In-Depth Notes on the Standard Trade Model

Chapter 6: The Standard Trade Model

Overview

• Standard Trade Model: A general model encompassing the Ricardian, specific factors, and Heckscher-Ohlin models as special cases.
• Models simplify the analysis of trade effects in economics, focusing on welfare impacts.

Key Models in Trade Theory:

• Ricardian Model:

  • Focuses on one factor of production.
  • Based on factor productivity differentials between countries.

• Heckscher-Ohlin Model:

  • Incorporates two factors of production.
  • Assumes identical technology across countries.
  • Considers relative factor endowment differentials.

• Specific Factor Model:

  • Involves three factors of production.
  • Accounts for restricted factor mobility (one factor mobile, two non-mobile).

Foundations of the Standard Trade Model

• Production Possibility Frontier (PPF): Each country's PPF is a smooth curve.
• Goods Analyzed: Focus on two key goods: food (F) and cloth (C).
• Understanding welfare effects through changes in trade dynamics and economic structure.

Welfare Effects of Trade

• Analyzes the welfare effects of trade based on:
  • Changes in the export sector.
  • Changes in the import sector.

Income Distribution and Trade

• Trade affects income distribution due to:
  • Different factors intensities across industries (Heckscher-Ohlin Model).
  • Limited and costly resource mobility (Specific Factor Model).

Source of Trade

• Arises from differences in production possibility frontiers across countries due to:
  • Variations in labor services, skills, physical capital, land, and technology.

Relative Supply and Demand

• Relative Supply Curve:

  • Shows the relationship between relative quantity of goods supplied and their relative prices.
  • Affected by changes in production based on relative prices.

• Relative Demand Curve:

  • Describes how the consumption of one good relative to another changes as prices fluctuate.
  • Typically downward sloping; as the price of cloth rises, demand for cloth relative to food diminishes.

Terms of Trade (TOT)

• Definition: Price of exports relative to the price of imports, expressed as rac{PX}{PM}.
• Impact on Welfare:
  • An increase in TOT implies better welfare as it allows countries to afford more imports.
  • A decrease in TOT harms welfare, as it reduces the ability to purchase imports.

Economic Growth and Trade

• Bias in Growth:

  • Rapid growth may occur in specific sectors unevenly, changing relative supply and affecting terms of trade.
  • Example: Growth in U.S. computer industries vs. slow growth in textile industries.

• Types of Growth:

  • Export-biased Growth: Expands production capabilities in a country’s export sector, may lower TOT.
  • Import-biased Growth: Expands production in the import sector, potentially raising TOT.

Equilibrium Prices and Trade Flows

• Trade results in equilibrium relative prices, where the quantity supplied equals the quantity demanded in the market.
  • Shifts in relative supply curves lead to changes in equilibrium prices and reflect changes in welfare.

Discussion Questions

• Analyze how economic growth in countries like China affects the U.S. standard of living.
• Assess the value of growth when integrated into the global economy.

Impact of Newly Industrializing Economies

• Evaluate whether growth in economies like China has negatively impacted advanced nations such as the U.S.
  • Key points: Changes in U.S. terms of trade have been minimal, while China’s terms of trade have seen sharper declines, indicating complex international effects.

Summary of Key Takeaways

• The standard trade model provides insights into the welfare implications of trade-induced shifts in real economic parameters and their effects on relative prices and consumption patterns within and among countries.