International Economics ECON 390
Lotta Moberg
Lecture notes - 6 September 15 - 17: The Standard Trade Model
The Standard Trade Model
1.
Includes Ricardian, specific factors, and Heckscher-Ohlin models as special cases.
 Two goods, food (F) and cloth (C).
 Each country’s PPF is a smooth curve.
2.
Different production possibility frontiers from differences in labor services, labor skills, physical capital, land, and technology between countries.
3.
Relative Prices Determine the Economy’s Output (As illustrated by the PPF
4.
and isovalue lines)
Relative supply of cloth to food increases with the relative price of cloth to food (Learn to illustrate this with the PPF and changes in the price lines)
Relative Prices and Demand
5.
The value of the economy’s consumption must equal the value of the economy’s production:
6.
P
C
D
C
+ P
F
D
F
= P
C
Q
C
+ P
F
Q
F
= V
An indifference curve represents combinations of cloth and food that leave the consumer equally well off.
 Consume at the point where the isovalue line is tangent to the indifference
7.
curve.
For an economy exporting cloth, the quantity of cloth produced exceeds the quantity of cloth consumed.
Production, Consumption, and Trade in the Standard Model
8.
An economy that exports cloth is better off when the price of cloth rises relative to the price of food.
9.
A higher relative price of cloth means that more calories of food can be imported for every yard of cloth exported. (This is what the standard trade model illustrates: The Equilibrium Relative Price with Trade and Associated

International Economics ECON 390
Lotta Moberg
Trade Flows, the Effects of a Rise in the Relative Price of Cloth and Gains from Trade)
Biased Growth
10.
Economic growth moves the PPF, as growth is often biased, occurring in one sector more than others and causing relative supply to change. (Learn to illustrate the effects of biased growth)
 In the Ricardian model, technological progress in one sector causes biased growth.
 In the Heckscher-Ohlin model, an increase in one factor of production causes biased growth.
 The resulting change in relative supply causes a change in the terms of trade
Terms of Trade = How much you get for your stuff
11.
The price of exports relative to the price of imports.
 When a country exports cloth and the relative price of cloth increases, the terms of trade rise, and welfare increases
 Use relative supply and relative demand to determine the price of cloth relative to the price food.
12.
Export-biased growth expands a country’s production possibilities disproportionately in that country’s export sector.
13.
Import-biased growth expands a country’s production possibilities disproportionately in that country’s import sector.
14.
Export-biased growth reduces a country’s terms of trade, reducing its welfare and increasing the welfare of foreign countries.
15.
Import-biased growth increases a country’s terms of trade, increasing its welfare and decreasing the welfare of foreign countries.
Import Tariffs
16.
Taxes levied on imports.
 Relative supply of cloth decreases/ supply of food increases

International Economics ECON 390
Lotta Moberg
 More domestic producers making food means that world supply of cloth decreases.
17.
Import tariff on food raises the price of food relative to the price of cloth for domestic consumers.
 The price of cloth relative to the price of food falls for domestic consumers.
 Domestic consumers will pay a lower relative price for cloth, and therefore demand more cloth.
 Before, they imported food and exported cloth. Now, they are importing less food. Relative demand for food decreases internationally, that is, relative demand for cloth increases.
Effects of a Food Tariff on the Terms of Trade
18.
The terms of trade increase - so the welfare of the country may increase – if the country is big enough to act like a monopoly!
19.
Thus, the magnitude of this effect depends on the size of the home country relative to the world economy. (Learn how you can illustrate this)
Export Subsidy
20.
An export subsidy on cloth by the home country raises its relative price.
 Domestic consumers pay a higher relative price of cloth to producers. They demand more food internationally. Relative demand for cloth decreases.
 Domestic producers receive a higher relative price of cloth when they exporting. They produce and export more cloth. Relative world supply of cloth increases.
21.
The terms of trade decrease and the welfare of the country decreases to the benefit of the foreign country. (Learn to illustrate the Effects of a Cloth
Subsidy on the Terms of Trade)
Implications of Terms of Trade Effects
22.
An import tariff by the home country can increase domestic welfare at the expense of the foreign country.

International Economics ECON 390
Lotta Moberg
23.
An export subsidy by the home country reduces domestic welfare to the benefit of the foreign country.
 If Mexico subsidizes the export of a good that the U.S. exports as well, the resulting price fall decreases the U.S.’s terms of trade.
 If Mexico imposes a tariff on an imported good that the U.S. also imports, the resulting price fall increases the U.S.’s terms of trade.
International Borrowing and Lending
24.
The standard trade model can be modified to analyze international borrowing and lending.
 Two goods: Current and future consumption (same good at different times).
25.
Countries have different opportunities to invest to produce more in the future.
26.
The intertemporal production possibility frontier depicts different possible combinations of current output and future output.
International Borrowing and Lending
27.
Home has a PPF biased towards current output, and Foreign towards future output.
 So Foreign should invest now to generate more future output.
 If you borrow $1 of output, you must repay it with interest = 1 + r in the future
 Home exports current consumption and imports future consumption.
 Home lends to Foreign by consuming less than it produces now.
 Foreign pays back the loan by consuming less than it produces in the future.
28.
The relative price of future consumption is determined by the intersection of world relative demand and world relative supply.
(Learn to illustrate the Intertemporal Production Possibility Frontier, and the intertemporal consumption pattern of two countries – on a borrower and the other a lender)