International Trade III Key Terms

Definitions of key terms, theories and models.

autarky

a national economy devoid of all international trade

(bilateral) trade balance

total exports H - total imports F (= X-M)

trade volume

total exports + total imports (X+M)

Ricardian Model

the simplest model of international trade of 2-2-1 dimensions wherein differences in technology/labour productivity create the opportunity for gains of trade based on comparative advantage.

Hecksher-Ohlin Model (H-O model)

A more complex theory of international trade (2-2-2) where relative endowments of 2 production inputs (usually K & L) foresee gains from trade.

the value-added method of calculating GDP

the contribution of each stage of production to the final value of a good, emphasizing the importance of domestic versus foreign inputs.

The autarkic conditions of the ‘no trade model’

1. identical production functions for each country

2. analogous relative endowments in each country

3. constant returns to scale (CRS)

4. homogeneous tastes in both countries

5. no distortionary policies or conditions like taxes, tariffs, subsidies, regulations, imperfect competition, etc.

Hecksher-Ohlin (H-O) Theorem

Domestic economic production will preference the good that utilises the more abundant input more intensively. Hence:

A country’s exports use its abundant production input more intensively. Conversely, its imports require the intensive use of its more scarce resource.

Stolper-Samuelson Theorem (H-O)

increases in the relative price of a good foresee higher returns (real income) for the factor used intensively in its production and lower returns of the other factor.

This also means that countries will export the good with the higher relative price and import the good with the lower relative price.

Rybczynski’s Theorem (H-O)

Any change in a factor endowment will precipitate a proportionally greater change in the volume of production for the good requiring said factor intensively, as well as an inverse change in the quantity produced of the good not using this factor intensively.

Factor price equalisation theorem (H-O)

2 countries producing the same 2 goods will eventually face consistent relative input prices.

gains from exchange

gains from trade specifically derived from the attainment of greater overall utility (IC curve) through trade with another actor with a different resource/factor endowment

gains from specialisation

gains of trade derived specifically from the devotion of resources to comparatively advantageous industries, resulting in higher global output compared to pre-trade levels

The specific-factors model (SFM)

a model that determines trade through the mobility, not intensity, of factors.

Leontief Paradox

contrary to the Hecksher-Ohlin Theorem, some economies do not export the good that intensively uses their relatively abundant factor, instead exporting goods that intensively use their relatively scare factor.

Specifically, this showed that the USA’s exports in the 1950s were labour intensive despite a relative abundance of capital to labour.

general equilibrium

a condition where all markets in an economy are in simultaneous equilibrium. This condition is a prerequisite for autarky models

constant returns to scale

changes in the quantity of inputs used in production (L, K, S, R) result in exactly equal change in production output

increasing returns to scale (IRS)

changes in the quantity of inputs used in production (L, K, S, R) results in proportionally greater change in the quantity of output

economies of scale (EoS)

a firm- or industry-level cost structure where there exists an inverse relationship between LRAC and quantity produced

import tariff

a compounded production subsidy of Good 1 and consumption tax of Good 2. This policy intends to reduce total trade volume to bring the trade equilibrium closer to the autarkic equilibrium

quota

trade balance condition

in a two country model, Country 1’s exports = Country 2’s imports & vice-versa.

the specific-factors theorem

the equalisation of commodity prices (eg: goods X & Y) through international trade does not equalise factor prices (eg: specific K, L)

assumptions of the specific-factors model (SFM)

1. Production follows the following functions:

   1. X = f_x(R_x , L_x) ; Y = f_y(S_y , L_y)

2. No factor is perfectly mobile nor immobile

   1. at least one factor (usually specific capitals R & S) are fixed in the short-run, but perfectly mobile into homogenous capital (K) in the long-run. Hence, returns to capital (rent) differ in the SR vs LR

   2. L is homogenous and perfectly transferrable in all time periods.

3. Both goods/commodities exhibit constant returns to scale (CRS)

4. Both countries share a community indifference curve (IC); tastes are identical & homogenous

5. Both countries are assumed to be SOEs

long-run (LR)

a theoretical period of time sufficiently far away in the future such that all inputs are perfectly mobile between the sectors of a national economy

short-run (SR)

a theoretical period of time in which at least one factor of production is immobile between sectors of a national economy and is bound to one the exclusive production of one good/commodity

value of marginal product of labour in x (VMPL_x); value of marginal product of labour in y (VMPL_y)

a formula in the specific-factors model (SFM) that demonstrates the marginal revenue of increasing employment in a specific sector

= P_x(MPL_x) ; P_y(MPL_y)

A consumption tax on Y is congruous to a…

consumption subsidy on X (& vice-versa)

A production tax on Y is congruous to…

a production subsidy on X (& vice-versa)

Autarkic assumption of the no-trade model accounting for monopolistic market structure(s)

• 2 goods & 2 countries

• constant returns to scale (CRS)

• the monopolist has no monopsonist, hence market power is concentrated in the production side

• consumer & producer prices are equal

• industries with perfect competition follow profit-maximising pricing

  • P = MC = MR

theory of the second best

in relation to trade derived from government policy (taxes, subsidies, tariffs, quotas), the removal of one distortion in the presence of another distortion does not inherently increase welfare. Conversely, the addition of another distortion in the face of a separate distortion does not always decrease welfare. This occurs because two unique distortions can have counteractive effects

corporate income tax

a factor tax on a private entity’s net income, often understood as a tax on capital. This affects the factor returns for that commodity/good and altering relative prices

consequences/distortions of a factor tax

1. movement to a new PPF created inside of the optimal laissez-faire PPF

2. movement along the distorted PPF

the production expansion condition

in a country with a monopolised sector, international trade increases welfare by increasing the production of the monopolised good/commodity (assuming that a monopolist intentionally restricts output to maximise profit)

pro-competitive gains from trade

in a country with at least one monopolised sector, the introduction of international trade may have additional benefits by increasing the competition that the monopolist(s) now face, “breaking up” the monopolist’s control of a market

external EoS (economies of scale)

EoS occurs at the industry/sector level. this allows for a general equilibrium analysis of international trade

internal economies of scale

EoS occurs in within certain firms, general equilibrium cannot be analysed

optimal tariff theory

a trade policy goal to use tariffs so that H (assumed to be a LOE) can export to the world market as a monopolist but enjoy perfect competition in its domestic markets. The policy hopes to increase the relative price of its exported good to create more favourable terms of trade. This would optimise H’s welfare, but the likelihood of reactionary tariffs in a trade war prevents this.

optimal tariff rate

equal to the inverse price elasticity of supply (PES) of foreign exports. The more inelastic foreign export supply is, the higher that this rate must be. The more elastic foreign export supply is, the lower that it must be.

outcomes of tariffs on international trade

• change in the relative price

  • decrease in the volume of H’s imports because of a higher distorted relative price

  • world trade price (P*) ≠ consumer price (P^T)

• change to import-competing and export sectors b/c tariff = cons tax on imports + production subsidy on exports

• change to welfare in H

  • almost guaranteed loss in U for a SOE

  • monopolistic power held by a SOE may lead to increase in U if not for retaliatory tariffs b/c reductions in world trade flows minimise gains from exchange

quota

a trade policy instating a ceiling (maximum) amount of imported or exported units of a product for a pre-determined period of time (eg: year). This policy creates a permit for certain actors to import/export a regulated quantity of said good

quota rent

the value of the change in relative prices of the import good as a result of the quota-induced scarcity

double-distortion problem

a domestic economy is simultaneously distorted by both protectionist trade policies and monopolistic market structure

concave (bowed-out) production possibilities frontier (PPF)

the default curved PPF used in the H-O model. This PPF illustrates increasing opportunity costs

customs union

a more restrictive type of trade bloc requiring all member countries to adopt a consistent external tariff to all non-member countries in addition to removing all trade barriers on other member countries. This agreement hopes to foster economic integration between the member states

free trade area

a trade bloc between a group of countries that collectively agree to remove all trade barriers like quotas and tariffs on other member countries. In this agreement, member countries can still maintain independent & unaligned trade policy

abundant factor of production

In the HO model, this determines which good a national economy will specialise its production in.