International Trade Models
• Mercantilism;
• The Classical Theories:
– The Principle of Absolute Advantage
– The Principle of Comparative Advantage
• The Heckscher-Ohlin-Samuelson Model;
• Alternative Trade Theories
Mercantilism
A school of thought dominant before the
19th century, which advocated restrictive
trade policies, so as to maximize exports
and minimize imports for the sake of
accumulating gold and foreign exchange
The Principle of Absolute
Advantage
“If a foreign country can supply us with a
commodity cheaper than we ourselves can
make it, better buy it of them with some part
of the product of our own industry, employed
in a way in which we have some advantage”
Wealth of Nations, Adam Smith
The Principle of Comparative
Advantage
“A nation, like a person, gains from trade by
exporting the goods or services in which it has its
greatest comparative advantage in productivity
and importing those in which it has the least
comparative advantage.”
David Ricardo
The Law of Comparative
Advantage
Mutually beneficial trade is possible
whenever relative prices (opportunity
costs) between two goods differ in
two countries.
Pre-Trade Equilibrium in
Country A
•
•
•
•
Production = 25X + 12.5Y
Consumption = 25X + 12.5Y
Relative Price of X = 1/2 Y
Relative Price of Y = 2 X
A has a comparative advantage over B in
producing X, because the relative price of X
in A is lower than the relative price of X in B.
Pre-Trade Equilibrium in
Country B
•
•
•
•
Production = 10X + 12.5Y
Consumption = 10X + 12.5Y
Relative Price of X = 5/4 Y
Relative Price of Y = 4/5 X
B has a comparative advantage over A in
producing Y, because the relative price of Y in
B is lower than the relative price of Y in A.
Free-Trade Equilibria
• Country A:
– Production = 50X + 0Y
– Consumption = 30X + 20Y
– Relative Price of X = 1 Y
Exports = 20X
Imports = 20Y
• Country B:
– Production = 0X + 25Y
– Consumption = 20X + 5Y
– Relative Price of X = 1 Y
Exports = 20Y
Imports = 20X
The Gains From Trade
A nation’s gains from
trade consists of two
components:
• the gain from the
reallocation of
consumption; and
• the gain from
specialization in
production.
The fact that a nation
unequivocally gains
from international
trade does not mean
that all groups within
the nation necessarily
gain: in fact some
groups will lose.
Who Gains?
• Producers and workers in the export industry
gain as a result of higher world prices and a
larger volume of trade;
• Consumers of the import competing good gain
as a result of lower world prices and a larger
supply; and
• Firms which use imported components and
materials in their production process gain as a
result of lower import prices.
Who Loses?
• Producers and workers in the importcompeting industry lose due to increased
competition from imports;
• Consumers of the export good lose due to the
smaller supply available to the local market
and higher world prices; and
• Firms which use exportable components and
materials in their production process lose due
to increased prices.