Chapter 2 International Trade Theory and Application Reading 19 57 Key Terms Concepts All international trade theories and arguments o The Mercantilist Doctrine great faith in ability of gov to improve well being of residents using system of centralized control first theory of international trade Required heavy gov intervention as trade being a zero sum game Increase wealth by acquiring gold raise prices domestic to boost export price but country with gold loses competitive advantage Extract trade gains from foreigners through regulations controls to achieve surplus in balance of trade by maximizing exports and minimizing imports Overlooks quantity of capital skill of workers strength of production inputs Pros national wealth equated with size of gold reserves gold reserves could be used to hire pay armies gov had more control over flows of goods in out of country Cons more exports more gold held currency worth more fewer exports more imports until eventually equilibrium reached costs go up and people wont want our goods Today neo mercantilism encourages exports discourage imports use currency reserves to influence exchange rate everyone manipulates currency through exchange o Absolute Advantage Theory permits individuals to specialize in goods best suited to produce because of natural and acquired advantages efficient allocation of natural resources globally Laissez faire freedom of enterprise or freedom of commerce Adam Smith The Wealth of Nations and trade liberalization Real wealth consists of goods services available to citizens not gold Imports should consist of goods made more efficiently abroad exports should consist of goods made more efficiently at home country A absolute advantage if produce item for less then Country B based on natural acquired advantages of nation Gov intervention in economic life trade relations is bad To calculate absolute advantage take labor hrs needed to produce item multiplied by demand of that item for each country separate no trade compare that to total units demanded of both countries multiplied by labor hrs of advantageous country o Comparative Advantage Theory David Ricardo gains from trade will occur even if country has absolute advantage in all products Opportunity cost of X is amt of other goods which have been given up to produce one unit X Country with lower opportunity cost has comparative advantage Country should give up less efficient output to produce more efficient Today explained by reference to diff in comparative production cost trade positive sum game output and price of factors To calculate opportunity cost of X take labor hrs needed to produce 1 unit X in country A divided by labor hrs needed to produce 1 unit Y in country A Always divide numbers from same country and number want o Heckscher Ohlin Theorem explains the link between factor opportunity cost of put in numerator endowments comparative advantages across nations countries not equal in factor endowments land labor capital Country has comparative advantage if production is intensive in abundant factor export and import when production is intensive in scarce factor of production Countries export commodities tat make heavy use of abundant factors and import those that make use of their scarce factors Structure of economy determines comparative advantage Production functions show amt of output that can be produced w any given quantity of capital labor law of factor price equalization o The Leontief Paradox research there is a demand basis for capital intensive goods and existence of trade barriers making an importance of natural resources Empirical results usually contradict above theory that exports of capital imports of capital and exports of labor imports of labor in US we like capital intensive goods so produce and consume import at a high demand Relative price of labor and capital change overtime factory intensity reversals important o Human Skills and Technology Based Views Certain countries special advantage as innovators of new products and imitation lag prevents other countries from immediately duplicating products vary by country and are primary functions of production o Product Life Cycle Model changes occur in input requirements of new products as it becomes established in a market and standardized in production Cost advantage will change and comparative advantage in innovation capacity maybe offset As producer moves through life cycles its cycle of international trade will change Innovation Imitation Lag Technology Gap Starting point innovation leads to new product 1 US has export monopoly in this new product 2 Foreign production of this product begins 3 Foreign production of this product becomes competitive in 4 US becomes importer of this no longer new product export markets consume produce o Linder s Income Preference Similarity Theory range of countries manufactured exports determined by internal demand trade in manufactures takes place largely among developed nations More similar demand preferences for manufactured goods in two countries more potential for trade between them preference similarity w per capita income important determinant Linder noted developed countries trade more with other developed countries nations Supply of manufacturing products driven by countries internal demand Preference similarities lead to trade of these products across o New Trade Theory countries don t specialize trade just to take advantage of their diff also b c of increasing returns they expect Economies of scale cause reduction of manufacturing costs per unit as result of increased production quality during time periods Externally actions of one agent directly affect environment of another agent International trade patterns show that service and trade are only of global trade o Developed countries dominate imports exports in both merchandise o With more globalization more exported products contain myriad of inputs trade commercial services from other countries Opposition to free trade may be good for national economy but impact varies across lines o Unskilled workers less likely to accept due to chance lose job to low cost o Threat to national sovereignty as shift in production to efficient locations o Lowest Common Denominator potential adverse consequences for locations deprives countries environment safety Balance of Trade exports minus imports of goods and services US deficit in merchandise but surplus in service Tariff Barriers official constraints on