International Trade

Compared to the United States

other countries are even more tied to international trade. Their imports and exports as a share of GDP are substantially higher. The United States, due to its size and diversity of resources, relies less on international trade than almost any other country.

U.S. exports and imports as shares of gross domestic product

have been on an upward trend.International trade has roughly tripled in importance compared to the economy as a whole in the past 60 years. Both imports and exports fell substantially in 2009 due to the recession. Both imports and exports fell again in 2020 due to the COVID-19 pandemic.

Exchange rates

measure how much domestic currency can be exchanged for foreign currency and thus affect how much: Goods denominated in foreign currency (imports) cost in the domestic country. Goods denominated in domestic currency (exports) cost in foreign markets.

Who Trades with Whom?

More than 30 percent of world output is sold across national borders. The largest 15 trading partners with the United States accounted for 75 percent of the value of U.S. trade. The five largest trading partners with the United States in 2019 were Mexico, Canada, China, Japan, and Germany.

What Do We Trade

Most (about 70 percent) of the volume of trade today is in manufactured products such as automobiles, computers, and clothing. Fuels and mining products (e.g., petroleum, coal, and copper) remain an important part of world trade at 15 percent. Agricultural products are a relatively small part of trade at 10 percent.

Relative Prices and Supply

Pc is the price of cheese pw is the price of wine wc is the wage paid to workers who make cheese, and, and ww is the wage paid to workers who make wine. Due to competition in the labor and goods markets: Hourly wages of cheese makers will equal the value of the cheese produced in an hour: wc=Pc/alc Hourly wages of wine makers will equal the value of the wine produced in an hour:Ww=Pw/alw If the price of cheese relative to the price of wine equals the opportunity cost of producing cheese Pc/Pw= alc/aw Then the wage in cheese will equal the wage in wine If the home country wants to consume both wine and cheese (in the absence of international trade), relative prices must adjust so that wages are equal in the wine and cheese industries. If Pc/alc=Pw/alw workers will not care whether they work in the cheese industry or the wine industry, so that production of both goods can occur. Production (and consumption) of both goods occurs when the relative price of a good equals the opportunity cost of producing that good: Pc/Pw=alc/aw

Effects of Government Policies on Trade

Policy makers affect the amount of trade through Tariffs: a tax on imports or exports, Quotas: a quantity restriction on imports or exports, Export subsidies: a payment to producers that export, or Through other regulations (e.g., product specifications) that exclude foreign products from the market, but still allow domestic products. If a government restricts trade, what are the costs if foreign governments respond likewise? Trade policies are often chosen to cater to special interest groups, rather than to maximize national welfare. Governments tend to adopt tariffs, then negotiate them down in exchange for reduction in trade barriers of other countries.

Using the Gravity Model: Looking for Anomalies

A gravity model fits the data on U.S. trade with European countries well but not perfectly. The Netherlands, Belgium, and Ireland trade much more with the United States than predicted by a gravity model. Ireland has strong cultural affinity due to common language and history of migration. Ireland also hosts many U.S.-based multinational corporations. The Netherlands and Belgium have transport cost advantages due to their location.

International economics

About how nations interact through trade of goods and services, flows of money, and investment.

U.S. trade deficit numbers for July,

Big numbers, and they have been increasing over the year but not increasing in the last month.

The International Capital Market

Capital markets are arrangements by which individuals and firms exchange money now for promises to pay in the future. International capital markets cope with special regulations that countries impose on foreign investments. Special risks of currency fluctuations and national default and Sometimes offer opportunities to evade regulations placed on domestic markets.

The most important insight of all international economics is that there are gains from trade.

Countries selling goods and services to each other almost always generate mutual benefits. When a buyer and a seller engage in a voluntary transaction, both can be made better off. How could a country that is the most (least) efficient producer of everything gain from trade? Countries use finite resources to produce what most productive at (compared to their other production choices), then trade those products for what they want to consume. Countries can specialize in production, while consuming many goods and services through trade. Trade benefits countries by allowing them to export goods made with relatively abundant resources and imports goods made with relatively scarce resources. When countries specialize, they may be more efficient due to large-scale production. Countries may also gain by trading current resources for future resources (international borrowing and lending) and due to international migration. Trade is predicted to benefit countries as a whole in several ways, but trade may harm particular groups within a country. International trade can harm the owners of resources that are used relatively intensively in industries that compete with imports. Trade may therefore affect the distribution of income within a country.

Impediments to Trade: Distance, Barriers, and Borders

Distance between markets influences transportation costs and therefore the cost of imports and exports. Cultural affinity: close cultural ties, such as a common language, usually lead to strong economic ties. Geography: ocean harbors and a lack of mountain barriers make transportation and trade easier. Multinational corporations: corporations spread across different nations import and export many goods between their divisions. Borders: crossing borders involves formalities that take time, often different currencies need to be exchanged, and perhaps monetary costs like tariffs reduce trade. Trade agreements between countries are intended to reduce the formalities and tariffs needed to cross borders and, therefore, to increase trade. The United States signed a free trade agreement with Mexico and Canada in 1994, the North American Free Trade Agreement (N A F T A), which was replaced in 2020 with a slightly modified agreement, the U.S.Mexico-Canada agreement (U S M C A). Due to N A F3T.A and because Mexico and Canada are close to the United States, the amount of trade between the United States and its northern and southern neighbors as a fraction of G D P is much larger than between the United States and European countries. Canada's economy is roughly the same size as Spain's (around 10 percent of E U G D P) but Canada trades as much with the United States as does all of Europe. Yet even with a free trade agreement between the United States and Canada, which mostly use a common language, the border between these countries still reduces trade. Data shows that there is much more trade between pairs of Canadian provinces than between Canadian provinces and U.S. states, even when holding distance constant. Estimates indicate that the U.S.-Canadian border deters trade as much as if the countries were 1,500-2,500 miles apart.

Empirical Evidence

Do countries export those goods in which their productivity is relatively high? The ratio of U.S. to British exports in 1951 compared to the ratio of U.S. to British labor productivity in 26 manufacturing industries suggests yes. At this time, the United States had an absolute advantage in all 26 industries, yet the ratio of exports was low in the least productive sectors of the United States. A very poor country like Bangladesh can have comparative advantage in clothing despite being less productive in clothing than other countries such as China because it is even less productive compared to China in other sectors. Productivity (output per worker) in Bangladesh is only 28 percent of China's on average. In apparel, productivity in Bangladesh was about 77 percent of China's, creating strong comparative advantage in apparel for Bangladesh. The main implications of the Ricardian model are well supported by empirical evidence: productivity differences play an important role in international trade comparative advantage (not absolute advantage) matters for trade

Tradable Industries' Share of Employment

Estimates based on trade within the United States suggest that trade in services may eventually become bigger than trade in manufactures.

Romer and Frankel

Examining the correlation between trade and income cannot identify the direction of causation between the two. Countries' geographic characteristics, however, have important effects on trade, and are plausibly uncorrelated with other determinants of income. This paper therefore constructs measures of the geographic component of countries' trade, and uses those measures to obtain instrumental variables estimates of the effect of trade on income. The results provide no evidence that ordinary least-squares estimates overstate the effects of trade. Further, they suggest that trade has a quantitatively large and robust, though only moderately statistically significant, positive effect on income To construct the instrument for international trade, we first estimate a bilateral trade equation and then aggregate the fitted values of the equation to estimate a geographic component of countries' overall trade. In contrast to conventional gravity equations for bilateral trade, our trade equation includes only geographic characteristics: countries' sizes, their distances from one another, whether they share a border, and whether they are landlocked. This ensures that the instrument depends only on countries' geographic characteristics, not on their incomes or actual trading patterns.

International Finance Topics

Exchanging risky assets such as stocks and bonds can benefit all countries by diversification that reduces the variability of income—another source of gains from trade. Most international trade involves monetary transactions. Many monetary events have important consequences for international trade.

A simple example with roses and computers explains the intuition behind the concepts of opportunity cost and comparative advantage in the Ricardian model.

For example, suppose a limited number of workers could produce either roses or computers. The opportunity cost of producing computers is the amount of roses not produced. The opportunity cost of producing roses is the amount of computers not produced. Suppose that in the United States, 10 million roses could be produced with the same resources as 100,000 computers. Suppose that in Colombia, 10 million roses could be produced with the same resources as 30,000 computers. Colombia has a lower opportunity cost of producing roses: has to stop producing fewer computers in order to free up resources to make a rose. A country has a comparative advantage in producing a good if the opportunity cost of producing that good is lower in the country than in other countries. The United States has a comparative advantage in computer production. Colombia has a comparative advantage in rose production. Suppose initially that Colombia produces computers and the United States produces roses, and that both countries want to consume computers and roses. Can both countries be made better off? When countries specialize in production in which they have a comparative advantage, more goods and services can be produced and consumed. Have the United States stop growing roses and use those resources to make 100,000 computers instead. Have Colombia stop making 30,000 computers and grow roses instead. If produce goods in which have a comparative advantage (the United States produces computers and Colombia produces roses), they could still consume the same 10 million roses, but could consume 100,000-30,000=70,000 more computers

Misconceptions about Comparative Advantage

Free trade is beneficial only if a country is more productive than foreign countries. But even an unproductive country benefits from free trade by avoiding the high costs for goods that it would otherwise have to produce domestically. High costs derive from inefficient use of resources. The benefits of free trade do not depend on absolute advantage, rather they depend on comparative advantage: specializing in industries that use resources most efficiently. Free trade with countries that pay low wages hurts high-wage countries. While trade may reduce wages for some workers, thereby affecting the distribution of income within a country, trade benefits consumers and other workers. Consumers benefit because they can purchase goods more cheaply. Producers/workers benefit by earning a higher income in the industries that use resources more efficiently, allowing them to earn higher prices and wages. Free trade exploits less productive countries whose workers make low wages. While labor standards in some countries are less than exemplary compared to Western standards, they are so with or without trade. Are high wages and safe labor practices alternatives to trade? Deeper poverty and exploitation may result without export production. Consumers benefit from free trade by having access to cheaply (efficiently) produced goods. Producers/workers benefit from having higher profits/wages—higher compared to the alternative.

The Gains from Trade

Gains from trade come from specializing in the type of production that uses resources most efficiently, and using the income generated from that production to buy the goods and services that countries desire. Using resources most efficiently" means producing a good in which a country has a comparative advantage. Domestic workers earn a higher income from cheese production because the relative price of cheese increases with trade. Foreign workers earn a higher income from wine production because the relative price of cheese decreases with trade (making cheese cheaper), and the relative price of wine increases with trade. Think of trade as an indirect method of production that converts cheese into wine or vice versa. Without trade, a country has to allocate resources to produce all of the goods that it wants to consume. With trade, a country can specialize its production and exchange for the mix of goods that it wants to consume Consumption possibilities expand beyond the production possibility frontier when trade is allowed. With trade, consumption in each country is expanded because world production is expanded when each country specializes in producing the good in which it has a comparative advantage.

Balance of Payments

Governments measure the value of exports and imports, as well as the value of financial assets that flow into and out of their countries. Trade deficits, where countries import more than they export in value, may be offset by net inflows of financial assets. The official settlements balance, or the balance of payments, measures the balance of funds that central banks use for official international payments. All three values are measured in the government's national income accounts.

David Hume

Hume showed that the increase in domestic prices due to the gold inflow would discourage exports and encourage imports, thus automatically limiting the amount by which exports would exceed imports. This adjustment mechanism is called the price-specie-flow mechanism.

International Policy Coordination

In an integrated economy, one country's economic policies usually affect other countries as well, leading to the need for some degree of policy coordination. Depends on type of exchange rate regime. Capital markets, where money is exchanged for promises to pay in the future, have special concerns in an international setting: Currency fluctuations can alter the value paid. Countries, especially developing ones, might default on debt.

Prices, Wages, and Labor Allocation

In each sector, employers will maximize profits by demanding labor up to the point where the value produced by an additional hour equals the marginal cost of employing a worker for that hour. The demand curve for labor in the cloth sector: MPLcxPc=W The wage equals the value of the marginal product of labor in manufacturing. The demand curve for labor in the food sector: MPLfxPf=W The wage equals the value of the marginal product of labor in food. Where the labor demand curves intersect gives the equilibrium wage and allocation of labor between the two sectors. At the production point, the production possibility frontier must be tangent to a line whose slope is minus the price of cloth divided by that of food. Relationship between relative prices and output: -MPLf/MPLc=-Pc/Pf What happens to the allocation of labor and the distribution of income when the prices of food and cloth change? Two cases: An equal proportional change in prices A change in relative prices When both prices change in the same proportion, no real changes occur. The wage rate (w) rises in the same proportion as the prices, so real wages (i.e., the ratios of the wage rate to the prices of goods) are unaffected. The real incomes of capital owners and landowners also remain the same. When only Pc rises, labor shifts from the food sector to the cloth sector and the output of cloth rises while that of food falls. The wage rate (w) does not rise as much as Pc since cloth employment increases and thus the marginal product of labor in that sector falls.

Basics

Inflation is high, markets are down, interest rates are going up,

International Trade Versus Finance

International trade focuses on transactions involving movement of goods and services across nations. •International finance focuses on financial or monetary transactions across nations.

Politics of Trade Protection

International trade shifts the relative price of cloth to food, so factor prices change. Trade benefits the factor that is specific to the export sector of each country, but hurts the factor that is specific to the import-competing sectors. Trade has ambiguous effects on mobile factors. Trade benefits a country by expanding choices. Possible to redistribute income so that everyone gains from trade. Those who gain from trade could compensate those who lose and still be better off themselves. That everyone could gain from trade does not mean that they actually do—redistribution usually hard to implement. Trade often produces losers as well as winners. Optimal trade policy must weigh one group's gain against another's loss. Some groups may need special treatment because they are already relatively poor (e.g., shoe and garment workers in the United States). Most economists strongly favor free trade. Typically, those who gain from trade are a much less concentrated, informed, and organized group than those who lose. Example: Consumers and producers in the U.S. sugar industry, respectively Governments usually provide a "safety net" of income support to cushion the losses to groups hurt by trade (or other changes).

Manufacturing Employment and Chinese Import Competition

Is import competition from developing countries—especially from China—at fault for declines in manufacturing employment in the United States? Would closing off the United States from trade with China increase the share of employment in U.S. manufacturing? Some workers in sectors that compete with Chinese imports may lose their jobs and take time to find new jobs. Meanwhile, jobs are opening up in the export sectors of the economy. What is the net effect of increase import competition on manufacturing employment? Figure 4.13 shows that this manufacturing employment share has been steadily decreasing over the last half-century. U.S. manufacturing was still producing the same quantity of goods, but was using fewer and fewer workers (due to increase productivity). Estimate share of manufacturing employment using data from before China became a major source of U.S. imports. Accurate fit to manufacturing employment now. China appears to have little, if any, effect.

Trade since 2015

It has been pretty steady COVID hurt it Hurt by war like Ukraine Also hurt by supply chain disruptions recently

Relative Wages

Relative wages are the wages of the home country relative to the wages in the foreign country. Productivity (technological) differences determine relative wage differences across countries. The home wage relative to the foreign wage will settle in between the ratio of how much better Home is at making cheese, and how much better it is at making wine compared to Foreign. Relative wages cause Home to have a cost advantage in only cheese, and Foreign to have a cost advantage in only wine.

David Ricardo

Ricardo's widely acclaimed comparative advantage theory suggests that nations can gain an international trade advantage when they focus on producing goods that produce the lowest opportunity costs as compared to other nations.

Russia currency

Russia is the only currency unit increasing If there is demand for your currency and your stuff, like the gas Russia has, then the currency increases

Service Offshoring

Service offshoring (or outsourcing) occurs when a firm that provides services moves its operations to a foreign location. Service outsourcing can occur for services that can be transmitted electronically. A firm may move its customer service centers whose telephone calls can be transmitted electronically to a foreign location. Service outsourcing is currently not a significant part of trade. Some jobs are "tradable" and thus have the potential to be outsourced. Most jobs (about 60 percent) need to be done close to the customer, making them nontradable.

Adam Smith

Smith argued that by giving everyone the freedom to produce and exchange goods as they pleased (free trade) and opening the markets up to domestic and foreign competition, people's natural self-interest would promote greater prosperity than could stringent government regulations.

The Trump Trade War

Substantial political pressure to protect import-competing sectors, even if leads to aggregate losses. Trade protection usually limited to a few hard-hit sectors. The Trump administration enacted a vast set of tariffs on solar panels, washing machines, steel, aluminium, and an expanding list of manufactured good produced in China. Many of the protected sectors contained a high proportion of intermediate goods imported by U.S. producers, harming jobs in these downstream sectors. Retaliation by trading partners had a negative impact on employment by U.S. exporters.

Teleshock

The teleshock, or the rise in telecommuting, received a major impetus from the pandemic, when so many Americans were forced to work from home. As it turns out, many prefer this new arrangement.

Comparative Advantage with Many Goods

Suppose now there are N goods produced, indexed by i=1,2...N The home country's unit labor requirement for good i is aLi and the corresponding foreign unit labor requirement is a*Li Goods will be produced wherever cheapest to produce them Let w represent the wage rate in the home country, and w* represent the wage rate in the foreign country. If waL1<w*a*L1, then only the home country will produce good 1, since total wage payments are less there. Or equivalently,a*L1/aL1>w/w* if the relative productivity of a country in producing a good is higher than the relative wage, then the good will be produced in that country. Suppose there are five goods produced in the world: apples, bananas, caviar, dates, and enchiladas. If w/w*=3, the home country will produce apples, bananas, and caviar, while the foreign country will produce dates and enchiladas. The relative productivities of the home country in producing apples, bananas, and caviar are higher than the relative wage. If each country specializes in goods that use resources productively and trades the products for those that it wants to consume, then each benefits. If a country tries to produce all goods for itself, resources are "wasted." The home country has high productivity in apples, bananas, and caviar that give it a cost advantage, despite its high wage. The foreign country has low wages that give it a cost advantage, despite its low productivity in date production. How is the relative wage determined? By the relative supply of and relative (derived) demand for labor services. •The relative (derived) demand for home labor services falls when w/w* rises As domestic labor services become more expensive relative to foreign labor services, goods produced in the home country become more expensive, and demand for these goods and the labor services to produce them falls. fewer goods will be produced in the home country, further reducing the demand for domestic labor services.

Babe Ruth comparative advantage

Teams must maximize success when each player specializes at a position for which is to team success is greatest, even if he has an absolute advantage at multiple positions, he must go where his advantage is greater, which is why Ruth went to hitter.

JP Morgan Guide to the Markets

The Great Depression brought in a big government, the democratic party, government is for the people Big recessions in the 1970s from energy 1980s recession Then went in the Great Moderation 1990 recession Gulf War

Transportation Costs and Nontraded Goods

The Ricardian model predicts that countries completely specialize in production. But this rarely happens for three main reasons: More than one factor of production reduces the tendency of specialization (Econ/Trade Chapters 4-5). Protectionism (Econ/Trade Chapters 9-12). Transportation costs reduce or prevent trade, which may cause each country to produce the same good or service. Nontraded goods and services (e.g., haircuts and auto repairs) exist due to high transport costs. Countries tend to spend a large fraction of national income on nontraded goods and services. This fact has implications for the gravity model and for models that consider how income transfers across countries affect trade.

The Response of Output to a Change in the Relative Price of Cloth

The economy always produces at the point on its production possibility frontier (P P) where the slope of P P equals minus the relative price of cloth. Thus, an increase in Pc>Pf causes production to move down and to the right along the production possibility frontier corresponding to higher output of cloth and lower output of food.

Production Possibilities

The more labor employed in the production of cloth, the larger the output. As a result of diminishing returns, however, each successive person-hour increases output by less than the previous one; this is shown by the fact that the curve relating labor input to output gets flatter at higher levels of employment. The shape of the production function reflects the law of diminishing marginal returns. Adding one worker to the production process (without increasing the amount of capital) means that each worker has less capital to work with. Therefore, each additional unit of labor adds less output than the last. For the economy as a whole, the total labor employed in cloth and food must equal the total labor supply: Lc+Lf=L Why is the production possibilities frontier curved? Diminishing returns to labor in each sector cause the opportunity cost to rise when an economy produces more of a good. Opportunity cost of cloth in terms of food is the slope of the production possibilities frontier—the slope becomes steeper as an economy produces more cloth. Opportunity cost of producing one more yard of cloth is MPLf/MPLc pounds of food To produce one more yard of cloth, you need 1/MPLc hours of labor. To free up one hour of labor, you must reduce output of food by MPLf pounds To produce less food and more cloth, employ less in food and more in cloth. The marginal product of labor in food rises and the marginal product of labor in cloth falls, so MPLf/MPLc rises

The Changing Pattern of World Trade: Has the World Gotten Smaller?

The negative effect of distance on trade according to the gravity models is significant, but it has grown smaller over time due to modern transportation and communication. A global economy, with strong economic linkages between even distant nations, is not new. There have been two great waves of globalization with the first wave relying not on jets and the Internet but on railroads, steamships, and the telegraph. Political factors, such as wars, can change trade patterns much more than innovations in transportation and communication. World trade grew rapidly from 1870 to 1913. Then it suffered a sharp decline due to the two world wars and the Great Depression. It started to recover around 1945 but did not recover fully until around 1970. Since 1970, world trade as a fraction of world G D P has achieved unprecedented heights. Vertical disintegration of production has contributed to the rise in the value of world trade through extensive cross-shipping of components. A $100 product can give rise to $200 or $300 worth of international trade flows.

The Concept of Comparative Advantage

The opportunity cost of producing something measures the cost of not being able to produce something else with the resources used. Comparative advantage will be determined by comparing opportunity costs across countries.

The Pattern of Trade

The pattern of trade describes who sells what to whom. Differences in climate and resources explain why Brazil exports coffee, and Saudi Arabia exports oil. But why does Japan export automobiles, while the U.S. exports aircraft? Why some countries export certain products can stem from differences in: Labor productivity Relative supplies of capital, labor, and land and their use in the production of different goods and services

Production Possibilities

The production possibility frontier (P P F) of an economy shows the maximum amount of a goods that can be produced for a fixed amount of resources. The PPF of the home economy is alcQc+alwQw<=L Maximum home cheese production is Qc=L/alc when Qw=0 Maximum home wine production is Qw=L/alw when Qc=0 For example, suppose that the home economy's labor supply is 1,000 hours. alc=1 hour/lb so one hour of labor produces one pound of cheese in the home country. alw=2 hour/gallon so two hours of labor produces one gallon of wine in the home country. •The P P F equation alcQc+alwQw<=L becomes Qc+2Qw<=1,000 Maximum cheese production is 1,000 pounds. Maximum wine production is 500 gallons. The opportunity cost of cheese is how many gallons of wine Home must stop producing in order to make one more pound of cheese:alc/alw The opportunity cost is constant because the unit labor requirements are both constant. The opportunity cost of cheese appears as the absolute value of the slope of the P P F Q=L/alw-(alc/alw)Qc Producing an additional pound of cheese requires alc hours of labor Each hour devoted to cheese production could have been used instead to produce an amount of wine equal to 1 hour/(alw hours/gallon of wine)=(1/alw) gallons of wine

The Fall and Rise of World Trade

The ratio of world exports to world G D P rose in the decades before World War I but fell sharply in the face of wars and protectionism. It didn't return to 1913 levels until the 1970s but has since reached new heights.

Do Old Rules Still Apply?

The sources of modern trade are more subtle than before. Human resources and human-created resources (in the form of machinery and other types of capital) are more important than natural resources. Political battles over trade typically involve workers whose skills are made less valuable by imports, such as clothing workers who face competition from imported apparel, and tech workers who now face competition from Bangalore. Even though much about international trade has changed, the fundamental principles discovered by economists at the dawn of a global economy still apply, as we shall see in the upcoming chapters about why international trade occurs.

The Specific Factors Model

The specific factors model allows trade to affect income distribution. Assumptions of the model: Two goods, cloth and food. Three factors of production: labor (L), capital (K), and land (T for terrain). Perfect competition prevails in all markets. Cloth produced using capital and labor (but not land). Food produced using land and labor (but not capital). Labor is a mobile factor that can move between sectors. Land and capital are both specific factors used only in the production of one good. How much of each good does the economy produce? The production function for cloth gives the quantity of cloth that can be produced given any input of capital and labor Qc=Qc(K,Lc) Qc is the output of cloth K is the capital stock Lc is the labor force employed in cloth The production function for food gives the quantity of food that can be produced given any input of land and labor: Qf=Qf(T,Lf) Qf is the output of food -T is the supply of land Lf is the labor force employed in food

Size Matters: The Gravity Model

Three of the top 15 U.S. trading partners are European nations: Germany, the United Kingdom, and France. Why does the United States trade more with these European countries than with others? These three countries have the largest gross domestic product (G D P), the value of goods and services produced in an economy, in Europe. The size of an economy is directly related to the volume of imports and exports. The gravity model assumes that size and distance are important for trade in the following way: Tij=AxYiYj/Dij where A is a constant term Tij is the value of trade between country i and country j, Yi is the the G D P of country i, Yj is the is the G D P of country j, Dij is the is the distance between the two countries

Determining the Relative Price after Trade

To see how all countries can benefit from trade, need to find relative prices when trade exists. First calculate the world relative supply of cheese: the quantity of cheese supplied by all countries relative to the quantity of wine supplied by all countries: RS=Qc+Qc*/Qw+Qw* If the relative price of cheese falls below the opportunity cost of cheese in both countries Pc/Pw<alc/alw<alc*/alw* No cheese would be produced. Domestic and foreign workers would be willing to produce only wine (where wage is higher). When the relative price of cheese equals the opportunity cost in the home country Pc/Pw=alc/alw<alc*/alw Domestic workers are indifferent about producing wine or cheese (wage when producing wine same as wage when producing cheese). Foreign workers produce only wine. When the relative price of cheese settles strictly in between the opportunity costs of cheese alc/alw<Pc/Pw<alc*/alw* Domestic workers produce only cheese (where their wages are higher). Foreign workers still produce only wine (where their wages are higher). World relative supply of cheese equals Home's maximum cheese production divided by Foreign's maximum wine production' When the relative price of cheese equals the opportunity cost in the foreign country alc/alw<Pc/Pw=alc*/alw* Foreign workers are indifferent about producing wine or cheese (wage when producing wine same as wage when producing cheese). Domestic workers produce only cheese. •If the relative price of cheese rises above the opportunity cost of cheese in both countries If the relative price of cheese rises above the opportunity cost of cheese in both countries alc/alw<alc*/alw*<Pc/Pw No wine is produced. Domestic and foreign workers are willing to produce only cheese (where wage is higher). Relative demand of cheese is the quantity of cheese demanded in all countries relative to the quantity of wine demanded in all countries. As the price of cheese relative to the price of wine rises, consumers in all countries will tend to purchase less cheese and more wine so that the relative quantity demanded of cheese falls.

International Trade in the Specific Factors Model

Trade and Relative Prices The relative price of cloth prior to trade is determined by the intersection of the economy's relative supply of cloth and its relative demand. Free trade relative price of cloth is determined by the intersection of world relative supply of cloth and world relative demand. Opening up to trade increases the relative price of cloth in an economy whose relative supply of cloth is larger than for the world as a whole. Gains from trade Without trade, the economy's output of a good must equal its consumption. International trade allows the mix of cloth and food consumed to differ from the mix produced. The country cannot spend more than it earns: PcDc+PfDf=PcQc+PfQf The economy as a whole gains from trade. It imports an amount of food equal to the relative price of cloth times the amount of cloth exported: Df-Qf=(Pc/Pf)x(Qc-Dc) It is able to afford amounts of cloth and food that the country is not able to produce itself. The budget constraint with trade lies above the production possibilities frontier in Figure 4.11.

Trade and Unemployment

Trade shifts jobs from import-competing to export sector. Process not instantaneous—some workers will be unemployed as they look for new jobs. How much unemployment can be traced back to trade? From 2001 to 2010, only about 2% of involuntary displacements stemmed from import competition or plants moved overseas. U.S. Trade Adjustment Assistance program provides extended unemployment coverage (for an additional year) and tuition reimbursement (for new job skill acquisitions) to workers who are displaced by a plant closure. To qualify, the plant closure must be due to import competition or an overseas relocation to a country receiving preferential access to the United States. Figure 4.12 shows that there no evidence of a positive correlation between unemployment and imports (relative to U.S. G D P) for the United States. After 2012, both imports and unemployment do drop significantly; However, the drop in imports was driven by falling oil prices. Non-oil imports as a share of U.S. G D P remained stable in those years. Unemployment is primarily a macroeconomic problem that rises during recessions. The best way to reduce unemployment is by adopting macroeconomic policies to help the economy recover, not by adopting trade protection.

A One-Factor Economy

We formalize these ideas by constructing a one-factor Ricardian model using the following assumptions: Labor is the only factor of production. Labor productivity varies across countries due to differences in technology, but labor productivity in each country is constant. The supply of labor in each country is constant. Two goods: wine and cheese. Competition allows workers to be paid a wage equal to the value of what they produce, and allows them to work in the industry that pays the higher wage. Two countries: home and foreign. A unit labor requirement indicates the constant number of hours of labor required to produce one unit of output. alc is the unit labor requirement for cheese in the home country. alc hours of labor produce one pound of cheese in the home country. alw is the unit labor requirement for wine in the home country. alw hours of labor produce one gallon of wine in the home country. A high unit labor requirement means low labor productivity. Labor productivity is how much output one hour of labor creates. Labor supply L indicates the total amount of labor resources—the number of hours worked (a constant parameter). alc indicates the amount of labor required for each pound of cheese produced (a constant). Cheese production Qc indicates how many total pounds of cheese that the home country produces. alw indicates the amount of labor required for each gallon of wine produced (a constant). Wine production Qw indicates how many total gallons of wine that the home country produces.

Trade in the Ricardian Model

When one country can produce a unit of a good with less labor than another country, we say that the first country has an absolute advantage in producing that good. If alc<alc* Home labor is more efficient than Foreign in producing cheese. Comparative advantage, not absolute advantage, determines the pattern of trade (more about this distinction later). Suppose that the home country has a comparative advantage in cheese production: its opportunity cost of producing cheese is lower than the foreign country. alc/aw<alc*/aw* When the home country increases cheese production, it reduces wine production less than the foreign country would. Since the slope of the P P F indicates the opportunity cost of cheese in terms of wine, Foreign's P P F is steeper than Home's. To produce one pound of cheese, must stop producing more gallons of wine in Foreign than in Home. Before any trade occurs, the relative price of cheese to wine reflects the opportunity cost of cheese in terms of wine in each country. In the absence of any trade, the relative price of cheese to wine will be higher in Foreign than in Home if Foreign has the higher opportunity cost of cheese. It will be profitable to ship cheese from Home to Foreign (and wine from Foreign to Home)—where does the relative price of cheese to wine settle?

Krugman

strategic trade policies to establish domestic firms in a dominant position in a global industry are beggar-thy-neighbor policies that boost national income at the expense of other countries, liberal