
T0
Y1
Y0
X
X
O
O
X0
X0
X1
X2
X3
Improvement of Trade Condition in B
Improvement of Trade Condition in A
20
Offer Curve
T2
Y
U2
G
U1
Offer Curve
U0
F
Y2
E
T1
A
L
M
B
T0
Y1
T0
N
C
T1
Y0
X
X
O
T2
X0
X1
X2
Each point along offer curve means the
equilibrium import and export in certain exchange
rate
T0Export LA( OX0),Import EL( OY0)
T1 Ex MB( OX1),Im FM( OY1)
T2 EX NC( OX2),Im GN( OY2)
21
General Equilibrium in International Trade
T1
Y
A1
A
T
Equilibrium international exchange rate
Y0
B
Y1
Improvement of trade condition for (That of B
fixed)
Offer Curve of A moves left
X
O
X0
X1
Exports decrease greatly, but exchanged imports
stay unchanged
22
Chap 5, Factor Endowment

• Used to solve problems left behind by Ricardo
  Reasons for comparative cost difference
• Put forward by Swedish Economists Heckscher and
  Ohiler, so it is also call the Heckscher-Ohlin
  model, or H-O model, also known as factor
  endowment theory.
• It offers good explaining to international trade,
  so still works as main stream theory in
  international trade.

23
Chap5. 1. Heckscher-Ohlin Model
One, Assumptions
1. Two nations, two products, two factors ( L and
K ), 2 22 model.
2. Fixed Endowment, free mobility of factor
domestically, non-mobility internationally.
3.Same technical level between two nations ( Same
production function, same endowment for same
products in two nations)
Two, Notions
Factor intensity
Factor abundance
24
?? Heckscher-Ohlin Theorem
Each country exports the good intensive in the
country's abundant factor, and imports the good
intensive in the countrys scarce factor.
????????,??????????
??????????????
????????????????????
??????????????????????
??????????? ??????????? ??????
25
Trade influence and benefits
Production Possibility curve in case of two
factors
Due to diminishing substitution of factors,
marginal opportunity cost will increase, thus
production possibility curve is concave.
Y
U
Its slope is the opportunity cost in point E.
Equilibrium in E means marginal opportunity cost
in E. Domestic equilibrium is equal to domestic
price ratio.
E
Y0
T
equilibrium
X
O
X0
26
Trade influences 1) price
Domestic equilibrium pre trade. T is domestic
exchange rate
Y
After trade, the country export X, and its
domestic supply of X decreases, and price X
rises.
E
T
T?T1
X
O
T1
A
27
Trade Influences 2) production
Since the international price of X is higher than
that of domestic, production of X will increase,
therefore, production of Y must decrease.
Production combination will move to S.
Y
E
Y0
Since in S, the international exchange rate is
equal to domestic marginal opportunity cost, the
countrys production of X will not increase. With
the increase of marginal opportunity cost, there
will not be perfect specialization.
T
S
Y1
X
O
X0
X1
T1
A
28
Trade Influences 3) Consumption
After trade, consumers in the nation will be able
to consume at international price T1, as budget
constraint moves to U1, consumption combination
moves to C. U1 is higher than U0, so consumers
are better off.
Y
C
U1
E
U0
T
S
X
O
T1
A
29
Equilibrium
Y OY1-OY2Y1Y2Im
Y
C
Y2
U1
E
U0
X OX1-OX2X2X1Ex
T
S
Y1
X
O
X1
X2
T1
30
Benefit from Trade
Trade makes a nations consumers better off, but
have different influences to producers.
PX
?HGP1 The export producers surplus after trade.
SX
Ex
G
F
P1
DifferenceP1GEP0 Trade will benefit export
producers.
E
P0
H
?HEP0 The export producers surplus pre trade
DX
QX
O
Q0
Export Producers
31
Influence to import competitive producers
PY
?P0EK Producers surplus before trade
SY
E
P0
DifferenceP0EFP1 Trade will harm the import
competitive producers
P1
F
H
K
DY
Im
QY
O
?P1FK Producers surplus after trade
32
Chap. 5. 2. An empirical study of H-O model

• 1, Leontif Paradox
• According to the statistical analysis of Leontif,
  he found out that U.S.A., which is a capital
  abundant country, imports more captial-intensive
  products, while exports more labor intensive
  goods. This is a paradox to H-O model.
• 2, Explain the Paradox
• Inverse of resource intensity
• Trade barriers
• Human resource
• Natural Resources

H-O??????
33
Chap5.3., Expansion of H-O model
International trade affects price production and
consumption, but will it also affect the factor
payoff and price? Basing on H-O model, we solve
problems of trade to income distribution.
Stolper-Samuelson Theorem
Factor Payoff Price(P)Marginal products of
factors(MP)
Value of marginal products (VMP)
W PMPL
R PMPK
34
Short term Factor non-mobility
Because of non-mobility, trade will only affect
price
????(X)????
W PXMPL
W increases
All export producers payoffs increase
R PXMPK
R increases
????(Y)????
W PYMPL
W Decreases
All import producers payoffs decrease
R PYMPK
R Decreases
35
Long term Because factors are mobile, trade not
only affects price, but also the marginal
products.
???????,???????
??????????????
???????????????
??????????????????????
??????,???? ??????,????
?????????,??/??????
?????????,?????????
?????????????
36
Continue
Payoff of the factor intensively used by
exporters will increase
????
W PXMPL
PX??,MPL??
W??
R PXMPK
PX??,MPK??
R?
??????
W PYMPL
PY??,MPL??
W?
R PYMPK
PY??,MPK??
R??
Payoff of the factor intensively used by
importers will decrease
37
Continue
Labor market is in equilibrium before trade
WX WY,RX RY
Factor market will also form equilibrium after
trade
WX increases,WY also increases RX decreases,RY
also decreases
In long term, after trade, Payoff of the factor
intensively used by exporters will increase, and
Payoff of the factor intensively used by
importers will decrease, this is try in any
industry.
38
Factor price equalization theory
Explains the influence of trade among countries
to the factor price in two countries.
B????
A????
W?
???
W?
???
W??
W??
??
R?
R?
R??
R??
39
Chap 6, New Trade Theory

• Changes in international Trade
• Increase of Intra-industry Trade
• Development of trade within developed countries

Trade between goods with similar or same
endowments
H-O cannot explain
Amendments of assumptions of H-O model, develops
to new trade theory
40
General points of new trade theories

• Imperfect Competition
• Differentiated products (Intra-industry trade)
• Monopoly power ( price difference)
• Large Scale Economy
• Internal ( enterprises)
• External ( Industry)

41
Intra-industry trade and cross- industry trade
Domestic (Rich in Capital)
products
Foodstuff
Cross-industry trade
Intra-industry trade
Foreign (Rich in labor )
42
Trade due to external scale economy
One, in case of perfect competition
P
P,C
MC1
S1
AC1
P1
D1
Q
q
O
O
q1
Q1
Before trade, supply and demand (S1,D1)determine
equilibrium price (P1), the MC and AC are MC1 and
AC1.
43
Reason of trade is because of the price change
due to external scale economy
Output from enterprises stay unchanged
Enlarge of industry, supply, supply increases to
S2
AC decreases
P
P,C
MC1
MC2
S1
S2
AC1
AC2
P1
P2
D2
D1
Q
q
O
O
q1
Q1
Q2
Meanwhile, market price falls, and trade happens
Foreign demands increase, demand curves moves
International price stays at P2
44
?? Trade Equilibrium at external Scale of economy
Y
Production curve of increasing return to scale
diminishing marginal opportunity cost
Suppose the production scale of two nations
change, production combination moves to J and H,
trade according to same exchange rate (T1) before
trade
H
U1
U
E1
E
Suppose X and Y are two products in same industry
T1
J
T
X
O
T2
Suppose other conditions are same for two
nations, equilibrium point is E
Trade is due to the price advantage of X when
industry scale is expanded.
45
Trade due to Internal Scale of Economy Imperfect
competitive market
P,C
Due to scale of economy, average cost falls,
enterprises will trade
No monopoly profit
Demand curve and marginal income curve move
right, but slope is less( more elasticity)
E
P1
P2
AC
AC2
D2
MC
D1
Q
O
Q1
Q2
Price (P2) in short ter is higher than average
cost (AC2), enterprise have monopoly profit
MR2
MR1
Suppose marginal cost stay unchanged
46
Long term equilibrium
Scale of economy causes trade, which consequently
increase consumer surplus( welfare improves),
better specialization
Short term monopoly profit
New firm enter
P,C
Expansion of industry scale lower average cost,
and competition eliminates monopoly profit.
P2
AC2
Demand of the products decreases
P3
AC
MC
D2
D3
Q
O
Q2
MR2
Q3
MR3
47
Krugman Model

• Three relations
• Relation of Quantity of producers and Average
  Cost The bigger the quantity of producers, the
  less a single producers output, and AC is higher
• Relation of Quantity of producers and price The
  more the producers, the more serious the
  competition, the lower the price.
• When price is higher than AC( has monopoly
  profit), other producers will go into the
  industry, while in other cases, when price is
  lower than AC( monopoly profit is negative),
  producers will go out of the industry.
• In graph, relation of quantity of producers and
  AC is CC curve( in positive relationship),
  Relation of Quantity of producers and price is PP
  curve in the graph ( in negative relationship).
  In long term, quantity of producers is determined
  by the cross of two curves.

48
Continued
Equilibrium??
P,C
CC
AC2
P1
E
Loss, producers go out, N decreases
AC1
P2
PP
N
O
N0
N1
N2
Monopoly profit exists, new producers go in, N
increases
49
Trade Equilibrium
Scale of economy lower the AC, has price
advantage, export
P,C
CC1
The lower AC makes CC curve moves right, new
producers go in, N increases
CC2
E1
P1
E2
P2
Scale of economy causes lower price, bring with
trade, improve consumers welfare, make
producers specialized, scale of economy
expands, and more choices for consumers.
PP
N
O
N1
N2
More competition means lower price
50
Products life cycle model ( technical transfer)
Ex
t
O
Im
Trade happens due to the technical difference,
explains intra-industry trade in different time
USA
UK
China
51
Chap 7, Economic growth and international trade
Solve problems of the influence of economic
variation to international trade
Resource of growth
Increase of factors and technical improvements
Increase of GDP
Y
Results of growth
A1
A
O
X
B
B1
52
Balanced growth and unbalanced growth
import replacing growth
Y
Y
Same Slope
F
export expansion growth
A1
C
E1
A
A
E
X
X
O
B
B1
O
B
D
G
Balanced Growth
Unbalanced growth
53
Economic growth and trade
Trade volume does not affect international
exchange rate ( Trade condition )
Trade condition stay unchanged, import and export
change in same ratio
Growth and trade of small country
Y
Y
L
C
U1
L
U1
M
N
C
F
F
A
U0
A
U0
T
N
M
G
H
G
H
T
X
X
O
B
D
O
B
D
T
T
IRG
EEG
54
RybcZynski Theorem
The scale of decrease of Xs cost is larger than
that of Y, so production of X will increase till
equal to marginal opportunity cost ( slope of T
), output of Y is absolutely lower.
Y
C
A
Y1
Y2
X
O
B
D
X1
X2
T
T
55
Growth and trade for Large Country???????
Import replacing growth
Welfare improves, HJgtGF, due to international
market price of Y falls, trade condition
improves, the certain amount of the nations
products could exchange for more import goods.
Y
C
H
U1
U2
J
K
G
A
U0
F
E
T2
T1
T0
X
O
B
D
56
Export expansion growth
Welfare improves. JKgtFE, more export products
are needed in exchange for a certain amount of
import goods, trade condition deteriorates.
Y
U2
H
C
U1
K
G
J
A
U0
F
E
T1
T2
T0
X
O
B
D
Export of X increase for large country, which
causes international market price of X falls,
trade condition changes.
57
Immiserizing growth
Y
U0
U1
C
A
T1
X
O
B
D
T
58
Chap 8, Protectionism and Policies
When free trade can make two countries better
off, why should there be trade protection?
One, Policies of the mercantilism
?????????????,???????????????????
????????
??????????????????????
???????, ??????
59
Two, Protection theory of List
There should be different trade policies in
different stages of economic development.
60
Trade protectionism of Keynesian
Aggregate Demand C I G X
Aggregate Supply C S T M

??
??
????
??
??
??
??
????
Equation of Aggregate Demands Y C I G
(X-M)
Net Export
61
Trade Multiplier
Consumption Function CCabY
YCabYIG(X-M)
????
????
???Ca?I?G
YbY(X-M)
MPC X Income
Y-bY(X-M)
1 1-b
Y
(X-M)
1 1-b
Let
k,Yk(X-M)
In order to increase Y, needs to increase (XM),
or the exports, and decrease imports, then Y is
increased by K times.
62
New Trade protectionism
Strategic Trade policy
Prisoners dilemma
B
confess
Not confess
A
confess
5,5
1,10
Not confess
10,1
0,0
Nash equilibrium
63
Strategic Trade policies
Air bus
?????????????????????
Produce
Not produce
Boing
Produce
-5,-5
100,0
Not produce
0,100
0,0
Air bus
produce
Not Produce
Boing
Produce
-5,20
100,0
Not Produce
0,125
0,0
64
Other reasons for trade protection

• Protect young industries
• Protect industries whose average cost not higher
  than that of international market price in future
• Cost should be lower than the income of the
  industry in future
• Industry must be free join an exit
• Promote capital formation and industry
  multilateral
• Improve trade conditions and international
  balance of payments
• Increase employment and sustain high salary
• Promote economic development of developing
  countries.

65
Chap 9, Trade management theories and policies
Quantity limitations
Limited import
Tariff
Price limitations
Purchase control
Non-tariff Barriers
Financial control
TBT
Export credit
Improve export
National Guarantee of export credit
Export subsidy
Dumping
66
Tariff
Basic Ideas(P.113116)
ERP
V -V
ERP
V
V (Final price of exports Duty) price of
Imported material
V price of foreign end productsforeign material
price
Under a certain nominal tariff rate, the lower
the nominal tariff rate attached to raw material
and medium goods, the more the protection level
to the end products
67
Economic effects of tariff
Solve problems of the influences on import price,
and welfare of import producer, consumer and
government.
1.Partial Equilibrium of small nation
68
?loss of consumer is abcd
? producer surplus is increased a
?government tariff income is c
PY
S
A
Lossabcd(Consumer)
Benefita(producer)c(government)
?net befefit -(bd)
G
H
P t
?imports decrease after tax
a
c
b
d
F
P w
C
e
?price increase
B
D
Price of imports after tax
QY
O
Q1
Q2
Q3
Q4
Price in international market
Import before tax
69
2.Partial equilibrium analysis of large countries
Pt1Domestic decreases after tax
PY
S
t
Pt
Pt1
a
c
b
d
Pw
f
PW1
D
QY
O
Q1
Q3
Q4
Q4
PW1Imports of large countries decreases,
international market price falls
70
Influence of tariff to some American products (
in Million dollars)


71
Non trade barreiers
Global Quota
Regional Quota
Absolute Quota
Import Quota
Importer Quota
????
Tariff Quota
Import license
Voluntary export restraint
72
Economic effects of import quota
P
S
PQ
a
b
c
d
PW
D
Q
O
Q1
Q3
Q4
Q2
73
Situation of Import Quota
Chinese products that carry with quota
?????????????
VER
The voluntary export limitation of Chinese
products
74
Policies aiming at improving export
Export Subsidy
?????????
????
Direct Subsidy
Indirect subsidy
????
?????
75
Dumping
price discrimination ????
Economic Effects
Foreign markets has more demand elasticity than
domestic market
P,C
Domestic price is higher than price in foreign
markets
PD
PF
MC
MC
DF
MRF
DD
MRD
Q
Q
O
Foreign markets
Domestic market
76
China and Anti-dumping
Chinese-made television sets
Latest cases
Issues of Chinas role as market economy
Chinas implement of anti-dumping
77
Revolution of Chinas foreign trade
???????
78
Chap 10, Economic Integration, theory and practice
Definition of WTO
Forms of economic integration
Preferential Tariff Area
Free Trade Area
Customs union
Common Markets
Economic Union
Perfectly economic integration ?
79
Theory of customs union
Trade creation
Once the zollverein is set up, as tariff is
cancelled, trade which was formerly banned by
tariff will generate
After the cancellation of tariff, foreign
products are imported, domestic supply increase
to S1
P
Consumer surplus increases P0EFP1
S
S1
E
P0
Producers surplus loses P0EGP1
F
P1
Net trade off increase EFG
G
Imports
D
O
Q
Q0
Q1
Q2
80
Trade diversion
After integration, trade with non-members will
be transferred to member countries.
Producer surplus decreases h
P
S
Consumer surplus after integration increases
hcad
PA
Tariff loss ab
PCT
a
c
d
h
PB
Net benefit (cd)-b
b
PC
D
Q3Q4Imports of B
Q
Q1
Q2
Q3
Q4
O
Q1Q2Imports before integration
81
Economic Integration in Europe
82
Economic Integration in Europe and China-Euro
Economic Relationship
Economic Integration in Europe
China-Euro Economic Relationship
83
Chinas participation into International Regional
Economic Integration
??????
84
CEPA
APEC
85
Construction of China-ASEAN Free Trade Area
ASEAN
86
CAFTA
87
Yunnan and CAFTA
88
(No Transcript)
89
Free Trade Area between China and other countries
China and Chile2004?12?????????05?9?????????11?18
???FTA??,?2006?7?1???,??????????????????,???????97
?????10???????????
04?6?,???????????????(SACU,?????????????????????)F
TA???
China and Gulf countries ????????????????????????
05?4?????? ????06???FTA
China and Pakistan 05?2?????????????????????4?,??
???2006?1?1??????????????,??2008?1?1????2246??????
??8?,?????????FTA??
90
China and Korea05?3??????FTA??????????????????
China and India05?4????????????????
China and Iceland05?5???????????????????????
China and Australia 05?5????????11?,?????,??????
China and New Zealand 04?12?????,05?7?????12?1???
??????????06?4?10???????????,????????????(FTA)????
???,?????????????????????
91
Chap. 12, WTO
Introduction (p.184194)
Doha Round
China and WTO