15.06.2023 Standard Trade Model#

General#

general Model, combines Ricardian, Specific Factors and Heckscher

  • two goods

  • each country PFF

Differences between countries:

  • labor

  • capital

  • technology

Countrys Decisions:

  • Production based on \(\frac{ P_C }{P_F}\)

  • to maximise value \(V = P_C Q_C+P_V Q_V\)

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relative Price Increases => steeper Isovalue Line => other combination better

Relative Prices#

Demand equal to Supply

\[ P_C D_C + P_F D_F = P_C Q_C + P_F Q_F = V \]

Assumption: single representative consumer with indifference curve

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resulting Diagram with IDC and trade

Whole-Economy:

  • better off when export good relative price rises

  • More Imports per export

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=> Trade = expands PPF

  • original Point without Trade: \(D^3\)

  • original Point with Trade: \(D^1\)

  • Point after Cloth Price Increase: \(D^2\)

Distributional Effects#

Uneven Distribution of Trade Gains

  • poorer HH = more foods and manufactured

    • better positioned after trade

  • richer HH = more services = not exportable

But: Factor Prices (Wages) the other way around affected

Terms of Trade#

Terms of Trade: price of exports relative to price of imports

higher ToT = better for country = afford to buy more imports

Determining relative Prices

  • Supply: World Supply of Cloth rel. to world supply of Food: \(\frac{ Q_C+Q_C^* }{Q_F+Q_F^*}\)

  • Demand: World Demand of Cloth rel. to world Demand of Food: \(\frac{ D_C+D_C^* }{D_F+D_F^*}\)

Situation with Trade

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Economic Growth#

is usually biased: one sector more than other

  • changes terms of trade

  • example: biased growth in cloth

    • lower relative price of cloth

    • lower Terms of Trade

    • effect depends on if cloth import or export

Type

Definition

Effect

Export-biased Growth

increase PPF mostly in export sector

reduces ToT = reduces welfare at home

import-biased Growth

increase PPF mostly in import sector

increase ToT = increase welfare

Instruments#

Import Tariff#

  • relative price of good (e.g food) rises

    • more producers into food

  • lower rel. price of cloth

    • more consumers into cloth

Effect (from 1 to 2)

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Effect: depends on size of economy in the world trade

Export Subsidies#

e.g subsidy on cloth exports:

  • rel. price of cloth rises

  • more producers into cloth

  • consumers want less

Effect of Instruments#

  • Import tariff: can increase domestic welfare

  • export subsidy: reduce domestic welfare

Additional Effects

  • another Foreign Country makes export subsidy

    • If home country also exporter = less competitive

    • reduces home ToT

  • Tariff vice versa = more ToT if both countries same role (import / export)

Export subsidies and Import tariffs:

  • reduce world prices for other countries (more supply / less demand)

  • better ToT depends on home countries role

Borrowing and Lending#

Countries maximize intertemporal consumption

  • produce more this year, consume more next year

  • then lend money to other countries this year and borrow next

=> interest rate globally come closer

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