International Trade Theory

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• International Trade Theory
• 1. Mercantilistic Theory (Hume Colbert)
• a. Econ. philosophy of Colonial period
  (16th-18th ).
• b. Nations Wealth
• c. Why gold?
• d. Mercantilistic way to max. N.W.

2

• Economic Doctrine
• 1.
• 2.
• 3.
• Problems of Mercantilism
• Internal
• External
• Neomercantilism

3

• Benefits of Free Trade
• Production Possibility Frontier combination of X
  and Y that country A can produce.
• Above PPF not attainable Below PPF
  attainable but under-utilization of resource.
• Social Indifference Curve (SIC) combination of X
  and Y that can provide the same
• 
  amount of utility (satisfaction) to
  country A.
• 
  Concavity represent
  (Diminishing
• 
  marginal utility).
• 
  Outer curve (more
  satisfaction).
• 
  When PPF (production) SIC
  
• X
  (consumption) meets, we
  have
• 
  domestic equilibrium (EQ)
  w/o trade.
• 
  If A trades with B and
  import more X,
• 
  its like PPF and SIC of
  A are pushed
• 
  pushed outward to PPF
  and SIC with
• 
  new EQ indicating A can
  have more
• 
  satisfaction beyond their
  original
• 
  production capability
  (PPF).
• 
  
  

B
SIC
SIC
PPF
X
EQ(new)
PPF
EQ
A
Y
4

• 2. Absolute Adv. Theory (Adam Smith)
• Q Why we have to buy expensive domestic goods
• New definition of N.W.
• Proposition We should specialize in the good
  that
• we have an absolute advantage (
• ) and
  then trade each other.
• Q Who should specialize in what?
• (
  )

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• Suppose we have two countries/two industries.
• Each country is given ( ) units of
  labor.
• A. Mercantilistic B.
  Absolute Adv.
• U.S. U.K. U.S. U.K. total U.S.
  U.K. total
• Textile 10/Y 5/Y
• Wheat 4/B 10/B
• A. Mercantilistic case
• They need to produce both.
• B. Absolute Adv. Case
• Q Who should produce what (who has abs. adv.)?
• A

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• 3. Comp. Adv. Theory (Ricardo Torrens)
• Q What if a country has abs. adv. in both
  products?
• (
  )
• Opportunity Cost
• Proposition We should specialize in the product
• that we have a comp. advantage (
• 
  ).

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• Q Who should specialize in what product?
• 
  
• We need to compare opp. cost in order
• to know who has a comparative adv.
• Opp. Cost of A
• Opp. Cost of A in terms of B
• Opp. Cost of wheat in terms of textile

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• Assuming two countries have 100 units of labor
  respectively.
• 
  A. Mercantilistic B.
  Comparative Adv.
• Output
  Total Output Total
• US UK US UK
  Output US UK Output
• Text 5/yd 10/yd
  
  
• Wheat 4/bs 10/bs
• Mercantilistic case
  
• Comparative adv. case
• Q Who should produce what?
• 1. What is opp. cost of wheat i.t.o. textile?
• The of ( ) you have to
  sacrifice to produce 1 bs of ( ).
• 2. What is opp. cost of wheat i.t.o of textile
  in US?
• to produce 1 bs of wheat , US should
  sacrifice ( ).
• 3. What is opp. cost of wheat i.t.o. of textile
  in UK?
• to produce 1 bs of wheat, UK should
  sacrifice ( ).

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4. Factor Proportion Theory
(Heckscher-Ohlin Theorem)

• Q What commodity a country is likely to have a
• comparative advantage?
• H.O. Theorem
• A country will have a comparative advantage in
  
• the commodity for which they can use more
• abundant factor more intensively.
• (i.e.
• Leontief paradox

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• 5. Gravity Theory ( Jan Tinbergen)
• The Gravity Theory proposes that international
  trade will
• be decided by (
  often using GDP
• measurements) and ( )
  between two units as below.
• Where F is the trade flow, M is the economic
  mass (size) of each
• country, D is the distance and G is a
  constant. Using logarithms,
• the equation can be converted to a linear
  form as below
• ln(Trade Flow) a ßln (GDPCountry1)
  ßln(GDPCountry2)
• - ßln
  (Distance) e
• The model often includes variables such as
  income level
• (GDP per capita), price level, lanuage,
  tariffs, contiguity, and
• colonial history (whether Country1 ever
  colonized Country2
• or vice versa). Often used to investigate
  the benefits of FTA.

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6. International Product Life Cycle Theory

• 
  Maturity
• Growth
• Introductory
  Decline
• Demand new rapidly level
  off rapidly
• from U.S. Industrial
  Developing decrease
• Tech. U.S. slightly
  Product tech Process tech
• Monopoly diffused standard
  standard
• Prod. U.S. Industrial
  Leading Dev. LDCs
• location
  NICs
• US start at dramatically
  decline at negative
• Export later half increase
  later half

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7. New Trade Theory (Krugman) New Trade
theorists argue that consumers prefer to have a
variety but we have a trade-off between
variety cost (economy of scale)- more variety
higher costs.  
W/O Trade
W/Trade production
domestic available production
domestic available
variety variety
variety variety Country
1 A,B,C A,B,C 3
A,B A,B
4 Country 2 X,Y,Z X,Y,Z 3
X,Y X,Y
4 Total 6
3 4
4

(econ of scale) (more variety)
(Without trade, country 1 produces
varieties A,B,C and country 2 produces varieties
X,Y,Z.  Both countries produce more varieties
with less efficiency. With trade, both countries
can have more varieties (4 instead of 3) with
more efficiency (economy of scale due to
producing only two instead of three).  Country 1
will concentrate in A,B and country 2 will
concentrate only X,Y.) According to New
Trade Theory, since consumers want a diversity of
products and economies of scale that make
production cheaper, multiple countries can build
similar products, such as cars and trade each
other. (e.g. Sweden builds its own car and
exports, while also importing cars from other
countries.) This explains the benefits of
globalization and also explains why large
portion of trade has been made among the OECD
members (due to similar consumer preferences).
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• 8.Theory of Competitive Advantage (Porter)
• a. Factor Condition
• b. Demand
  c. Related,support
• Condition
  Industries
• d. Domestic Environment

GLOBAL COMPETIVENESS
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• Strategic Motivation for Exportation
• 1. Take advantage of segmented market.
• (different prices)
• 2. Use excessive capacity.
• 3. Take advantage of economy of scale
• (mass production cost reduction) .
• 4. Diversify the risk.
• 5. Tap a market before FDI.

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• Practice questions
• US
  UK
• Textile 5/yd
  10/yd
• Agr. (wheat) 4/bs
  10/bs
• 1.What is the exact meaning of opp. cost of
  textile in terms of wheat?
• 2.What is opp. cost of textile in terms of wheat
  in US?
• 3. What is opp. cost of textile in terms of wheat
  in UK?
• 4. Who has a comparative advantage in textile and
  why?

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• Practice questions
• US
  FRANCE
• Steel 4 labor/MT 5
  labor/MT
• Wheat 3 labor/BS 5
  labor/BS
• 1. What kind of product France should produce
  under Absolute Advantage theory?
• 2. What is the meaning of opportunity cost of
  wheat in terms of steel ?
• 3. What is opportunity cost of wheat i.t.o. steel
  in US?
• 4. What is opportunity cost of wheat i.t.o. steel
  in UK?
• 5. Who has comparative advantage in wheat and
  why?