Standard Trade Model

11 Key excerpts on "Standard Trade Model"

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  eBook - ePub

  International Trade

  New Patterns of Trade, Production and Investment

  • Nigel Grimwade(Author)
  • 2020(Publication Date)
  • Routledge

    (Publisher)

  Chapter 2 Basic Theories of International Trade CHAPTER OUTLINES: Introduction. Classical Theories of Trade - absolute advantage, comparative advantage, the empirical evidence. The Terms of Trade. The Factor Proportions, Heckscher-Ohlin Theory of Trade - the Leontieff Paradox, other empirical evidence. Increasing Opportunity Costs. Indifference Curves. General Equilibrium. The Factor Price Equalisation Theorem. Demand-Side Theories of Trade. Economies of Scale. Technology-Based Theories of Trade - technology-gap trade, the product life-cycle model of trade. The Case of Monopoly. Conclusion. Introduction Why do countries engage in trade? What benefits does trade bring to countries? What products will a country export and what will it import? What determines the pattern of its trade? And, since trade is the result of specialisation, what determines the products in which a country specialises? Moreover, how does a country's pattern of specialisation and trade change over time? These are some of the questions which have pre-occupied trade theorists for over two centuries. In this chapter, we shall identify some of the theories which economists have developed (and the various theoretical tools which they have used in the process) in an attempt to answer these questions. This chapter is primarily concerned with the basic or more conventional theories which set out the gains which countries can expect from specialising in those activities in which they are relatively efficient. These constitute necessary 'building blocks' for understanding the more esoteric models which have been developed in recent years, which take into account some of the complexities of trade in today's world. These newer trade theories are not considered until Chapter 3. Usually, the term 'conventional' is restricted to the theory of trade expounded by the Classical and Neo-Classical schools of economic thought

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  Neoliberalism

  A Critical Reader

  • Alfredo Saad-Filho, Deborah Johnston(Authors)
  • 2004(Publication Date)
  • Pluto Press

    (Publisher)

  While the preceding assumptions are necessary to make the story work, they are not sufficient. We also need to consider the implications for employment. Countries exposed to trade may lose jobs in some sectors and gain them in others. Some firms may prosper, while others may go out of existence. None of this excludes the possibility of overall job losses in the countries involved. So we need something more. Standard theory solves this problem by assuming that competitive markets automatically provide jobs for all who desire them. When this is carried over to trade theory, it ensures that the international adjustments will not lead to any overall job losses, because those who lose one job are presumed to find another. This is the third pillar of the conventional theory of international trade.

  To summarise. Standard trade theory relies on three claims. First, that any deficit in a nation’s trade would provoke a fall in its export prices relative to its import prices, i.e. a fall in its terms of trade. Second, that such a fall would increase the money value of exports relative to that of imports, i.e. would improve the trade balance. This requires the relative physical ratio of exports to imports to rise more than the fall in relative price of exports to imports, i.e. that the ‘elasticities’ be propitious. And third, that once the dust has settled, no nation would suffer overall job losses from international trade. These three propositions constitute the neoclassical theory of comparative cost advantage. They collectively imply that nations will always gain from international trade.

  It is important to distinguish between the theory of comparative cost advantage and the theory of comparative factor advantage. The two are often confused, although they are conceptually distinct. The theory of comparative cost advantage implies that international trade between nations will settle at balanced trade with no departure from full employment in both nations. Even if one of the nations had absolutely lower costs when trade opened, and was therefore able to run an initial trade surplus, the theory of comparative costs says that free trade would automatically eliminate this initial superiority. To understand what this implies, suppose that when trade opened we were to rank all industries in the surplus nation according to their degree of absolute cost advantage over their foreign competitors. Then, for free trade automatically to erode the trade surplus, the industries with the least initial absolute advantage would be the first to lose their cost advantage (we will shortly return to the mechanism proposed by the theory). This would have to be repeated on the survivors, until the tide of red ink had proceeded sufficiently far up the chain to make the initial trade surplus disappear altogether. The final survivors would then be from those industries at the top of the chain, i.e. from those with the greatest initial ‘comparative’ cost advantage. Obviously, the reverse would hold for the country whose initial absolute inferiority in trade led it to begin with a trade deficit. Here, the most favoured would be the industries with the least initial comparative cost dis

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  Evolving Patterns In Global Trade And Finance

  • Sven W Arndt(Author)
  • 2014(Publication Date)
  • WSPC

    (Publisher)

  This view of the world is more than a little at odds with reality. While reduction of trade barriers and opening of national economies have brought fresh winds of competition, market structures in many parts of the world have evolved in the opposite direction, with fewer firms and more concentration of economic power, with capture of economic policy by private interests in a variety of instances, and with non-trivial information asymmetries and assorted externalities. There may be grounds for arguing that freeing markets from the trade restrictions that remain may be less urgent than freeing markets from the welter of other distortions and barriers to efficient utilization of the world’s productive resources.

  This chapter begins by reviewing the basic case for free trade in terms of the workhorse factor-proportions model. The conclusions of this “benchmark” model are then stress-tested by removing each of the key assumptions in turn. Not surprisingly, the case for free trade becomes less airtight, as a variety of specific market situations arises in which trade-based barriers such as tariffs or non-trade interventions such as production and other subsidies can produce superior welfare outcomes. But these theoretical findings of superiority do not necessarily translate into interventionist policy prescriptions, because in many cases the costs associated with practical implementation may exceed the expected benefits.

  2. The Benchmark Model

  The benchmark model assumes perfect competition in all markets, constant returns to scale and no externalities or market distortions of any kind. It focuses on “comparative advantage” based on differences across countries in resource endowments and across industries in factor intensities. Countries are assumed to be differentially endowed with the main factors of production—land, labor (skilled and unskilled) and capital—and technologies are assumed to differ across products ensuring that the factors will be combined in different proportions at given relative factor prices.

  The essential conclusion of this model is that the economic welfare of each country is best served when it focuses on producing goods and services that make intensive use of the factor or factors of production with which it is relatively well-endowed. Each will then produce more than it consumes of goods and services in which it has comparative advantage

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  International Trade Theories and the Evolving International Economy

  • Richard Anthony Johns(Author)
  • 2013(Publication Date)
  • Bloomsbury Academic

    (Publisher)

  In the H-O model it follows clearly that international trade would continue even if there were perfect transmission of knowledge and techniques and absolute freedom for the costless migration of factors. For the identity of techniques is part of the model in any case, and factor price equalization shows that there would be no incentive for factor endowments to become uniform, so resulting in the cessation of trade. The H-O model, therefore, deserves a place at the centre of international trade theory. It is, in fact, the simple model of international trade when things are reduced to most elemental terms (not necessarily the most elementary terms). However, simplicity is one thing, simplisticity is another. Despite the fact that its analysis is superior to classical theory, which emphasised labour efficiency differentials as the basis for comparative advantage, it is still subject to at least three fundamental objections. (i) It has nothing to say about antecedent development in the pre-trade economies. As R. Robinson (1956a: 173-4) has commented: Comparative advantage theory, to be of the slightest analytic value ... requires an explanation of when and how production functions come to differ. The problem is to stop the theory from degenerating into a surface explanation, capable of explaining anything ex post and nothing ex ante. (ii) Its assumption set makes the basic theory 'exiguous in its reference to reality'. Ford (1963: 470-1) argues that (1) a large number of production functions are subject to a condition of increasing returns to scale; (2) production conditions are not everywhere identical; (3) factor-intensities can vary for each and every commodity; and (4) there are international differences in the quality of the productive agents, and conditions of factor ownership and taste.

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  Introduction to International Economics

  • Dominick Salvatore(Author)
  • 2014(Publication Date)
  • Wiley

    (Publisher)

  CHAPTER T H R E E The Standard Trade Model After studying this chapter, you should be able to: ■ Draw a production possibility frontier with increasing costs ■ Draw a set of community indifference curves ■ Show a nation in equilibrium without international trade under increasing costs ■ Show the basis and the gains from trade with increasing costs ■ Explain the meaning of the terms of trade ■ Explain the relationship between international trade and deindustrializa- tion in the United States and other advanced countries CHAPTER OUTLINE 3.1 Introduction 3.2 The Production Frontier with Increasing Costs 3.3 The Marginal Rate of Transformation 3.4 Community Indifference Curves 3.5 Equilibrium in Isolation 3.6 The Basis and the Gains from Trade with Increasing Costs 3.7 Equilibrium-Relative Commodity Prices with Trade Case Study 3-1 Specialization and Export Concentration in Selected Countries 53

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  The International Economy

  • Peter B. Kenen(Author)
  • 2000(Publication Date)
  • Cambridge University Press

    (Publisher)

  The model cannot yield testable hypotheses about the commodity composition of trade; a more complicated model, with many countries and goods, is needed for that purpose. Nevertheless, the simple model can be used to illustrate the law of compar-ative advantage and show the gains from trade. It also provides testable hypotheses about the general character of trade. The model is developed in three steps. First, we will show how production, consumption, and prices are determined when there is no trade. Second, we will show how trade affects a single country. Third, we will look at two countries together to show how world prices are determined and how the gains from trade are shared between the trading countries. 24 Comparative Advantage and the Gains from Trade Quantity Price S H D H S W S T T P' E' E Q C 0 P H' H F' F Q' C' FIGURE 2-2 A Tariff on a Single Good The demand and supply curves, D H , S H , and S W , are reproduced from Figure 2-1. Do-mestic production is OQ initially, domestic consumption is OC , and imports are QC . A tariff that adds P P to the import price raises the domestic price to OP . Therefore, it raises domestic production to OQ and reduces domestic consumption to OC . Imports fall to Q C . Producer surplus was OE P initially and is OH P with the tariff. Consumer surplus was P E T initially and is P HT with the tariff. Hence, producer surplus rises by P E H P , and consumer surplus falls by P E HP , which is E E HH bigger than the rise in producer surplus. But the government collects P P of tariff revenue on each imported unit, or F FHH in total tariff revenue, and returns it to consumers by cutting some other tax. Therefore, the net welfare loss is E E HH − F FHH , or E F H + FE H . The production effect, QQ , also called the protective effect, contributes E F H , which reflects the substitution of high-cost domestic output for low-cost foreign output.

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  Palgrave Handbook of International Trade

  • David Greenaway, R. Falvey, U. Kreickemeier, Daniel Bernhofen, David Greenaway, R. Falvey, U. Kreickemeier, Daniel Bernhofen(Authors)
  • 2016(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  The factor content of trade can be measured using either the domestic technolo- gies, technologies at the location of production or based on the actual content of consumption. 33. This specification assumes that countries have identical technologies. 34. Applying the concept of log-super modularity, Costinot (2009) has taken an impor- tant step towards a unifying theory of comparative advantage. His approach is a bit more restrictive than Deardorff’s (1980) autarky price formulation but has the advantage of focusing just on the trading equilibrium. 35. Harrigan’s approach builds on Kohli (1991) and Harrigan (1995). See Harrigan (2003) for an in-depth discussion of empirical approaches to the neoclassical trade model that build on the Rybczynski relationships. 36. See also Levchenko (2007) and Levchenko and Do (2007) for alternative approaches that examine the role of institutions on trade patterns. References Balassa, B. (1963) ‘An empirical demonstration of classical comparative cost theory’, Review of Economics and Statistics, XLV, 231–38. —— (1965) ‘Trade liberalization and comparative advantage’, The Manchester School of Economics and Social Studies, XXXIII, 99–123. —— (1966) ‘Tariff reductions and trade in manufactures among the industrial countries’. American Economic Review, LVI, 466–73. Baldwin, R. (1971) ‘Determinants of the commodity structure of US trade’, American Economic Review, LXI, 126–46. Bernard, A.B., J. Eaton, J.B. Jensen and S. Kortum (2003) ‘Plants and productivity in international trade’, American Economic Review, XCIII, 1268–90. Bernhofen, D.M. (2005) ‘The empirics of comparative advantage: overcoming the tyranny of nonrefutability’, Review of International Economics XIII, 1017–1023. Bernhofen, D.M., and J.C. Brown (2004) ‘A direct test of the theory of comparative advantage: the case of Japan’, Journal of Political Economy, CXII, 48–67.

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  Contemporary Issues in Development Economics

  • B. N. Ghosh(Author)
  • 2001(Publication Date)
  • Routledge

    (Publisher)

  7 The pure theory of international trade, globalization, growth and sustainable development: Agenda for the future

  M.R. Aggarwal

  Introduction: the historical perspective

  The pure theory of international trade, as expounded by classical, neoclassical, and modern economists, seeks to provide an explanation of the factors, originating both from demand and supply side which tend to influence the observed pattern of trade flows and specialization among nations, and their welfare implications measured in terms of Pareto optimality, for each of the trading partners and for the world as a whole. The principle of comparative advantage was developed by Torrens (1808) and used by Ricardo (1817) to explain the pattern of trade and the benefits flowing from free trade and competition. Ricardo argues that trade between countries arises because of the relative differences in the pre-trade prices of the goods, on the assumption that the relative production costs of goods and hence relative prices (PX /PY ) in a closed economy, under competitive equilibrium conditions in both commodity and factor markets and a simple production function with the single input and constant returns, are entirely determined by relative labour inputs (LX /LY ), i.e.:

  and the differences in the pre-trade domestic price ratios of the goods and the comparative advantage and disadvantage, in costs between countries will be mainly due to differences in relative labour productivity. The theory assumes, among other things, immobility of the factors of production internationally, with negligible transport costs, and unchanged technology, factor inputs and demand patterns.

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  Introduction to International Economics

  • Dominick Salvatore(Author)
  • 2012(Publication Date)
  • Wiley

    (Publisher)

  4. Out of all the possible forces that could cause a difference in pretrade- relative commodity prices between nations, Heckscher and Ohlin isolate the difference in factor endowments (in the face of equal technology and tastes) as the basic determinant or cause of comparative advantage. International trade can also be a substitute for the international mobility of factors in equalizing the returns of identical factors across nations. 5. The first empirical test of the H–O model was conducted by Leontief in 1951 using 1947 U.S. data. Leontief found that U.S. import substitutes were about 30 percent more K-intensive than U.S. exports. Since the United States was the most K-abundant nation, this result was the opposite of what the H–O model predicted and became known as the Leontief paradox. Recent studies provide strong support of the basic H–O model. 6. Even if two nations are identical in every respect, there is still a basis for mutually beneficial trade based on economies of scale. When each nation specializes in the production of one commodity, the combined total world output of both commodities will be greater than without specialization when economies of scale are present. With trade, each nation then shares in these gains. 7. A large portion of international trade today involves the exchange of differentiated products. Such intra-industry trade arises in order to take advantage of important economies of scale in production, which result when each firm or plant produces only one or a few styles or varieties of a product. The more similar nations are in factor endowments, the greater is the importance of intra- relative to inter-industry trade. 8. According to the technological gap model, a firm exports a new product until imitators in other countries take away its market. In the meantime, the innovating firm will have introduced a new product or process.

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  International Economics

  • Dominick Salvatore(Author)
  • 2019(Publication Date)
  • Wiley

    (Publisher)

  First, we explain the basis of (i.e., what determines) comparative advantage. We have seen in the previous chapters that the difference in relative commodity prices between two nations is evidence of their comparative advantage and forms the basis for mutually beneficial trade. We now go one step further and explain the reason, or cause, for the difference in relative commod- ity prices and comparative advantage between the two nations. The second way we extend our trade model is to analyze the effect that international trade has on the earnings of fac- tors of production in the two trading nations. That is, we want to examine the effect of inter- national trade on the earnings of labor as well as on international differences in earnings. These two important questions were left largely unanswered by Smith, Ricardo, and Mill. According to classical economists, comparative advantage was based on the differ- ence in the productivity of labor (the only factor of production they explicitly considered) among nations, but they provided no explanation for such a difference in productivity, except for possible differences in climate. The Heckscher–Ohlin theory goes much beyond that by extending the trade model of the previous two chapters to examine the basis for comparative advantage and the effect that trade has on factor earnings in the two nations. Section 5.2 deals with the assumptions of the theory. Section 5.3 clarifies the mean- ing of factor intensity and factor abundance, and explains how the latter is related to factor prices and the shape of the production frontier in each nation. Section 5.4 presents the Heckscher–Ohlin model proper and illustrates it graphically. The effect of interna- tional trade on factor earnings and income distribution in the two nations is examined in Section 5.5. The chapter concludes with Section 5.6, which reviews empirical tests of the Heckscher–Ohlin trade model.

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  Turning Point

  End of the Growth Paradigm

  • Robert Ayres(Author)
  • 2014(Publication Date)
  • Routledge

    (Publisher)

  In the public policy arena, what should be a serious debate has been caricatured as a simple-minded conflict between progressives (waving a banner misleadingly labelled ‘freedom’) versus reactionary protectionists who are either racist or parochial. Because the assumptions underlying the standard theory are less than transparent, the weaknesses of the theory – and their implications as regards its relevance – are not obvious to the public. In short, trade theory has not been used to clarify the issues, but more often as a weapon in this rather one-sided conflict.

  If capital, labor and resources stayed at home while goods (and services) were traded freely without any restriction, free trade in an unchanging world would ensure that every good and service would be produced as cheaply and efficiently as possible. Thus maximum possible aggregate output would be achieved at the minimum aggregate cost. Since overall goods availability would be maximized and prices minimized, it follows that each country would maximize its static welfare, ceteris paribus. Given the validity of the assumptions, the conclusion follows. I do not argue that point; it is mathematically provable. I do argue, below, that some of the core assumptions are so unrealistic that the major conclusions do not hold in the real world.

  This chapter is intended to explain why the protectionists may have a much better economic case than their academic opponents have acknowledged. I confess to some embarrassment over the likelihood of being seen as a defender or ally of H Ross Perot or the late Sir James Goldsmith. I do not admire either their works or their words nor would I defend their over-simplifications or their narrow-minded xenophobia. Nevertheless, I think they are more nearly right than wrong on this ticklish issue.

  The Implications of Standard Theory

  The conventional theory of free trade in its basic form says that free trade increases the efficiency of the economy and therefore increases the size of the economic ‘pie’, which is ipso facto good for everybody. Free trade advocates go so far as to assert that a country that opens its markets to all comers will benefit even if its trading partners do not reciprocate. The beneficiaries, in this case, are mainly consumers, of course. The free trade theory also qualifies as a paradigm. It embraces many and diverse models, but all of them share certain common features and omit others. The basic notion is simple and quite long in the tooth. Trade theory is really a theory to explain the benefits of specialization based on ‘factor endowments’. Its theoretical development began two centuries ago, more or less, with Adam Smith, David Hume and David Ricardo. Ricardo is famous for his observation that, based on natural endowments and ‘comparative advantage’, the English should manufacture cotton cloth for export to Portugal and the Portuguese should produce wine for export to England. Adam Smith made similar comments with respect to France. The basic argument was, and still is, that if each country specialized in producing and exporting the product or service it produces most efficiently, while importing the rest of its needs from other producers, then all countries would be more prosperous than otherwise. In other words, economic interdependence is more efficient than autarchy.

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