International Trade Theory• Increasing wage inequality in the US– Is international trade the culprit?• Why study Trade Theory?– Provides systematic understanding of the winners and losers of trade policy. Necessary since distribution and redistribution is the stuff of politics.– Can predict who will support free trade or protection--groundwork for understanding government policy. Helps fill in societal approach.Classical Trade Theory• Ricardo and Comparative Advantage– A relative concept: countries gain if they specialize and trade the good that they produce most efficiently, relative to other goods they produce.– A comparative advantage means that no matter how good (or bad) you are at producing stuff, there's always something that you're best (or least worst) at doing.– All countries have a comparative advantage in something.– No country can have a comparative advantage in everything.Trade Theory and International Relations• Implications for international relations– Very optimistic view of international economic relations. Trade makes all nations better off.– Global welfare is maximized by free trade. – National welfare is maximized by unilateral free trade (a stronger proposition). • National welfare analysis of a tariff– consumer surplus and producer surplus– “deadweight” losses– rent-seekingDiagram: Welfare analysis of a tariff- consumers lose A+B+C+D- producers gain A- government gains C- “deadweight” loss to society B+D- plus “dynamic” costs- plus waste of “rent-seeking”Psupplydemandworld priceABCDpWpUS = pW + tariffImports with tariffImports without tariffQNeoclassical Trade Theory• Why do countries produce and trade what they do?– Key is national differences in endowments of factors of production (e.g, labor, capital, land).– Core suppositions: 1) goods differ in factor requirements. 2) countries differ in their factor endowments.– Heckscher-Ohlin Theorem: a country will produce and export goods whose production makes intensive use of the factor of production that is relatively abundant (cheap) before trade.– Factor-Price Equalization Theorem: trade will diminish cross-national differences in factor