Chapter 2: International Trade Theory and ApplicationReading: 19-57All international trade theories and argumentsThe 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 gameIncrease wealth by acquiring gold  raise prices domestic to boost export price but country with gold loses competitive advantageExtract trade gains from foreigners through regulations/controls to achieve surplus in balance of trade by maximizing exports and minimizing importsOverlooks quantity of capital, skill of workers, strength of production inputsPros: 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 countryCons: 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)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 goldImports 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 nationGov intervention in economic life/trade relations is badTo 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 countryComparative 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 XCountry with lower opportunity cost has comparative advantage (trade positive sum game)Country should give up less efficient output to produce more efficient outputToday explained by reference to diff in comparative production cost and price of factorsTo 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 AAlways divide numbers from same country and number want opportunity cost of put in numeratorHeckscher-Ohlin Theorem explains the link between factor 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 productionCountries export commodities tat make heavy use of abundant factors and import those that make use of their scarce factorsStructure of economy determines comparative advantageProduction functions show amt of output that can be produced w/ any given quantity of capital/labor (law of factor price equalization)The Leontief Paradox (research) – there is a demand basis for capital intensive goods and existence of trade barriers making an importance of natural resourcesEmpirical 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 importantHuman Skills and Technology Based ViewsCertain 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)Product Life-Cycle Model: changes occur in input requirements of new products as it becomes established in a market and standardized in productionCost advantage will change and comparative advantage in innovation capacity maybe offsetAs producer moves through life cycles its cycle of international trade will changeInnovation + Imitation Lag = Technology GapStarting point: innovation leads to new product1. US has export monopoly in this new product2. Foreign production of this product begins3. Foreign production of this product becomes competitive in export markets4. US becomes importer of this no-longer-new product (consume>produce)Linder’s Income: Preference Similarity Theory: range of countries manufactured exports determined by internal demand  trade in manufactures takes place largely among developed nationsMore 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 countriesSupply of manufacturing products driven by countries internal demandPreference similarities lead to trade of these products across nationsNew Trade Theory – countries don’t specialize/trade just to take advantage of their diff, also b/c of increasing returns they expectEconomies of scale cause reduction of manufacturing costs per unit as result of increased production quality during time periodsExternally actions of one agent directly affect environment of another agentInternational trade patterns show that service and trade are only ¼ of global tradeDeveloped countries dominate imports/exports in both merchandise trade/commercial servicesWith more globalization more exported products contain myriad of inputs from other countriesOpposition to free trade may be good for national economy but impact varies across linesUnskilled workers less likely to accept due to chance lose job to low-cost locationsThreat to national sovereignty as shift in production to efficient locations deprives countriesLowest Common Denominator  potential adverse consequences for environment/safetyBalance of Trade – exports minus imports of goods and services (US deficit in merchandise but surplus in service)Tariff Barriers