New Classical Theories of International Trade

International Economics Chapter 2 New Classical Theories of International Trade

Chapter 2 New Classical Theories of International Trade • 2.1 Specific Factor Model • 2.2 Factor Endowment Theory (H-O Model) • 2.3 Other New Classical Theories • 2.4 Leontief Paradox

2.1 Specific Factor Model • The specific factor model is to analyze the effect of a change in commodity price on the returns of factors in a country when at least one factor is not mobile between industries. • It indicates that workers may be better or worse off, depending on preferences; • It predicts that owners of factors used in export industries gain from trade, while owners of factors used in import-competing industries will lose from trade.

2.1 Specific Factor Model • specific factor • Its use is specific to either the production of machines or the production of cloth and cannot move between industries. • Such as capital in the model. • mobile factor • It can move between machine production and cloth production over time. • Such as labor in the model.

2.1 Specific Factor Model DM : the machine industry’s demand for labor. DC : the cloth industry’s demand for labor W0 : equilibrium wage, which occurs when OL labor is employed in the machine industry and O’L labor is employed in the cloth industry. As the demand for labor in the machine industries increases, the wage rate rises and workers move from the cloth industries to the machine industries.

2.1 Specific Factor Model • The existence of specific factors can help explain why some groups resist free trade. • In general, owners of the abundant factor of production in a country should be in favor of free trade. • However, both capital and labor in the industry with a comparative disadvantage suffer losses and may well resist free trade.

2.2 Factor Endowment Theory (H-O Model) • The Ricardian principle of comparative advantage explains why specialization and trade lead to gains for producers and consumers. • It does not, however, in itself explain why the production possibilities frontiers (PPF) of different countries have different shapes, and thus why a country’s comparative advantage is in one product rather than another.

2.2 Factor Endowment Theory (H-O Model) The factor-endowment theory states that comparative advantage is explained exclusively by differences in relative national supply conditions. In particular, the theory highlights the role of countries’ resource endowments (such as labor and capital) as the key determinant of comparative advantage.

2.2 Factor Endowment Theory (H-O Model) • Assumptions • Countries all have the same tastes and preferences (the same indifference curves); • They use factor inputs which are of uniform quality; • They all use the same technology.

2.2 Factor Endowment Theory (H-O Model)

2.2 Factor Endowment Theory (H-O Model) • In summary, the factor endowment model asserts that the pattern of trade is explained by differentials in resource endowments. • A capital abundant country will have a comparative advantage in a capital-intensive product; • While a labor abundant country will have a comparative advantage in a labor-intensive product.

2.2 Factor Endowment Theory (H-O Model) Implications Factor price equalization The shift within each country towards use of cheaper factors, and away from expensive ones, leads to more equal factor prices (if factors are mobile). Distribution of income Trade changes domestic distribution of income as demand for different factors changes.

2.3 Other New Classical Theories • Rybczynski Theorem • It basically says that the way in which a country grows has an impact on the production and trade mixes of the country. • Countries with low savings rates that invest little in new plants and equipment will tend to produce and trade labor-intensive goods. • Countries with high savings and investment rates will tend to produce and trade more capital-intensive goods.

2.3 Other New Classical Theories At constant world prices, if a country experiences an increase in the supply of one factor, it will produce more of the product whose production is intensive in that factor and less of the other product. The Effect of an Increase in Country A’s Capital Stock

2.3 Other New Classical Theories Factor Price Equalization Theory Free international trade will lead to equalization of in the returns to homogeneous or identical factors across. The theory predicts that some factor payments will rise and others fall with the introduction of trade.

2.3 Other New Classical Theories • Given all the assumptions of the H-O model, free international trade will lead to the international equalization of individual factor prices. • In countries that have high wages before trade begins, there will be tendency for wages to fall. • In countries with initially low wages, trade will produce tendency for wages to rise. • Under the strict assumptions of the H-O model, these tendencies will continue until the equalization of wages is achieved. The same will be true for rental rates on capital.

2.3 Other New Classical Theories • Stolper-Samuelson Theorem • Free international trade benefits the abundant factor and harms the scarce factor. • Wages initially high in Country A because labor is relatively scarce and hence can exploit its scarcity power in the factor market. • International trade means manufacturers using scarce labor in Country A must now compete with manufacturers using more abundant labor in Country B. • International competitive pressures tend to force down wages in Country A. • Thus, even though labor is immobile between countries, its price is equalized through competitive bidding for its services.

2.3 Other New Classical Theories Implications First, we now have established a reason for some groups in a community to oppose in international trade. Second, the Stolper-Samuelson theorem provides insights into why governments may impose barriers to trade. Finally, it is important to remember that even though some interest groups lose from international trade, the country as a whole gains from international trade relative to autarky.

2.3 Other New Classical Theories • Explaining Wage Inequality

2.3 Other New Classical Theories • A shift in either the supply curve or demand curve of skilled workers available relative to unskilled workers will induce a change in the equilibrium wage ratio. • Factors can affect wage inequality. • International trade and technological change • Immigration • Education and training

2.4 Leontief Paradox • According to the H-O model ,the United States should export capital-intensive goods and import labor-intensive goods. • Leontief’s experiment found was exactly the opposite of the H-O model. According to Leontief’s experiment, U.S. exports tend to be labor intensive relative to U.S. imports. • Attempted Reconciliations of Leontief’s Findings.

New Classical Theories of International Trade