International Trade Theory (ch.1-4)

Related Notes:

CHO1 Introduction

Merchantilism(precious metal are wealth)—Classical trade theory(Advantage&Comparative Advantage)—Neoclassical trade theory(H-O theory)—New trade theory(Economies of scale)

CH02 Comparative Advantage

2.1 The Mercantilists’ Views on Trade


The stock of precious metals possessed by a country.

Gains from the trade:

The wealth of one country must come at the expense of another country.

Mercantilist policy

Strict government control over economic activity to ensure a positive trade balance.

2.2 Trade based on Absolute Advantage: Adam Smith

Basic assumption of absolute advantage :

  • Two nations, two goods and one factor(Labor)(2 ×2 ×1)
  • Perfect competitive market
  • Labor is homogeneous
  • Constant returns to scale
  • Complete factor mobility within a country and complete immobility between countries
  • No government barrier and transport cost

Basis of Trade

Nations differ in their ability to produce goods.

Pattern of Trade/Policy

Specializing in the production.


Absolute advantage requires one country to be better at production of one product and another country to be better at production of another good for specialization and trade to be mutually advantageous.

2.3 Trade based on Comparative Advantage: David Ricardo

Basis of Trade

The difference of production cost.

Gains from Trade

Gains from trade is determined by range of exchange.

Opportunity Costs

Opportunity cost holds that the cost of an item is the amount of another item the must be given up to release sufficient resources to produce one more unit of the first item.

Production Possibility Frontier with Constant Cost

The concept of relative commodity price MRT = dC/dW= Pw/Pc

Trade with the PPF Model

Exchange rate: 70:70

CH03 The Standard Trade Model

3.1 PPF with Icreasing Costs

Increasing opportunity costs

  • Non-homogenous factors of production.
  • Factors that are not used at constant fixed proportions in production.

(PPF figure)

  • Production possibility frontiers are different because the two nations have different factor endowments or resources at their disposal or they use different technologies in production.
  • The marginal rate of transformation (MRT) increases as more units of good X are produced.

3.2 Community Indifference Curves

A community indifference curve displays the combinations of two products that offer the community the same level of satisfaction.

3.3 Equilibrium in Isolation

The equilibrium relative commodity price in isolation (or autarky) is given by the slope of the tangent.

3.4 The Basis and The Gains from Trade with Increasing Costs


Trade in the standard model

Neither country completely specializes in the production of X or Y.

  • Complete specialization is an outgrowth of constant opportunity costs.
  • Since constant opportunity costs do not hold, complete specialization is unlikely to be seen.

3.5 Terms of Trade

The terms of trade is the ratio of the index price of a nation’s exports to the index price of its imports.[P(exports)/P(imports)]

  • For Nation 1 in the previous example, PY/Px was its terms of trade.
  • For Nation 2 in the previous example, Px/PY was its terms of trade.

Appendix: Offer Curve

The offer curve: also called the reciprocal demand curve, it shows the quantity of one type of product that a nation will export (“offer”) for each quantity of another type of product that it imports.(The offer curve is derived from the country’s PPF. )

(figure of offer curve)

CH04 The Heckscher-Ohlin and Other Trade Theories

4.1 The Heckscher-Ohlin Theory

4.1.1 The Heckscher-Ohlin (H-O) theory is based on two subsidiary theorems:

  1. The H-O theorems
    • A nation will export the commodity whose production requires the intensive use of the nation’s relatively abundant (and therefore, cheap) factor and import the commodity whose production requires the intensive use of the nation’s relatively scarce (and therefore, expensive) factor. (In other words, relative factor abundance drives comparative advantage and the pattern of trade.)
  2. The factor price equalization theorem
    • International trade will bring about equalization in the nominal and real returns to homogenous factors across nations. (In other words, wages and other factor returns will be the same after specialization and trade has occurred.)

4.1.2 Basic assumption of H-O theory:

  • Two nations, two goods and two factors(K & L)(2 ×2 ×2)
  • The two goods have different factor intensities
  • The two nations have different factor endowments
  • The two nations have identical technology and societal preferences.
  • Perfect competitive market
  • Constant returns to scale
  • No government barrier and transport cost

The nations differ in that one is relatively labor abundant while the other is relatively capital abundant.

  • The country with the greater K/L ratio is defined as being capital abundant.
  • The commodities produced differ in factor intensity.

4.1.3 The Formal Heckscher-Ohlin Model



4.1.4 Factor Price Equalization

In the H-O model of trade, the pattern of trade is driven by relative factor abundance.

The Stolper-Samuelson theorem demonstrates that an increase in the relative price of a commodity raises the return of the factor used intensively in its production.(At the same time, the return of the relative scarce factor will fall.) Thus, the labor abundant country will see an increase in wages, but a fall in the return to capital while the capital abundant country will experience the opposite pattern of change. ————H-O-S theorem

Appendix: The Specific-Factor Model

The only change of assumption: Labor is mobile, while capital is immobile.

4.2.Economy of Scale and International Trade

A greater division of labor and specialization becomes possible.

4.3 Trade based on Product Differentiation

  • Differentiated products
  • Intra-industry trade may arise from product differentiation.
  • Reasons for intra-industry trade
    • Allows producers to exploit product specific economies of scale.
    • Allows consumers to benefit from product variety that would not exist without international trade.

4.4 Technological Gap and Product Cycle Model of Trade

  • Advanced industrialized countries develop and introduce new products
    • While only one country possess the product, it possesses international monopoly power and will be the sole exporter of the product.
  • As the technology producing the product becomes more widespread, production will spread to other nations.
    • This moves international trade to a standard comparative advantage framework.
  • As production becomes standardized, the original introducer of the product loses its technologically based comparative advantage in the production of the product and becomes an importer of the product.

The product cycle model of trade

4.5 Transportation Cost Models of Trade

  • The introduction of transportation costs into the standard model of trade may eliminate a country’s comparative advantage in the production of an item.
  • Transportation costs may provide an advantage for trade between geographically close countries.

4.6 Environmental Standards and Trade

  • A nation’s environmental standards determine the level of acceptable pollution that may be generated from production.
  • Strict environmental standards are expected to raise the costs of production.
  • In order to maintain comparative advantage, a nation may reduce its environmental protections.
  • This concern has spurred calls for inclusion of environmental legislation along with agreements to lower barriers to trade.

作者: 公子小白



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