Commerce and Coalitions
Review of International Trade Theory
© Randall W. Stone, 2002
Comparative Advantage
1. Comparative advantage –› trade
2. Gains from trade in an industry
3. Effects of a tariff
© Randall W. Stone, 2002
1. Comparative Advantage →
→ Trade
Definition: Lower relative price (not
necessarily absolute)
• Different productivity
• Different technology
• Different factor endowments
© Randall W. Stone, 2002
Comparative Advantage
Example:
Common technology, different
factor endowments:
• Technology:
1 K + 2 L = 1 Textile
2 K + 1 L = 1 Iron
• Factor endowments:
– Australia has 4 K and 2 L (2 iron or 1 tex)
– Bulgaria has 2 K and 4 L (2 tex or 1 iron)
© Randall W. Stone, 2002
Comparative advantage
Iron
PA: Iron = 1/2 Textile
2
1
W
PB: Iron = 2 Textile
A
PWorld: 1 Iron = 1 Textile
B
1
2
Textiles
© Randall W. Stone, 2002
Conclusions:
• Trade improves welfare because higher
indifference curves become reachable
• Trade lowers price of Textiles in capitalrich country A, hurting laborers
• Trade lowers price of Iron in labor-rich
country B, hurting capital owners
Intuition: Scarcity → High price.
Trade reduces scarcity
© Randall W. Stone, 2002
2. Gains from trade in an industry
Importing country (P > P )
D
P
D
W
S
PD: Domestic price
PD
PW: World price
PW
QPW
QD
QCW
Q
© Randall W. Stone, 2002
2. Gains from trade in an industry
Importing country (P > P )
D
P
D
W
S
PD
PW
Value of
imports
QPW
QD
QCW
Q
© Randall W. Stone, 2002
2. Gains from trade in an industry
Importing country (P > P )
D
P
D
W
S
PD
Consumer gain
PW
QPW
QD
QCW
Q
Consumer gains: QD (PD - PW) + 1/2 (QCW - QD)(PD - PW)
© Randall W. Stone, 2002
2. Gains from trade in an industry
Importing country (P > P )
D
P
D
W
S
Welfare
PD
Gains > Losses
Producer loss
PW
QPW
QD
QCW
Q
Producer loss: QPW (PD - PW) + 1/2(QD - QPW)(PD - PW)
© Randall W. Stone, 2002
2. Gains from trade in an industry
Exporting country (P < P )
D
P
D
W
S
PW
PD: Domestic price
PD
PW: World price
Value of
exports
QCW
QD
QPW
Q
© Randall W. Stone, 2002
2. Gains from trade in an industry
Exporting country (P < P )
D
P
D
W
S
PW
Producer gains
PD
QCW
Producer gain:
QD
QPW
Q
QD (PW - PD) + 1/2(QPW - QD)(PW - PD)
© Randall W. Stone, 2002
2. Gains from trade in an industry
Exporting country (P < P )
D
P
D
S
PW
PD
W
Welfare
Consumer loss
Gains > Losses
QCW
QD
QPW
Q
Consumer loss: QCW (PW - PD) + 1/2(QD - QCW)(PW - PD)
© Randall W. Stone, 2002
2. Gains from trade in an industry
Importing country
D
P
P
P
Exporting country
S
P
D
S
D
Pl Cg
P
Cg
W
W
P
Q Q Q
PW
D
CW
Conclusions:
Q
Pg
Cl Pg
D
Q
CW
Q Q
D
Q
PW
- Trade increases welfare
- Winners and losers
- Compensation?
© Randall W. Stone, 2002
3. Effects of a tariff
P
D
S
PD
PD: Domestic price
PT
PW: World price
PW
PT: Price with tariff
QPW
QPT
QCT
QCW
Q
Imports with tariff
Imports with no tariff
© Randall W. Stone, 2002
3. Effects of a tariff
P
D
S
PD
Consumer loss:
PT
PW
A
B
QPW
QPT
C
A+B+C+D
D
QCT
QCW
Q
Imports with tariff
Imports with no tariff
© Randall W. Stone, 2002
3. Effects of a tariff
P
D
S
Producer gains: A
PD
Government gains: C
PT
PW
Gains:
A
B
C
D
Welfare loss:
B+D
QPW
QPT
QCT
QCW
Q
Imports with tariff
Imports with no tariff
© Randall W. Stone, 2002
Why not compensate the losers?
•
•
•
•
•
Concentrated costs, diffuse benefits
Incentives to defect
Economic change shifts political power
Bargaining
Why bother?
© Randall W. Stone, 2002
Stolper-Samuelson
• Intuition: scarcity -> high price
• Factors of production that are more
scarce domestically than globally have
a higher price in the absence of trade
• Domestically abundant factors are more
valuable if there is trade
• Domestic coalitions should depend on
which factors are abundant
© Randall W. Stone, 2002
Trade and Cleavages
Land-Labor ratio
High (land)
High K
Low K
Low (land)
(class
(urban-
conflict)
rural)
(urban-
(class
rural)
conflict)
Change occurs when:
– Trade increases (transport costs decrease)
– Relative factor endowments change
(development: K increases)
© Randall W. Stone, 2002