Advanced International Trade Theory and Policy
Advanced International Trade Theory and Policy ECON 433
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Date Created: 11/01/15
Advanced International Trade Lecture 5 Prof Tybout September 19 2006 Lecture outline A digression Macro in the background The workhorse models an overview A simple Ricardian model A Ricardian model with increasing returns to scale Relevant reading Caves Frankel and Jones chapter 4 Reminder Problem set due Thursday Sept 21 A digression Macro in the background We typically assume balanced trade presuming that countries neither deplete nor build up their foreign exchange reserves This should be a reasonable approximation to long run equilibrium but deviations from this condition occur especially over short time horizons Why Macro in the background Private saving S Y C T National income with no trade Y C l G Hence without trade 8 l G T Savings investment scal deficit Macro in the background When an economy trades some goods and services produced are exported X and some goods and services consumed are imports M so the identity becomes Y Cl G XM Once again substituting into S Y C T we find SClGXM C TlX MT G Private savings private investment current account surplus scal surplus Macro in the background SlX MT G Given savings and investment an increase in the scal de cit lTG must be offset with an increase in the current account de cit 1XM lf investment is falling ll or savings is rising TS less adjustment in the current account de cit is necessary Macro in the background Selected Series from the National Accounts 20 15 M Balance on current a W account 8 10 Net privatesaving 5 5 M E H Fiscal surplus g o A l l l n g iv 55 0V 6 0H Sross private 9 5 9 3 19 19 19 omestlc Investment 10 7 Chronology During the 1990s the US gradually restored scal balance Nonetheless the trade balance began to deteriorate The reason was declining private savings and rising investment Falling investment and stabilizing savings should have pushed the current account back toward balance in the 00 s But beginning in 200001 the scal situation sharply reversed This turnaround re ected tax cuts and to a lesser extent new spending To import more than we export that is to consume more than we produce we must borrow from abroad 80 the current account deficit is matched by capital inflows ie foreigners are nancing the excess consumption of the United States 8 Workhorse trade models Overview Ricardian model Emphasizes interactions between technological differences wages and tra e Also useful for analysis of sectorlevel increasing returns to scale Downplays the role of differences in factor endowments differences in tastes market distortions Workhorse trade models Overview HecksherOhlin model Emphasizes differences in factor endowments relation between factor rewards and trade Useful for the analysis of trade taxes and subsidies Downplays differences in technologies differences in tastes Workhorse trade models Overview Speci c factors model Like HecksherOhlin emphasizes differences in factor endowments but Focuses on instances where different sectors use different factors Thus especially useful for analysis winners and losersshortrun reactions to trade shocks Downplays differences in technologies differences in tastes The Ricardian model Technology Suppose the world is made up oftwo agrarian economies each of which can produce 2 goods pork P and beans B using a single input labor L and constant returns production technologies Tastes As in earlier lectures assume identical homothetic tastes The Ricardian model Good Workers per unit output Home United States Pork 4 more generally up Beans 8 more generally ab Foreign Canada Pork 2 more generally azi Beans 1 more generally ab The Ricardian model L 40 units oflabor in the US and L 20 units of labor in Canada 61pr0be L40 61pr61be L20 The Ricardian model B United States B Canada 20 5 P 10 P 10 15 The Ricardian model PpPb Autarky equilibrium 12 QpQb The Ricardian model In autarky relative prices simply re ect productivity What purchasing power do workers have in terms of pork In terms of beans The Ricardian model Is there a basis for mutually advantageous trade between Canada and the US Absolute advantage if country A uses fewer resources to produce a unit of a certain good than does country B it has an absolute advantage in the production ofthat good relative to B Comparative Advantage If the opportunity cost of another unit of X in terms of foregone Yis lower in country A than in country B then A has a comparative advantage in X The Ricardian model Consider shifting one unit of pork production from Canada to the US This allows Canada to produce 2 more units of beans The US gives up 12 a unit of beans to produce the extra unit of pork So together the US and Canada are up 2 12 1 2 units of beans Whenever MRTs differ across countries the possibility for mutually beneficial arbitrage is there The Ricardian model PW Trading equilibrium 12 1020 Q1 The Ricardian model Trading equilibrium QB Qp United States Canada QP The Ricardian model When the US and Canada trade what happens to the US wage in terms of the price of pork w 7 1 1 4 P1 ap What happens to the U S wage in terms of beans iiiigtiiii i The Ricardian model Does free trade mean wage equalization w wPpap wa b gtllt w W 0 P w 1 w w 4 p o The higherthe world price of pork and the more productive the US workforce in pork production the better offare US workers The Ricardian model Suppose one country had been very small How would the effects oftrade have been different