Local & Regional Economics
Interregional Trade
Regional and Local Economics (RALE)
Lecture slides – Lecture 4b
1
Local & Regional Economics
Lecture 8
Last lecture: - Industrial Location Theory
This lecture: - Interregional Trade
Aim:
To discover why regions specialise in
certain commodities
Outcomes:
Awareness of Ricardian and HeckscherOhlin theories of regional trade
Awareness of more radical explanations
of regional trade and specialisation
Regional and Local Economics (RALE)
Lecture slides – Lecture 4b
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Local & Regional Economics
Proposition - Regions need to trade if they
are to be prosperous.
All regions are becoming more “open” EU,
GATT.
Proportion of goods and services % GDP
exported imported
Luxembourg 93%
80%
Belgium
75%
69%
Greece
16%
24%
Success breeds Success.
Regional and Local Economics (RALE)
Lecture slides – Lecture 4b
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Local & Regional Economics
 Ricardian Trade Theory - regions can gain from
trade by specialising in production and export of
goods in which they have a “comparative
advantage”
Commodity
Wheat
Cars
South
2
10
North
3
21
Possibility of mutually advantageous gains from trade.
Exchange rate cars for wheat South 1:5 North 1:7 if world rate settles at 1:6
South exchanges one car for 6 tonnes of wheat can only get 5 tonnes at
home
North imports car for 6 tonnes of wheat but cost of home produced is 7
Regional and Local Economic Analysis (RALE)
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tonnes
Lecture slides – Lecture 8
Local & Regional Economics
Question - what is the source of comparative
advantage?
 Labour productivity (is this realistic?)
 Technology or capital stock?
 Could it be wages?
Regional and Local Economics (RALE)
Lecture slides – Lecture 4b
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Local & Regional Economics
Heckscher- Ohlin Trade Theorem
 Simple version only two
factors of production K and L.
 Comparative advantage from
initial factor endowment each
region specialising in its rich
factor.
 capital abundance in south
leads to car production
 Labour abundance in north
leads to wheat production.
P of labour/
price of capital
Fcs
Fcn
Wheat 1 unit
Cars 1 unit
Rcs Rcn Rws Rwn
Regional and Local Economics (RALE)
Lecture slides – Lecture 4b
Adapted from Armstrong
and Taylor (2000) pp 125
Ratio of labour
to capital L/K
6
Local & Regional Economics
P ric e
o f la b o u r
P ric e o f c a p ita l
(P L /P K )
Adapted from Armstrong and Taylor
(2000) pp 125
Fs
Fn
W heat
C a rs
o f c a rs P n
P ric e o f w h e a t
(P c /P w )
P ric e
Ps
0
R
c
c
s
R nR
w
s
R
w
n
R a tio o f la b o u r to
c a p ita l (L /K )
Prediction
South has an advantage in producing cars because it uses a lot of its
cheaper factor (capital)
North has advantage in Wheat because it uses a lot of its cheaper factor
(Labour)
Regional and Local Economic Analysis (RALE)
The difference in the price ratios
the8opportunity for trade
Lecturecreates
slides – Lecture
7
Local & Regional Economics
Restrictive assumptions
 There are only two factors of production – labour and
capital
 Factors of production are of the same quality in both
regions
 Each region’s endowments of capital and labour are
fixed
 Production functions are the same in each region (no
regional advantage from superior technology)
 Production functions have constant returns to scale
 There is perfect competition in each region’s factor and
commodity markets
 Trade is free of all obstructions (tariffs etc.)
 There is strong factor intensity at all sets of factor prices
 Tastes are identical in all regions and do not vary with
regional income levels
Regional and Local Economics (RALE)
Lecture slides – Lecture 4b
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Local & Regional Economics
Relaxing the assumption of fixed factor
endowment
P ric e
o f la b o u r
P ric e o f c a p ita l
(P L /P K )





Adapted from Armstrong and Taylor
(2000) pp 130
More than two factors of production
Factor quality (human capital)
Strong factor intensities
Constant returns to scale
Factor migration
Fs
F*
Fn
W heat
C a rs
o f c a rs P n P *
P ric e o f w h e a t
(P c /P w )
P ric e
Ps
0
R
c
c
s
R nR
w
s
R
w
n
R a tio o f la b o u r to
c a p ita l (L /K )
Regional and Local Economics (RALE)
Lecture slides – Lecture 4b
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Local & Regional Economics
Intra-industry trade theory (exchange of
virtually identical products)
Horizontal
 Wide range of choice may loose share in
domestic market but openings in export
markets
 Need high levels of output, economies of scale
 Highest in closely integrated economies
Vertical
 In same industry but at different stages in the
production chain
Regional and Local Economics (RALE)
Lecture slides – Lecture 4b
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Local & Regional Economics
Competitive Advantage
 Mutually reinforcing competitive advantage
 Importance of interactions between elements
 Not a formalised model but draws on case
studies - not all regions will have all elements
“in place”.
F irm stra te g y,
s tru c tu re & riv a lry
F a cto r c o n d itio n s
Adapted from Armstrong
and Taylor (2000) pp 133
D e m an d c o n d itio n s
R e la ted & s u p p o rtin g
In d u s trie s
Regional and Local Economics (RALE)
Lecture slides – Lecture 4b
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Local & Regional Economics
New Economic Geography
 Home market effect
 Footloose labour/industries model
 Vertically linked industries model
Centripetal forces
Market-size
Thick Labour market
External economies
See Krugman 1998
Centrifugal forces
Immobile factors
Land rents
External diseconomies
Regional and Local Economics (RALE)
Lecture slides – Lecture 4b
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Local & Regional Economics
Conclusions - Why specialisation exists
 Ricardian opportunity cost advantage creates
climate for trade.
 Heckschler-Ohlin theorem predicts local factor
abundance as the reason for regional
specialisation
 Intra-industry trade models explain observed
behaviour
 Geography still matters.
Next Week Inter-regional Labour Migration
Regional and Local Economics (RALE)
Lecture slides – Lecture 4b
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