International Economics and Trade Theories
International Economics and Globalization
International economics developed mainly due to globalization. Drivers of Globalization: ITC developments, transportation technologies, Multinational companies, and liberalization of trade and finance. Presence of companies in less developed countries help the development of international trade theories.
International Economics
Studies the production, distribution, and consumption of goods/services on a global basis between countries. It focuses on financial or monetary transactions across nations. International trade focuses on transactions involving the movement of goods and services across nations.
- Trade occurs -> transaction goes across borders.
- “Non-tradable” goods = buildings, lands
Trade Flow:
Goods and services Exports: sells to another county Imports: buys from another country
Free on Board: prices of the good as they were at the port of exit (excluding transportation and insurance costs) -> X Valuation/Carry, insurance, freight: prices of the good as they are at the port of entry that is including transportation and insurance costs -> M Valuation/Usually cif>fob: Find transactions cost of trade: PM (cif) – PX (FOB) = Transactions costs
Perspectives of International Trade Theory
Country perspective: Autarky: Situation without trade, self-sufficiency “With Trade”: Situation where trade occurs
Are there gains from trade?
Yes, if not they wouldn’t occur
Global perspective:
holistic view of the bottom line for all countries, net perspective of welfare effects of all countries as a result of trade.
How are those gains distributed globally?
When a country enters into trade with another country, it gains from trade. The gain from trade leads to income distribution in the country. ADVERTISEMENTS: … The government redistributes income between them in accordance with a defined welfare function.
Costs
Opportunity Costs: The benefit forgone of the next-best alternative to the activity you have chosen Normal price: Price expressed in terms of money/Relative price: Ratio of two product prices/Production possibility curve (PPF), “TRAFO”/Maximum amount of two goods that can be produced given the country’s fixed resources and technology. If it is located on the curve means full and efficient employment of resources, underneath is not productive and above cannot be produced. If the costs are constant, we have a linear function. Increasing, we have a convex PPF (Production Possibility Frontier). The slope of the PPF is the opportunity cost: how much to I have to give up un good Y in order to get an additional unit of X.
Indifference curves
Different combinations of two goods which consumers have for a fixed income and which provides the same level of satisfaction. The further away from the origin the better = higher welfare
Marginal Rate of Transformation (MRT)
Rate with which you can transfer one good into another given your production function. It represents the slope of the transformation slope. MRT = -MCx/MCy -> Marginal costs are defined in terms of opportunity costs, in a perfect market Price = Marginal cost. Therefore; MRT = Px/Py
Price Line
Measure the domestic price ratio of X and Y commodities. It’s slope is given by -Px/Py -> MRT = Px/Py
Production Point
Where production (PPF) meets indifference curve (IC -> what consumers want given a set budget)
Terms of trade
Relative price of imported and exported goods and services at which trade occurs between countries. It forms the relative world market place (line). The higher the ToT the higher the welfare for the economy. It measures the number of units of import a country can obtain for each unit it exports: ToT = Px/Pm -> Px price a country receives relative to Pm price it pays. The terms of trade determines the distribution of gains between the trading countries.
Balance of Payments
Record of all economic transactions resulting from the exchange of goods, services, income, and assets. It follows double-entry bookkeeping credit and debit. Credit: leaves a country and is held by nationals -> receipt from foreigners Debit: enters a country and is held by foreigners -> payment to foreigners/BOP -> Surplus (credit > debit) / Deficit (credit
Current Account
Record of all international transactions including payments for good, service, and others. Composed of: Trade balance goods / Trade balance services / income from foreign investments (interest rates and dividends) / Unilateral transfers: (Foreign aid gifts and retirement pensions from aboard. C.A Surplus: export (credit) > import (debit) -> trade balance surplus: lending money C.A Deficit: export (credit) trade balance deficit: borrowing money Trade Balance: Registers all goods and services that cross a national border Surplus means exports (valued f.o.b) are more than the imports (valued at c.i.f)
Is a deficit necessarily bad?
No, it can indicate full employment where demand exceeds supply and the difference has to be imported. It also depends on what goods we are importing; intermediate/ investments goods have a different meaning than consumer goods. Gains from trade are fully exploited. It also can indicate a lack of competitiveness and cause foreign debt caused by excess consumption over production. Foreign savings are needed to satisfy demand.
Financial Account
Record of financial flow from domestic assets to foreigners (capital export = debit) and financial inflows from foreigners to domestic (capital import = credit): Non-bank claims and liabilities / Portfolio/financial investments / Foreign direct investment. Financial outflow is a debit (national buys abroad) and an inflow is a credit (foreigner buys national). There is a surplus if inflow > outflow -> country is in debt and requires financing from abroad. A deficit means that the county has receivables on foreigners. A FA surplus (inflow > outflow) can finance a CA deficit (= finance part of domestic consumption) and implies capital inflow in which is a sign for a country’s attractiveness for financial investments. A deficit can indicate low-interest rates and unattractiveness for financial investments, the depreciation of the domestic currency or the money supply being reduced and inflationary pressure being eased. The causes of imbalances always should be analyzed.
Official Reserve Account
Foreign assets held by central banks to cushion against financial instability: Gold holdings / Foreign currency / Special drawing rights: foreign government bonds. If there is a deficit, it means that net foreign assets/currency held by the central bank is rising. If surplus, it means they are falling.
Balance of Payments Disequilibrium Refers to Subaccounts
A BOP deficit (surplus) means that debit entries exceed (are less than) credits, and this imbalance only applies to a particular component of the BOP. Autonomous transactions: transactions of individuals, firms, or government agencies done for their purpose. Autonomous BOP = CA + FA + stat. discrepancies -> CAN be imbalanced. Accommodating transactions: triggered by imbalances in the autonomous BOP. Aim: To balance BOP and balancing transaction: CA + FA + stat. discrepancies = -ORA / ORA Balance = Autonomous BOP -> ORA = CA + FA (Autonomous BOP) The ORA is the only account that indicates an “overall” deficit or surplus in BOP. BOP imbalance refers to the imbalance of autonomous BOP or imbalances in ORA. An ORA deficit indicates that international reserve assets are being built up to intervene in forex to stabilize own currency or that it may be incurring large debts to foreign central banks.
ERV=(V`-V)/V
being V` value added with tariff and V = value added with free trade// when is the ERP the highest?: 1. the greater the nominal tariff on the good, the greater ERP; 2. the lower the tariffs on inputs required to produce a final good, the greater the ERP; 3. if the nominal rate of protection is the same on all inputs and its output, the ERP = nominal protection// implications of ERP analysis: 1. ERP protects domestic producers, if products are sold domestically; 2. reflects the actual extent of protection of a domestic industry; 3. extent of ERP depends on the level of nominal tariff on the final good, intermediate goods, and inputs for a specific industry.
Free Trade vs Protectionism
FOR FREE TRADE: Gains from trade / Cost of deviating from free trade are large / Deviating from trade cause political costs / Arguments on welfare from protectionism are theoretical / AGAINST FREE TRADE: Infant industry protection / Counter unfair trade / Protect domestic jobs / terms of trade: gain national welfare with optimal tariff / correction of market failure
Arguments for Protectionism
Infant industry New industries suffer from an infant sickness: they are weak and vulnerable in this early phase. Long run, comparative cost advantage and need temporary protection to overcome their weakness Problems: Welfare increases must be high enough to offset losses during protectionism / Industry might have succeeded without protection, which means a waste of resources TEMPORARY PROTECTION, PERMANENT DUE TO LOBBYING
Terms of Trade
Assumption of imperfect markets and large country/small country. A large country can, by imposing a tariff on its imports, force the X countries to accept lower export prices. X prices fall, I prices rise. The large country can improve its ToT Problems: Most countries are small countries / Using an optimal tariff invites retaliation
Unfair trade
International trade is unfair when foreign producers can produce cheaper than domestic producers due to better technologies. Trade therefore only is fair if both countries have the same starting position. In order to remove the unfairness, the propose to implement protectionism to levy out the advantage Problems: Not a question of trade itself but of distribution / Neglects basis of gains from free trade: differences are sources of gains from trade
Protecting domestic jobs
Unfair competition from low wage countries leading to jobs being lost in industrialized countries. To counter this, protectionism is needed to compensate the disadvantage. Problems: Lower wages often justified by lower productivity. Only when wCorrect market failure
+ externalities occur when social benefits > private benefits and from a society’s point of view there is a provision. Export Subsidies are justified to ensure that the entity generates the + externality gets the benefits and will supply a sufficient amount of its output. No investment, no positive externalities for the domestic economy. For the firm to test the returns it must have a protected mark or subsidies. Problems: Neglect cost of protectionism / How quantitatively relevant are gains from this measure?
Strategic Trade Policies
Goal under market failure -> increase welfare for importing country beyond free trade level via targeted protectionism. Under imperfect competition in the world industry rent shifting is implemented to gain some of the excessive gains of the foreign country, rent creation supports market entry of domestic firms with export subsidies for examples. When influencing ToT in case of being a large country with optimal tariff settings implies rent shifting. Externalities need to be considered: Negative externalities: use export taxes to change ToT in favor of imports to avoid – externalities Positive externalities of export goods: protect that industry with tariffs/NTM to benefit from positive externalities Problems: Only works if other government does not retaliate / Only can be applied by a few dominating firms / As the government is involved lobbyism will be an issue
Trade Wars:
Protectionism can lead to retaliatory reactions by trading partners because one government is trying to gain at the expense of another one. One government thinks there is unfair trade, implements protectionism and that can trigger a protectionist spiral.
Trade Policy Protectionism
Trade issues. Protectionism: obstructing free trade and thus the gains from trade of a county. Aim: limit the competitiveness pressure from aboard. Instruments: traditional trade tariffs (developing countries) and the non-tariff measures (industrialized countries). Tariffs: Tax that is imposed on a good as it crosses the border into another country. Impact: Tariffs raise prices/limit the amount of quantity.
Average applied Tariff rates
by Region show the actually charged tariff rates Simple average bound tariff rate shows the level of agreed tariff binding in the countries. Developed countries, product lines are subject to bound tariffs
Types of tariffs rates:
Bound tariffs: legally binding maximums of a tariff resulting from trade negotiations / Applied tariffs: tariff that is actually charged on an import, can be lower than the committed “bound” ceiling / Simple average: same weight for all products, not taking into account how much of the products are traded / Trade-weighted average: average between bound and applied tariffs according to the volume traded / Tariff binding coverage: the % of products country has committed to set a tariff for in the WTO
Types of tariffs:
Import tariffs: used to protect domestic producers, generate government revenue, and deal with BOP deficits / Export tariffs: used for national security and to reduce the quantity supplied on the world market to keep prices of own products high, that improves the ToT but only if the country is large enough to influence the world market / Prohibitive tariff: raises the price of imported goods out of the market / Nominal tariff rate: rate that is applied to imported good
Levy of tariffs:
Specific tariff: fixed charge for each unit of imported goods / Ad valorem tariff: fraction of the value of imported goods / Compound tariff: combination of both
Welfare effects on “small countries”
Small country is established I reference to specific goods in world trade. If a country is small, it has no effect on the world market price: price taker. Domestic demand of this country insignificant regarding to world demand. The World price (Pw) not influenced by changes in domestic demands and the price paid for imports in the home marked rises by the full amount of the tariff to Pt = Pw + t.
Welfare effects on “large countries”
If a country X/I in large shares of the world supply/demand it can influence world prices through changes in quantity E/I. The optimal tariff -> raises the welfare level of the tariff-imposing country by the greatest amount relative to free-trade welfare levels / The effect on the ToT (ToT = (Px/Pm): due to high market power the large country can influence Pm with tariffs and shift the welfare losses due to tariff onto the exporting country. Sometimes benefit from it: the greater the tariff burden or the revenue paid by foreign exporter relative to the country’s deadweight costs incurred through the tariff, the more of the welfare loss will the foreign exporter carry. The price effect of a tariff in a large country with price effect in exporting country is: Exporting country lowers their price to Pt* as consumers in importing country have to pay a higher price due to tariffs, which will lower the demand. As importing country is a large country, a fall in import volume causes problems for exporters. To compensate part of the volume loss, foreign producers lower their price from initially Pw*Pt thus carrying part of the welfare burden of a tariff by paying more tariff revenue (e). If ToT effect € > Deadweight losses (b+d) the welfare of the larger county that is imposing the tariff will increase.
Welfare effects:
Exporting country carries part of the importing nation’s tariff burden. Welfare loss / Large importing country: redistribution from the foreign to the importing country / World welfare: falls as the gains for the large importing country imply a loss for the exporting country -> deadweight losses.
Non-Tariff Measures
Instruments to protect the domestic market. Many different forms -> difficult to assess the real level of protection of an economy. Not separate from industrial policy measures because these also claim to be domestic support measures. Less visible than tariffs but significant impact on trade although they don’t result in government revenue.
Tax-like measures:
Anti-Dumping: compensate unfair price policy from exporting country / Countervailing duties: compensate competitive advantage due to subsidies / Variable levies / Temporary import surcharges: crisis // Quotas: Quantitative restrictions on the import volume of a country for a specific time period. It is based on a decision of the policymakers. It temporarily pushes up import price and it is usually enforced by G (tariff revenue) issuing licenses or quota rights / Embargo: complete ban of certain good / Tariff rate Quota: allows a certain quantity of a good into a country at low or zero tariff rate, but applies higher tariff to quantities exceeding the quota / Voluntary Export restraint: indirect quota resulting from an exporting country voluntarily limiting its exports Quota Rent: Profit that accrues to whoever has the right to bring imports into the country and sell these goods in the product market
Who gets rent?
Government: government sell quota licenses = tariff / Domestic firms get licenses: government gives quota licenses to domestic producers or importers; the latter group gets quota rents. D+B, government gets no revenue. / Foreign firm gets license: give license to export into importing country a limited quantity and foreign producers get the quota rent. The net welfare loss in importing country would be d.
Export quota
Quantitative restriction on the amount a country exports to a rise world market price to have ToT effect, or to rise government revenue.
Voluntart export restrainsNegotations thtat exporter voluntarily limits export volume to the trading partners country. REASONS: avoid higher restrictions/ trade wars of trade partners, often on request of importing country that is usually a large economy and has the power to force exporters to VER. The result is that mostly exporters increase the quality of their products. Differences quotas and tariffs: tariff rents definitely accrue to the government and stay in importing economy, while quota renta do not necessarily remain in the economy/ With a tariff a large country can influence ToT and gain welfare. With quotas that is not possible. Other non-tariff measures: 1.technical barriers to trade TBT: refer to a countrys national standards. For example exported goods may have to meet different labelling anf technical standards. Motives are to protect environment, insure consumer safety, promote national security and guarantee product quality. 2types: health and safety standards: protect health and safety of citizens and protect domestic firms from foreign competition and labour environmental standards: global competition can lead to aggressive cutting of costs and forces companies to locate lower costs countries with lower environmental regulations. A global standard of about and environmental regulations should be implemented./2. Local content requirements: regulation by importing country that requires a specific fraction of a final good to be produced domestically. It might be in value terms or in physical units. Reasons: domestic input producers (increase demand on domestic market); domestic producers of the final good (less competition from fpreign countries); workers in domestic industry (increases demand for labour)// 3. Custom valuation practices: countries wanting to raise government revenue may instruct customs officials to raise estimates of the value of imports: include freight and insurance, set administrative fees or other taxes/4.government procurement policies: “Buy American”: requires Government to buy domestically-made products, unless comparable foreign products are substantially cheaper/How to measure overall rate of protection form tariffs of a country?1.Unweighted average of industry tariff rates: add up all rates and divide them by the number of tariffs//2.wighted average of industry tariff rates: reflects the relative importance of goods as imports and gives a precise idea of the overall level of protection from tariffs//Problem:none of both considers the trade that doesn’t take place because of the tariff for consideration of protectionism through NMTs//effective rate protection: measures the net protective effect on producers of any product due to the structure of protection both on its inputs and outputs. Looks at protectionist effect of a whole industry not only on final goods and considers tariff structure along
Neoclassical theories: trade is globally welfare enhancing and can improve situation for consumers, producers and countries/Types of gain which result in classical and modern trade theories/Static gains from trade; only accrue once. Gains in world output resulting from specialization and trade (classical)/Specialization Gains: This table shows the needed input (labour) per unit of output (Chopsticks/bikes). As china produces more chopstcks per unit of labour and EU produces more bikes per unit of labour, China will specialize in chopsticks and EU in Bikes. The global output increases. Important difference between output matrix (refers to productivity: the more gets produced the bette) and input matrix (refers to costs: the less is used the better)/Exchange Gains International exchange will occur with the cheapest or most efficient world supplier bc we assume a perfect competitively market with 100% information. Each country will exchange its cheapest produced good for the cheapest foreign produced good. Prices for imports are lower relative to the autarky case and consumers benefit bc their rent rises. If there is more demand than domestic supply, the difference is imported. Free trade occur, there will be a price adjustment btw the two countries: US the demand for US-produced cloths will fall bc the ones from India are cheaper, therefore producers will have to lower their price to be competitive. They won’t we willing to produce under a certain price level given by the supply curve, and at that price the difference between supply and demand (d-c) is covered by the imports from India. A new equilibrium is reached when imports= exports. Importing: higher consumers rent; producers rent lowers. Exporting: Consumers rent lowers; producers rent higher. Import demand curve(MD=D-S)/ Export supply curve form india(XS=S-D)World Trade Equilibrium: Unifying MD (Demand for import from US) and XS (Export supply from India) world equilibrium Above Pindia the exporting country will supply the world market, and below PUS the importing county will demand cloth from the world market. Home demand-Home supply = Foreign supply-foreign demand/Home deman+foreign demand = foreign supply+ home supply WORLD DEMAND=WORLD SUPPLY Dynamic gains of trade: the have a repeated effect. Gains over tie bc trade induces greater efficiency in the use of existing resources;Increased competition: noncompetitive factors exit the market/Economies of scale: the reallocation of resources can raise world productive efficiency. Economies of scale in production then free trade can after an appropriate reallocation of labour improve welfare for both countries realtive to autarky. Welfare improvement arises bc by concentrating production in the ECS industry in one country, advantage can be taken of the productive efficiency improvements/Broadening of the range of goods and product differentiation/International Risk diversification/Expert-led growth/Import of capital goods/Technologies transfer/Financial inflow and acess to international capital markets gains from trade and trade theories: gains from trade show that it is potentially worthwhile for every country to engage in trade
Classical trade theories Main focus on the cost differences: production costs are determined by two factors: Differences in productivity of factors and differences in factor endowment of an economy. They explain the inter-industry trade (North(more developed countries)-South(less developed countries) trade). ASSUMPTIONS:Two goods and two countries/Perfect elastic demand=any quantity would be bought at any price/Perfect competition and no externalities/Constant costs/Full employment, opportunity costs/Factor endowment is fixed (K/L konstant) and no technological changes. Trade theories about differences in productivity. Absolute cost advantage theory- Smith (Productivity) Specialization and division of labour would increase productivity. Differences in productivity btw countries explained through technology, production condition, climate conditions and efficiency in production process, quality /quantity of factors and work behavior of individuals -> lead to costs differences and these results in trade. Output per unit= productivity/ input per unit of output = real costs and input coefficient.
Trafo curves-> calculate Marginal Rate of Transformation, which gives the number of units we need to give up in order to produce an additional good of the other kind= opportunity cost. The differences in MRT reflects the differences in relative prices. Therefore, specialization makes sense. Where do the TRAFO curve and its slope come from? Movement along TRAFO line implies no change in GDP= if you produce one good less of A, you produce one good more of B and that balances the benefit to zero. Trade increases the world output when countries specialize according to their absolute cost advantage: absolute advantage in lower costs or higher productivity Comparative cost advantage theory- Ricardo (Productivity) Condition of Relative productivities (Different MTR) btw two countries. Priceline are parallel it means that both countries are equally unproductive. Comparative cost advantage can be determined by productivity and national opportunity costs. What happens if we now would consider increasing costs? The Trafo curve is now convex which means that relative prices change along the trafo: As opposed to constant cost no full specialisation occurs, with disregard to what trade theory is applied. The production costs of the goods will converge across countries and the comparative cost advantage will be lost at point before full specialisation: International price line = Terms of trade one international Price = one international price line. It will always be between the national price lines otherwise no trade will occur. At market equilibrium the volume exported by one country will be imported by the other and viceversa, and how much a country will gain will depend on position of ToT. The general definition of ToT is Px/Pi -> price of export / price of import
Trade theories about differences in factor endowment Factor endowment theory: Heckscher-Ohlin
Assumptions Identical social preferences in both contries/Fixed factor endowment and of same quality across countries /Increasing costs, that is diminishing marginal products → convex trafo/Both countries produce same goods, and each good has different factor intensities/Production functions are identical in both countries/Both countries have different factor endowments Factor intensity: relative amount of different production factors used in the production of one unit of a given good. The ratio of the production factors usage is laid down in the production function. Shown as a K/L ratio for a specific good. They are identical across countries but different across goods.Factor abundance: amount available of each factor.
Relative factor abundance: amount of one factor relative to the amount of the other factor available in a country. It can be derived along relative quantities of factors (K/L) or along relative factor prices (r/w). That means that if a country is relatively labour abundant it will specialize in the labour intensive good and vice versa.
Autarky situation: Germany is relatively labour abundant, while china is relatively capital abundant: (K/L)GERMANY > (K/L)CHINA.The production of Teddy’s is relatively labour abundant while the production of cars is capital abundant (K/L)CARS > (K/L)TEDDYS. According to H-O Germany will specialize in cars and China in teddies.
Trade situation: Factor endowment is not constant; it can change over time. The capital stock in developing countries is increasing over time and so will the relative K/L ratio rise and induces change in trade pattern. In industrialized countries the availability of labour declines so there is a shift in relative labour abundance to LDCs.
Extensions of the H-O Model Neo-factor endowment model – Leontief Paradox The classical assumption of the inputs being homogeneous does not work, especially with reference to labour. It is not only relative quantity but also relative quality of factors that should be considered. We divide labour into unskilled labour and skilled labour (human capital). This explains the phenomenon of USA being a relatively capital abundant country but exporting labour intensive goods. USA was relatively abundant with human capital and exported these goods.Stolper-Samuelson theorem A change in relative output prices will lead to a change in relative and real (absolute) factor prices in the same direction.Theory looks at the income distribution aspect of trade within one country. In an economy of full employment (on PPF) according to H-O the country which is labour abundant will specialize on the labour intensive good. We have two goods: corn (labour abundant) and TV (capital abundant). In home market That means: DDC ↑→PCL↑→DDL ↑→w↑ and DDT ↓→PTK ↓→DDK ↓→r↓ The result is a rise in w/r Ratio. Factor Price equalization theorem / H-O-S Theorem International trade leads to a tendency of relative factor price equalisation across countries.Autarky: China: labor abundant country Switzerland: capital abundant country (w/r)china Trade: China specializes on labor intensive good → demand for labor up Switzerland the opposite→Demand for capital up (w↑/r)china (rises) and (w/r↑)Switzerland (falls) (w/r)china = (w/r)Switzerland
New Trade theories The focus shifts from differences of countries in global trade towards trade between similar and trade of similar, while focusing on the dynamic aspects of trade. Cost and productivity -> multi-national companies and the changing environment is taken into account. Increasing economies of scale – Krugman change in the assumtions: analyse trade flows under imperfect competition (not everyone is a 100% informed) and trade offers scope for gains from trade even if no differences in resources exist (H-O theory) and no differences in productivity exist (Ricardo). What are Economies of scale? mean that production at a larger scale (more output) can be achieved at a lower cost. When production within an industry has this characteristic, specialization and trade can result in improvements in world productive efficiency and welfare benefits that accrue to all trading countries. To be found in industries with large fixed costs in production. Fixed costs are those costs that must be incurred even if production were to drop to zero. The larger the output, the more the costs of this equipment can be spread out among more units of the good Economies of scale are used to explain trade between similar countries bc according to traditional models these countries would have little reason to engage in trade (little difference =little cost advantage=no reason to trade). Two types of EoS: INTERNAL Output of a firm/ Product variety ↑ due to market enlargement niche products are produces/New products produced and offered/Average cost and prices fall/ Could lead to market dominance and negative effects of imperfect competition EXTERNAL Output of an industry/ Product variety stays the same/ Same products produced and offered/ Average cost and prices fall/ Compatible with perfect competition outcome External EoS: incurred by the whole industry in perfect competition. Where? settles where there was an early comparative advantage or due to historical coincidence. Why is it sustained? The causes of sustained external EoS are specialized suppliers and infrastructure, labor market pooling and knowledge transfer. External EoS and trade with comparative advantage (Dos graficos): Both countries have external EoS, but china has a comparative cost advantage because it has a lower price at the beginning. China therefore is going to export which makes the demand for chinese products go up and the one for US products go down. As a consequence and due to EoS prices in the US will go down (more units produced, less costs incurred) and prices in the US up. Trade in this case leads to a lower price in both countries due to specialization in country with comparative cost advantage and benefit of economies of scale. In traditionally models prices normally converge when trade occurs, here they diverge. Welfare gains from trade with external EoS are typically greater than from comparative advantage. As we can see it matters what country specializes in which product because national prices in autarky could be different between countries. External EoS explains trade patterns along comparative cost advantages. Disadvantage from trade(grafico): Historically Switzerland has a comparative cost advantage, and produces watches for world market (DWORLD) at point 1. Thailand has a lower cost structure and in autarky with DTHAI has equilibrium at 2; we see that P1>P2. Thailand cannot enter the world market as its initial starting costs are over the world price P1. Switzerland is the exporting country due to existing EoS, although it a cost disadvantage. The consequence for Switzerland is a lower price than in autarky and gains from trade. Thailand has a higher world price than domestic price and has a welfare loss.
Welfare impact external EoS: World: positive welfare effect due to specialization and lower production cost/price due to Eos and comparative advantage/Exchange of goods and services to maintain /increase consumption variety Country: Usually consumers of a country benefit from lower prices → higher consumer rent. Sometimes country is left worse off after trade (see Thailand example above). Internal EoS: EoS within a firm lead to imperfect market structures with one or few firms providing output and benefitting from falling average costs. Doesn’t matter which country specializes on which good, the only important thing is that each country specializes to obtain EoS. Offers explanation for pattern of trade along comparative cost advantage. Imperfect competition When economies of scale exist, large firms may be more efficient than small firms. Internal economies of scale result in cost advantages of large firms over small firms causing an imperfectly competitive industry: Few major producers of particular good or product differentiation between rival firms/ Firms are price setter: aware that they can influence their product prices/ Aware that can only sell more by reducing prices. Focus of imperfect competition and trade is monopolisti competition.KRUGMAN Assumptions Monopolistic competition – Internal EoS in niche markets/ Two countries that are fully identical in factor endowment, production function, tastes, prices and offer the same two goods/Other causes of trade removed/Trade will be explained for similar/identical countries resulting in a so called “intra-industry trade”: many countries export and import similar products; it arises because many different types of products are aggregated into one category. Intra-industry trade is explained in a model that includes economies of scale and differentiated products even when there are no differences in resources or technologies across countries. This model is called the monopolistic competition model = advantageous trade in differentiated products can occur even when countries are very similar in their productive capacities/Internal EoW imply decreasing average cost implying falling unit cost as output increases. Due to marked enlargement caused by free trade, any good can be produced with EoS. According to Krugman variety increases as niche market sizes become large enough to produce efficiently. This makes consumer welfare go up (lower prices).When we talk about internal EoS we talk about a firms output, not industry output like with external EoS. Autarky situation Two identical countries with no comparative cost advantage are in autarky (Germany and France that produce large and small cars). Trade would be beneficial to them in internal EoS exist and an imperfect market in form of monopolistic competition exist.The products they produce are varied, in a niche market but limited by market size, and not all of them are produced as domestic market is too small. The prices are above perfect competition level due to monopolistic gains. As always, the domestic consumers like to consume different varieties at the lowest possible price. Trade situation Intra-industry trade occurs with both countries consuming both varieties at lower prices: Specialization occurs according to comparative cost advantage. This makes average costs fall (= price fall) and customers have more variety at a lower price, consumer welfare goes up.
Transport costs/geography: Almost all goods can be transported globally with exception for the non-transportable goods (Land) and non-tradable goods (buildings) –>transport costs are prohibitive for them; Transport cost influence international trade in intensity and creation of trade; Transport cost is determined by: size and weight of good relative to value, distance, quality of infrastructure, means of transport and technological advance in infrastructure and means of transportation. They can be an important factor in determining trade flows as they can make up between 5-6% of goods value//a) trade intensity: transport costs raise price of exported goodàreduce the margin of cost advantage and the quantity imported. They can be prohibitive and “eat away” the comparative cost advantage/b)creation of trade: foreign producer closer to consumer market than domestic producesàlower transport costsàint. trade works only in border areas and is rare; assumptions: goods are similar (intra-industry trade), transport costs are the same for domestic and foreign producers, no barriers to trade and no productivity difference; example: Luxembourg is closer to Trier that Frankfurt. If transport costs go by distance, the total cost of importing from Luxembourg is much cheaper. That leads to the creation of trans-border trade. Product life cycle- posner: the first stage of a product life cycle is usually high tech and capital intensive, while the last stages are relatively low-tech and labour intensive. The comparative advantages shift due to changes in production technology and factor endowment. Y aparte. The H-O model states that as a factor intensities shift, cost advantages shift to different countries according to more suitable factor endowment at product stage: early phases in industrialized countries and later phases typically LDCs. Ricardos model can also explain the shifting trade directions due to comparative cost advantage//Value chain/ intra-firm trade: Intra-firm trade consist of trade between parent companies of a compiling country with their affiliates abroad and trade of affiliates under foreign control in this compiling country with their foreign parent group ex. Boeign 787 pieces or car// problem of double counting: Trade is typically registered in a sales logic (value of gross output) with global value chains increasingly trade is in intermediates. Consequence: Trade figures do not reflect value generated by country and Value of trade is exaggerated; Solution: express share of imports as exports and only calculate value added trade flows. This is a challenging process.