Advanced International Trade Theory and Policy
Advanced International Trade Theory and Policy ECON 433
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Advanced International Trade Lecture 3 Prof Tybout September 12 2006 Lecture outline Winners and losers a closer look Production possibility frontiers Autarky equilibrium when output isn t fixed Trade and the gains from specialization when output isn t fixed Relevant reading Caves Frankel and Jones chapter 2 A brief recap Last time we considered an economy that could produce a xed amount ofwheat and a fixed amount of cloth Some households specialized in the production ofone good others in the other good We characterized the autarky equilibrium then we introduced another economy and characterized the trading equilibrium At any relative price of Wheat the demand for wheat and cloth is C A determined as the tangency point with a social indifference curve C1 V 5 P2 P1 P0 W1 W W Sup ly of wheat By trying different relative prices for vxneat one can trace out a demand curve for wheat Demand for wheat matches supply for wheat at only one relative price This price reflects the slope of the social indifference curve that passes through the production point Demand for wheat l The trading equilibrium Foreign demand Home demand Global demand home foreign demand W W W V7W Global demand falls short of global supply at p0 and global demand exceeds global supply at p1 so the free trade price must lie between these two prices Winners and Losers A Closer Look The relative price of wheat rises at home and the C economy reaches a higher social indifference curve O pworld I70 Q a Winners and Losers A Closer Look Farmers earn Ifam WPw and face the budget constraint IfW PWWPCC WPW PW CIf quotquot PWW W PC PC PC PC When the price ofwheat rises this constraint pivots outward Winners and Losers A Closer Look Opening to trade drives up the relative price of wheat causing farmers budget line to pivot outward C 0i I Q a Winners and Losers A Closer Look Weavers earn weave 5P0 and face the budget constraint 1mm PWWPCC C IW M ePlW 57PlW PC PC PC Note that 1me IWW PWW 1365 I When the price ofwheat rises the weavers budget constraint pivots inward Winners and Losers A Closer Look Opening to trade hurts weavers because it drives down the relative price of cloth causing their budget line to pivot inward C n C l Winners and Losers A Closer Look Could the winners compensate the losers Suppose prior to trade we were to reallocate productive capacity between the two types of households so that each household could produce the consumption bundle it chooses in autarky This must be feasible because markets clear in the autarky equilibrium Winners and Losers A Closer Look Winners and Losers A Closer Look Now opening to trade generates gains for everyone C 5A pworld I70 V7 W Both types of household are able to reach higher indifference curves at the free trade prices Winners and Losers A Closer Look C 7 world Winners and Losers A Closer Look Instead of reallocating endowments of wheat and cloth before opening to trade the government could achieve the same outcome by taking income away from farmers and giving it to weavers after opening to trade C Trade without redistribution puts households on the red budget lines i pworld I70 V7 Winners and Losers A Closer Look Instead of reallocating endowments of wheat and cloth before opening to trade the government could achieve the same outcome by taking income away from farmers and giving it to weavers after opening to trade A Taxing farmers income shifts their posttrade budget line in and generate revenue with which to subsidize pworld 70 Winners and Losers A Closer Look Aside from equity issues why would a government want to do this Do we see this type of policy in practice Gains from Specialization Thus far we have seen that there are gains from trade when a country doesn t adjust the mix of goods it produces Gains from exchange Next we will see that if an economy s production mix adjusts in response to changes in relative prices there are additional gains from trade Gains from specialization Production Possibility Frontiers Production possibility frontiers PPF show the maximum amount of any one good that an economy can produce at each feasible production level for the other goods PPFs re ect factor endowments and technologies Typically PPFs are convex because of heterogeneous factors and technologies Production Possibility Frontiers Plot Goats g Bushels Beans per goat number of beans sacrificed MRT 1 2 20 100 2 4 18 450 3 6 16 267 4 8 14 175 5 10 12 120 6 12 10 083 7 14 8 057 8 16 6 038 9 18 4 022 10 20 2 010 Total 110 110 Production Possibility Frontiers De nition Marginal Rate of Transformation For any point on the PPF gives the number of units ofone good gained per unit sacri ced of the other good That is it is the slope ofthe PPF Production Possibility Frontiers Number of plots Total number of Total number of devoted to beans goats beans 0 110 0 1 108 20 2 104 38 3 98 54 4 90 68 5 80 80 6 68 90 7 54 98 8 38 104 9 20 108 10 0 110 23 Beans 1969 lt9 2 6 99 0933ng Goats Profitmaximizing production point How much of each good will producers choose to supply if The relative price of goats is i G 1 The relative price of goats is PG 1 PB 2 P General principle ifMRTgt P G go for beans othenNise go for goats B Profit Maximizing Production Point Implication production takes place at the point on the PPF where the slope MRT matches the relative price of beans Anywhere else somebody can do better by switching production to the other good Beans Beans Q S lt P N N Q Vb q qd Goats Goats Autarky Equilibrium Implication the relative supply of goats is a positive function oftheir relative price Convex homothetic indifference curves imply that relative demand for any good is a negative function of its relative price from previous lecture Autarky Equilibrium PoPs 3935 0905 QoQs Note Equilibrium relative prices can be found by focusing on a single market as we did last lecture or by equating relative supply to relative demand as we do here 29 Autarky Equilibrium QB Slope p Trading Equilibrium Suppose the world price of goats exceed the autarky price and this country opens to trade QB Trading Equilibrium Things to note Since the economy reaches a higher SIC with trade it would have possible to make everyone better off with trade by sharing the gains But without income redistribution trade creates some losers Who are they In the trading equilibrium the marginal rate of transformation and the marginal rate of substitution both match the relative price ratio In the trading equilibrium the value of exports matches the value of imports The fact that the economy can adjust its production mix leads to a second basic source of gains from trlacde g ains from specialization refer to graph next sI e Gains from Trade The total gain in social welfare U2 U0 can be decomposed into gains from exchange U1 U0 and gains from specialization U2 U1 Slope pW Global Price Determination Pan DGDG DBDB SGSG sBsZ SG GoatsBeans Advanced International Trade Lecture 19 Prof Tybout November 4 2006 Outline Quotas The MultiFiber Arrangement Trade policy versus domestic policy Shortrun effects of import competition who loses hisherjob Policy issues Relevant reading Caves Frankel and Jones chaps 10 and 13 The Multifiber Arrangement Background A patchwork of bilateral trade agreements mainly involving the US Canada the EU and Norway as importers of textiles and apparel and various developing countries as exporters Started with quotas on Japanese exports in 1957 codified as MFA in 1974 Imposed quantitative restrictions quotas country by country on textile and apparel exports to each importing country Tariffequivalent of quotas in the mid1980s was estimated at 56 percent for the US and 33 percent for the EU The Multifiber Arrangement WTO members signed the Agreement on Textiles and Clothing ATC effective in 1995 which mandated a phaseout ofthe MFA quotas over the period 19952005 The phaseout Stage 1 1995 VVTO members must integrate 16 percent of the total volume oftheir 1990 imports Stage 2 1998 must integrate an additional 17 percent Stage 3 2002 an additional 18 percent Stage 4 2005 remaining 49 percent Cost of the MFA in Europe EU consumers paid roughly 12 billion more in 1997 for textile and clothing products than they would have in the absence of the quotas abc About 65 billion ofthis represented quota rents that were passed on to the holders ofthe import licenses 0 some of the remainder represented extra producer surplus a and a substantial amount represents ef ciency loss The annual cost of each job saved in the EU textiles and clothing industries by delayed implementation was 28000 for the textile industry and 41000 for the clothing industry MFA phaseout Although the developing world should have been happy overall about the elimination of MFA quotas many countries including lndia Egypt and Pakistan worried that free trade would make things worse Why MFA phaseout Did the phaseout affect trade ows The United States Commerce Department said Friday that in the first three months of the year United States imports of textile and apparel products from China rose more than percent from a year ago NYT April 4 2005 In some crucial categories previously governed by the old MFA like underwear cotton trousers and cotton knit shirts the increases were even more stark jumps of as much as 2000 percent NYT April 4 2005 Afterthe lifting of worldwide textile trade quotas last January Chinese textile exports to Euro e ballooned 82 percent in the first four months compared wit the same period last year according to Chinese customs statistics NYT September 6 2005 MFA phaseout Government reactions The Bush administration announced on Friday that it would impose new quotas on cotton shirts trousers and underwear NYT May 14 2005 The proposed new restrictions would limit growth in Chinese imports of the affected garments to 75 percent above the level that exports reached in the previous 12 months the lowest possible undertrading rules NYT May 17 2005 The move toward new quotas on Chinese clothing exports is a quotbetrayal of the fundamental spirit of trade liberalization espoused by the WTOquot said a spokesman for China s Ministry of Commerce quotThe Chinese government reserves the right to adopt further measures under the WTO framework NYT May 17 2005 MFA phaseout European garment makers complained that their livelihood was in peril But after an agreement was signed in June to limit export growth of Chinesemade clothes to 8 percent to 125 percent a year European retailers complained that orders they had placed before the deal took effect were held up at ports because quotas for 2005 had already been filled NYT September 6 2005 China and Europe agreed to share the burden of absorbing the unlicensed shipments stranded at European ports China would subtract halfthe amount from its export quotas for subsequent years and Europe would absorb the other half NYT September 6 2005 Tariffs versus production taxes or subsidies Slope 1tp X lfthe objective is to move the production point from A to B a tariff on X imports a tax on Yproduction or a subsidy on Xproduction could be used A production tax or subsidy would move consumption from Eto D but a tariff would move consumption from Eto C resulting in a larger welfare loss Subsidy to an importcompeting industry partial equilibrium analysis Sdomes c Ddomestic mm W ab total cost of subsidy a gain to producers b deadweight loss P 11 Subsidy to an exporting industry partial equilibrium analysis S domestic domestic 1SPW a x c d P W Q abcd total cost of subsidy abc gain to producers b deadweight loss Tariffs versus consumption taxes or subsidies If the objective is to reduce consumption of Xfrom X7 to X2 a tariff on Ximports a tax on Xconsumption or a subsidy on Yconsumption could be used Slope 1tp Consumption point with a consump ion tax or subsidy Consumpt on point with tari X A tariff would result in a larger welfare loss because it would induce produces to move into Xproduction ie from A to B That is a tariff would induce a reduction in the gains from specialization Consumption tax versus tariff An exercise Use partial equilibrium diagram to demonstrate the superiority of consumption taxes over tariffs as a means to discourage consumption Tariffs versus domestic policies The general point Tariffs are a blunt instrument They affect both consumption and production Ifthe objective is to in uence on one ofthese better policy tools are available To affect production use a production tax or subsidy To affect consumption use a consumption tax or subsidy Subsidy versus tariff for an import competing industry m Example Bush imposed a 30 percent tariff on imports of many types of steel in 2002 Steel users were hurt by the higher prices and protested A subsidy would have avoided this collateral damage Why wasn t a subsidy used Subsidy to an exporting industry Example Cotton The United States subsidizes cotton production In this industry however the US is major exporter 20 percent of global production 30 percent of global exports Because the US is so big in this market and because the subsidies are so large world prices are affected Subsidy to an exporting industry Cotton subsidies continued The government has guaranteed cotton rices to US producers regardless of global prices T e support price has been above world prices encouraging extra production Between 1999 and 2002 they received 20 billion Oxfam stud Every acre of cotton farmland in the US attracts a subsidy of 230 or around five times the transfer for cereals In 2 0102 farmers reaped a bumper harvest of subsidies amounting to 39 billion double the level in 1992 Subsidy to exporting industry Redistributive effects of cotton subsidies the largest 10 percent of cotton farms receive more than three quarters of total payments In 2001 ten farms between them received subsidies equivalent to 17 million Oxfam 2004 Estimates bythe International Cotton Advisory Committee ICAC using its World Textile Demand Model indicate that the withdrawal of American cotton subsidies would raise cotton prices by 11 cents per pound or by 26 percent The World Bank estimates that cotton producers in developing countries face annual losses of some 95 billion as a result of subsidies benefiting rich countries Some ofthe affected countries rely heaVIly on cotton earnings especially in Africa and South Asia Subsidy to exporting industry Cotton subsidies and dispute mediation at the WTO Brazil filed a complaint with the WTO arguin that the US was exceeding the target price it agreed to in 19 2 and that the subsidies depressed world prices In April 2004 the WTO found in favor of Brazil and ruled that the US should remove the subsidies within 6 months The US and the National Cotton Council objected The US Claim World prices are low because of growing supply elsewhere and falling demand with recession and a shift toward synthetic fibers The US filed an appeal in October that delayed the requirement that it comply but the WTO has recently March 2005 upheld the ruling The Dispute Settlement Body on 21 March 2005 adopted the Appellate Body andganel reports on the United States39 subsidies on upland cotton WT web site Job loss and import competition Linking job losses and trade How do we know which job losses were created by foreign competition or reductions in exports Lori Kletzer 2001 winners and industries at least in the short ru Identify industries that are importcompeting and call all 39ob losses in these sectors due to closures layoffs and ankruptcies traderelated losers are associated with n Distinguish 3 levels of import competition high medium and low High competition industries ranked in the top 25 percent in terms of import share Increases during 197994 Medium and low definitions not provided Patterns of job displacement Mean job loss among high import competition group 59 per annum among medium 62 among low 42 Are high job loss sectors also high job creation sectors Do importcompeting sectors also generate jobs through exports loss rate Radiu and Eievisiun Mutur VEhtEiES and 350900 Unbaianced exporter Office and accuunting 40626 Baianced importer Biast furnaces Baianced exporter Scientific instruments Tires and inner tube 6454017 Patterns ofjob displacement Refining the industry clasification GrubeILloyd index of intraindustry trade for industry j 1 IXr MrIWM Modified index 1 XrMWrm Balanced trade I 1 pure importcompeting 2 pure exporting 0 Implications of refined classification Three ofthe top 5 US export industries are members ofthe high importcompetition group electrical machine mo or ve icles and electronic compu ing equipment The other two are medium import competing aircraft and nonelectrical machinery Nonetheless unbalanced importers dominate the group of high importcompeting industries Together they account for 605 of the group s total job displacement but only 55 percent of employment Do they also dominate job creation The presumption is that protection would reduce job destruction in these sectors Characteristics of displaced workers High importcompeting sectors employ workers at all wage levels But the low wage industries tend to be unbalanced importers while the high wage ones are balanced or even exporters as predicted by the HO model Low wage industries are also Heavily reliant on women as employees 6580 of displaced in these sectors are women Employ a lot of high school dropouts 2550 of displaced in these sectors are dropouts versus 710 in the high wage industries Post displacement outcomes 197999 losses gt 30 percent High Import Medium Import Low Import Competition Competition Competition Share reemployed 0637 0654 0668 at survey date Average percentage 0132 0126 0086 change in earnings Share with no 036 034 038 earnings loss or earning more Share earnings 035 036 034 losses gt 15 percent Share with earnings 025 025 026 Post displacement outcomes con nued Workers displaced from high import competition sectors Are less likely to be reemployed Suffer larger average earnings losses upon reemployment Why Its not the import competition per se Its their individual characteristics low education advancing age high tenure minority status marital status PoHcyissues Do those displaced by import competition deserve special assistance They are no different from others with similar characteristics who lose theirjobs But theirjob loss is partly attribute to a policy that benefits others PoHcyissues What form does assistance take Trade Ad39ustment Assistance Act of 1962 frequently revised thereafter gives an extra year of unemployment compensation to tradedisplaced workers who enroll in training programs NAFTATAA augments TAA by covering those who lose theirjobs in an industry directly hurt by NAFTA or an industry that supplies an industry hurt by NAFTA Same benefits as TAA Policy issues D0 training programs work Alternative policy options Job search assistance Subsidy to wages of reemployed workers Advanced International Trade Lecture 21 Prof Tybout November 16 2006 Outline Trade with a domestic monopolist Trade with international oligopoly the Boeing Airbus rivalry Relevant reading Caves Frankel and Jones chap 12 including appendix Trade policy with a domestic monopolist P m anapaly P M AC MR In the absence of foreign competition the usual monopoly equilibrium prevails How would free trade affect this equilibrium Trade policy with a domestic monopolist Pm anapalyPW i i Q The monopolist no longerfaces a downwardsloping demand curve Its market power is eliminated Trade policy with a domestic monopolist What about trade sub39ect to a tariff P The marginal revenue curve becomes the dotted line Monopoly power is curtailed The domestic price becomes the tariffdistorted world price The shaded areas constitute a net welfare gain why P V 1tPW quotmmquot PW I M Ac I Q Monopoly power and foreign competition Case study Mexican Tradel quot quot quot In the 1980s Mexico underwent a dramatic trade liberalization Between 1985 and 1990 effective protection rates went from weighted average of 31 to 9 for manufactured goods license coverage ratios went from 92 to 11 Producers with large market shares who had enjoyed a relatively large amount of monopoly power exhibited the largest reductions in prices Monopoly power and foreign competition Tariffs Market Share and Markrups I IIIIIII 4quot I ll zzzzmzzyt I Source Grether 1996 Mexico 198590 Trade Liberalization Market Structure and Manufacturing Performance in M Roberts and J Tybout eds Induxtrial Evolution in Develop39n Court 71 Moro Patterns 0 f Turnover Productivity and Market Structure 1996 Oxford Oxford Univ 39ex ersity Press 7 Monopoly power and foreign competition Do we really see firms expanding output when confronted with foreign competition costs Not usually Firms typically either contract output or shut down depending upon expectations about the future and entryexit Trade policy with a domestic monopolist Suppose instead we had gone from autarky to trade with a quota Would the same procompetitive effect have obtained A quota and a domestic monopolist WWW N P P quam PW I M AC PW R total domestic demand I W qum MR quota 1 Q The quota preserves in large measure the domestic producer s monopoly power It shifts his demand curve in some but leaves intact the downward slope and thus leaves intact the incentive to hold back production and drive up price 10 Domestic monopolies when imports are imperfect substitutes Implicitly we ve been assuming that monopolists produce a good that is a perfect substitute for imports But more tygically a domestic monopolist will produce an imperfectsu stitute Think of Renaut as a domestic monopolist in Honduras confronted with imported autos from Europe an the US When this the case the monopolist retains some market power in the face of trade even free trade To diagram this case we need to distinguish firmspecific demand from total demand for products in the monopolist s industry Trade and monopoly power when imports are imperfect substitutes Mc I l I I I free trade I I I I I I I I I I I I I I I I I I l Qmanky Q I Qrm Me Free trade drives down prices and output may contract too Exit may occur When would this happen 12 Summary of trade and monopoly In all the cases we have considered heightened import competition reduces prices for the domestic monopolist Whether the monopolist expands or contracts output depends upon how much market power it retains Qualitatively the results we have seen apply not just to monopolists but to domestic firms with market power in general Import competition may induce exit if their profits are squeezed too much If some firms exit what happens to output at the remaining firms Oligopoly and trade policy Sometimes several dominant producers are located in different countries Then it is possible that the trade policies of each producer s government can give it a strategic advantage in the global market for its good Example Widebody aircraft The United States has long complained that French and German subsidies to Airbus give that firm an unfair advantage The EU counters that military research funding and tax breaks from local governments amount to Boeing subsidies Oligopoly and trade policy In the past several years the dispute has heated up The EU has provided Airbus with development subsidies for its new A380 superjumbo meant to go head to head with Boeing s 747 The US has recently withdrawn from its 1992 accord with the EU limiting the form and extent of subsidies to civil aircraft producers On October 6 2004 the United States lodged a complaint against European plane development subsidies to Airbus with the VVTO triggering a titfortat European objection to indirect US subsidies for Boeing Earlier this week Europe and the United States moved closer to a VVTO showdown over plane subsidies after Airbus said it had received quotlegally bindingquot government funding pledges for its newly launched A350 jet program from France Germany Britain and Spain Oct 21 2005 Oligopoly and trade policy Most recently Airbus has be beset by problems of its own making Airbus and Boeing have been in a longrunning battle over aircraft orders a contest Airbus has been losing elsewhere but not in Russia because of production delays for its A350 jet NYT Nov 8 2006 Citing production delays dogging the Airbus doubledeck A380 airliner the FedEx Corporation canceled its order for 10 cargo versions of the huge aircraft and in their place ordered 15 Boeing 777 freighters and took options on 15 more NYT Nov l l 2006 Oligopoly and trade policy But the trade dispute continues The United States on Wednesday filed an updated complaint with the World Trade Organization against European government spending on Airbus warning that the plane maker would break international rules if it accepted launch aid to build the new wide body A350 lnt l Herald Tribune Nov 15 2006 The negotiation remains snagged on the definition of state aid that is not allowed under WTO rules Boeing39s position is that the only major issue to be settled is launch aid under which it argues Airbus has received substantial amounts of state aid to develop new aircraft That aid must then be repaid when the aircraft begins selling The EU maintains that Boeing receives its own US government aid through military contracts and tax breaks given by local jurisdictions like Boeing Aircraft39s headquarters city Seattle Boeing rejects those charges and so far has refused to treat them as a tradeoff for launch aid in the negotiations lnt l Herald Tribune Nov 15 2006 Oligopoly and trade policy Technology Costs Boeing C cy Airbus 0 cy Tastes Demand P a byy Policy Boeing marginal costs after subsidy c 015 Why subsidies rather than tariffs Oligopoly and trade policy Cournot competition each firm takes the quantity supplied by its rival as given and chooses its profitmaximizing output level Boeing s total revenue is R a7byyy so its marginal revenue is MR a 7 by 72by Assume no subsidies forthe moment Profits are maximized by equating marginal revenue to marginal cost a by 2by 0 Or solving for y Boeing s profitmaximizing output level is a7 c 1 gtxlt y 212 2y Oligopoly and trade policy P whyquot P abyy y Oligopoly and trade policy Reaction functions tell us each firm s profitmaximizing output choice given the output level of its competitor When there are no subsidies these functions are 0 y Boein 9 y 212 2 a cl Airbus y 2b 2 Note that when a rival s output increases the optimal response is to cut back production Oligopoly and trade policy reaction functions aic aic y 1 Boeing y 2b 2 Oligopoly and trade policy There is one y y combination at which neither Boeing nor Airbus wishes to change its output choice given the choice of its rival This is the Cournot Nash equilibrium Why are other combinations ruled out Oligopoly and trade policy Now suppose that the US government reduces production costs by some fraction 5 perhaps with a tax break The new marginal production cost is c c l s Replacing cwith c for Boeing the graphs can be redrawn Oligopoly and trade policy With a subsidy Boeing chooses a larger y at each y Oligopoly and trade policy effects of a subsidy ygtllt aic b 1 I H C7 Boe1ngy 2b 2y H C 2b aic y Alrbus y 2b 2 die H C y Oligopoly and trade policy effects of a subsidy The home firm is encouraged to supply more by the subsidy and Airbus s optimal reaction to the reduction in demand for nonBoeing airplanes is to reduce y We end up with a new equilibrium at which the home firm has gained market share and the foreign firm has lost Oligopoly and trade policy effects of a subsidy More generally the effects of a subsidy are the following Production shifts away from foreign supplier toward the home supplier Price decreases because the reduction abroad is less than the increase at home The slope ofthe foreign reaction function would have to l in order for the two adjustments to be offsetting but it is in fact 2 Oligopoly and trade policy effects of a subsidy Surplus changes for all agents involved Consumers are better off because they face a lower price The us government has spent some money on the subsidy Some profits have been shifted from the foreign producer to the home producer If there had been scale economies this would have created additional benefits for the home producercountry It is possible that net home country welfare increases at the expense of the foreign country Advanced International Trade Lecture 13 Prof Tybout October 17 2006 Lecture outline The HeckscherOhlin model with exible technologies Product prices factor prices and factor endowments Issue How does technological change affect factor rewards The Edgeworth box and the PPF Relevant reading Caves Frankel and Jones chapter 6 including the Appendix Last time A small open economy producing a single good K Q1PW I L lr K1 L L lw Last time A small open economy producing a single good The economy s factor endowment determines the factor intensity of each producer Factor intensities determine marketclearing factor prices higher KL leads to higher wr Factor intensities in combination with endowments determine how much ofthe good is produced The world price of the good determines the level of w and r Last time A small open economy that potentially produces two ooods X and Y The HO model Output prices factor prices and endowments Given that the country produces both goods what factor prices will prevail What factor intensities kX KXLX ky KyLy How would a reduction in the global price ofXaffect factor prices at home Will the country produce both goods How much of each good will it produce The HO model Output prices factor prices and endowments Factor markets clear when KXKYE and LX Ly E Given factor intensities these conditions determine output levels in each sector Ki The HO model Output prices factor prices and endowments Ifthe country has more capital per worker it thus shifts production toward the capitalintensive good The HO model Output prices factor prices and endowments If the country has lots of capital per worker it produces only the capitalintensive good and factor prices must adjust as in the one good case already considered The HO model Output prices factor prices and endowments Summary of results thus far Given world prices for Xand Y there is a unit isocost line consistent with zero profits in the production of each good Associated with this isocost line are factor prices wr and factor intensities of production kx ky If a country s aggregate capitallabor ratio falls between kX and ky it will produce both goods If I gtk produce only the capitalintensive good have high wr I lt gx produce only the laborintensive good have low wr The HO model Output prices factor prices and endowments With more than two goods countries with different factor intensities may specialize in different subsets of goods The goods that they have in common may be produced with different capital intensities in different countries K The HO model Output prices factor prices and endowments With more than two goods countries with different factor intensities may specialize in different subsets of goods The goods that they have in common may be produced with different capital intensities in different countries K 1 1r The HO model Output prices factor prices and endowments What does this analysis say about the effects on wages w and returns to capital r when opening to trade drives down the price of the laborabundant good The HO model Output prices factor prices and endowments A reduction in the price oszhifts the unit revenue isoquant for good X outward driving up r and driving down w K QY1PYW The HO model Technological progress and factor prices Some analysts have argued that the increasing wage gap is due to skillbiased technological progress instead What is the logic behind this claim The HO model Technological progress and factor prices Consider first a country that has balanced technological progress Both factors enjoy wage gains High productivity countries have higher wages just as in the Ricardian model The HO model Technological progress and factor prices Now consider a country that has technological progress concentrated in its skillintensive goods Highskill workers gain and lowskill workers lose Why The HO model Technological progress and factor prices This scenario is consistent with the rising wage gap But is it consistent with other facts Ifthe technological progress is global we should see the same pattern everywhere But this should drive down relative prices of the skillintensive goods offsetting the productivity effect on wages Perhaps global demand for skillintensive goods is growing too Another puzzle this scenario implies that the skillintensity of production should be falling In fact it has been rising We need a change in the shape of the isoquants to do this The HO model Technological progress and factor prices Skillbiased technological progress concentrated in its skillintensive goods Skilled labor gains and unskilled labor loses while the skill intensity of good Y rises How might skill intensity rise in Xtoo Qx lPx