ECONOMIC GROWTH AND INTERNATIONAL TRADE
OUTLINE
7.1 Introduction
7.2 Growth of Factors of Production
7.2a Labor Growth and Capital Accumulation Over Time
7.2b The Rybczynski Theorem
7.3 Technical Progress
7.3a Neutral, Labor-Saving, and Capital-Saving Technical Progress
7.3b Technical Progress and the Nation's Production Frontier
Case Study 7-1: Changes in Relative Resource Endowments of Various Countries and Regions
Case Study 7-2: Change in Capital-Labor Rations in Selected Countries
7.4 Growth and Trade: The Small Country Case
7.4a The Effects of Growth on Trade
7.4b Illustration of Factor Growth, Trade, and Welfare
7.4c Technical Progress, Trade, and Welfare
Case Study 7-3: Growth of Output per Worker from Capital Deepening, Technological Change, and Improvements in Efficiency
7.5 Growth and Trade: The Large-Country Case
7.5a Growth and the Nation's Terms of Trade and Welfare
7.5b Immiserizing Growth
7.5c Illustration of Beneficial Growth and Trade
Case Study 7-4: Growth, Trade, and the Giants of the Future
7.6 Growth, Change in Tastes, and Trade in Both Nations
7.6a Growth and Trade in Both Nations
7.6b Change in Tastes and Trade in Both Nations
Case Study 7-5: Change in the Revealed Comparative Advantage of Various Countries or Regions
Case Study 7-6: Growth, Trade, and Welfare in the Leading Industrial Nations
Appendix: A7.1 Formal Proof of Rybczynski Theorem
A7.2 Growth with Factor Immobility
A7.3 Graphical Analysis of Hicksian Technical Progress
Key Terms
Comparative statics Antitrade production and consumption
Dynamic analysis Neutral production and consumption
Balanced growth Normal goods
Rybczynski theorem Inferior goods
Labor-saving technical progress Terms-of-trade effect
Capital-saving technical progress Wealth effect
Protrade production and consumption Immiserizing growth
Lecture Guide
1. This is not a core chapter and it is one of the most challenging chapters in international trade
theory. It is included for more advanced students and for completeness.
2. If I were to cover this chapter, I would present two sections in each of three lectures.
Time permitting, I would, otherwise cover Sections 1 and 2, paying special attention to the
Rybczynski theorem.
Answer to Problems
1. a) See Figure 1.
b) See Figure 2
c) See Figure 3.
2. See Figure 4.
3. a) See Figure 5.
b) See Figure 6.
c) See Figure 7.
4. Compare Figure 5 to Figure 1.
Compare Figure 6 to Figure 3. Note that the two production frontiers have the same vertical
or Y intercept in Figure 6 but a different vertical or Y intercept in Figure 3.
Compare Figure 7 to Figure 2. Note that the two production frontiers have the same
horizontal or X intercept in Figure 7 but a different horizontal or X intercept in Figure 2.
5. See Figure 8 on page 66.
6. See Figure 9.
7. See Figure 10.
8. See Figure 11.
9. See Figure 12.
10. See Figure 13 on page 67.
11. See Figure 14.
12. See Figure 15.
13. The United States has become the most competitive economy in the world since the early
1990’s while the data in Table 7.3 refers to the 1965-1990 period.
14. The data in Table 7.4 seem to indicate that China had a comparative advantage in capital-intensive commodities and a comparative disadvantage in unskilled-labor intensive commodities in 1973. This was very likely due to the many trade restrictions and subsidies, which distorted the comparative advantage of China. Its true comparative advantage became evident by 1993 after China had started to liberalize its economy.
App. 1a. See Figure 16.
1b. For production and consumption to actually occur at the new equilibrium point after the doubling of K in Nation 2, we must assume either than commodity X is inferior or that Nation 2 is too small to affect the relative commodity prices at which it trades.
1c. Px/Py must rise (i.e., Py/Px must fall) as a result of growth only.
Px/Py will fall even more with trade.
1. If the supply of capital increases in Nation 1 in the production of commodity Y
only, the VMPLy curve shifts up, and w rises in both industries. Some labor shifts
to the production of Y, the output of Y rises and the output of X falls, r falls, and
Px/Py is likely to rise.
2. Capital investments tend to increase real wages because they raise the K/L ratio and the productivity of labor. Technical progress tends to increase K/L and real wages if it is L-saving and to reduce K/L and real wages if it is K-saving.
Multiple-Choice Questions
1. Dynamic factors in trade theory refer to changes in:
a. factor endowments
b. technology
c. tastes
*d. all of the above
2. Doubling the amount of L and K under constant returns to scale:
a. doubles the output of the L-intensive commodity
b. doubles the output of the K-intensive commodity
c. leaves the shape of the production frontier unchanged
*d. all of the above.
3. Doubling only the amount of L available under constant returns to scale:
a. less than doubles the output of the L-intensive commodity
*b. more than doubles the output of the L-intensive commodity
c. doubles the output of the K-intensive commodity
d. leaves the output of the K-intensive commodity unchanged
4. The Rybczynski theorem postulates that doubling L at constant relative commodity prices:
a. doubles the output of the L-intensive commodity
*b. reduces the output of the K-intensive commodity
c. increases the output of both commodities
d. any of the above
5. Doubling L is likely to:
a. increases the relative price of the L-intensive commodity
b. reduces the relative price of the K-intensive commodity
*c. reduces the relative price of the L-intensive commodity
d. any of the above
6.Technical progress that increases the productivity of L proportionately more than the
productivity of K is called:
*a. capital saving
b. labor saving
c. neutral
d. any of the above
7. A 50 percent productivity increase in the production of commodity Y:
a. increases the output of commodity Y by 50 percent
b. does not affect the output of X
c. shifts the production frontier in the Y direction only
*d. any of the above
8. Doubling L with trade in a small L-abundant nation:
*a. reduces the nation's social welfare
b. reduces the nation's terms of trade
c. reduces the volume of trade
d. all of the above
9. Doubling L with trade in a large L-abundant nation:
a. reduces the nation's social welfare
b. reduces the nation's terms of trade
c. reduces the volume of trade
*d. all of the above
10.If, at unchanged terms of trade, a nation wants to trade more after growth, then the
nation's terms of trade can be expected to:
*a. deteriorate
b. improve
c. remain unchanged
d. any of the above
11. A proportionately greater increase in the nation's supply of labor than of capital is likely
to result in a deterioration in the nation's terms of trade if the nation exports:
a. the K-intensive commodity
*b. the L-intensive commodity
c. either commodity
d. both commodities
12. Technical progress in the nation's export commodity:
*a. may reduce the nation's welfare
b. will reduce the nation's welfare
c. will increase the nation's welfare
d. leaves the nation's welfare unchanged
13. Doubling K with trade in a large L-abundant nation:
a. increases the nation's welfare
b. improves the nation's terms of trade
c. reduces the volume of trade
*d. all of the above
14. An increase in tastes for the import commodity in both nations:
a. reduces the volume of trade
*b. increases the volume of trade
c. leaves the volume of trade unchanged
d. any of the above
15. An increase in tastes of the import commodity of Nation A and export in B:
*a. will reduce the terms of trade of Nation A
b. will increase the terms of trade of Nation A
c. will reduce the terms of trade of Nation B
d. any of the above
ADDITIONAL ESSAYS AND PROBLEMS FOR PART ONE
1. Assume that both the United States and Germany produce beef and computer chips with the following costs:
United States Germany
(dollars) (marks)
Unit cost of beef (B) 2 8
Unit cost of computer chips (C) 1 2
a) What is the opportunity cost of beef (B) and computer chips (C) in each country?
b)In which commodity does the United States have a comparative cost advantage?
What about Germany?
c)What is the range for mutually beneficial trade between the United States and Germany for each computer chip traded?
d)How much would the United States and Germany gain if 1 unit of beef is exchanged for 3 chips?
Ans. a) In the United States:
the opportunity cost of one unit of beef is 2 chips;
the opportunity cost of one chip is 1/2 unit of beef.
In Germany:
the opportunity cost of one unit of beef is 4 chips;
the opportunity cost of one chip is 1/4 unit of beef.
b) The United States has a comparative cost advantage in beef with respect to Germany, while Germany has a comparative cost advantage in computer chips.
c)The range for mutually beneficial trade between the United States and Germany for each unit of beef that the United States exports is
2C < 1B < 4C
d) Both the United States and Germany would gain 1 chip for each unit of beef traded.
2. Given: (1) two nations (1 and 2) which have the same technology but different factor endowments and tastes, (2) two commodities (X and Y) produced under increasing costs conditions, and (3) no transportation costs, tariffs, or other obstructions to trade. Prove geometrically that mutually advantageous trade between the two nations is possible.
Note: Your answer should show the autarky (no-trade) and free-trade points of production and consumption for each nation, the gains from trade of each nation, and express the equilibrium condition that should prevail when trade stops expanding.)
Ans.: See Figure 1 on page 74.
Nations 1 and 2 have different production possibilities curves and different community indifference maps. With these, they will usually end up with different relative commodity prices in autarky, thus making mutually beneficial trade possible.
In the figure, Nation 1 produces and consumes at point A and Px/Py=PA in autarky,
while Nation 2 produces and consumes at point A' and Px/Py=PA'. Since PA < PA',
Nation 1 has a comparative advantage in X and Nation 2 in Y. Specialization in
production proceeds until point B in Nation 1 and point B' in Nation 2, at which PB=PB' and the quantity supplied for export of each commodity exactly equals the quantity demanded for import. Thus, Nation 1 starts at point A in production and consumption in autarky, moves to point B in production, and by exchanging BC of X for CE of Y reaches point E in consumption. E > A since it involves more of both X and Y and lies on a higher community indifference curve. Nation 2 starts at A' in production and consumption in autarky, moves to point B' in production, and by exchanging B'C' of Y for C'E' of X reaches point E'in consumption (which exceeds A').
At Px/Py=PB=PB', Nation 1 wants to export BC of X for CE of Y, while Nation 2 wants to export B'C' (=CE) of Y for C'E' (=BC) of X. Thus, PB=PB' is the equilibrium relative commodity price because it clears both (the X and Y) markets.
3. Draw a figure showing: (1) in Panel A a nation's demand and supply curve for A traded commodity and the nation's excess supply of the commodity, (2) in Panel C the trade partner's demand and supply curve for the same traded commodity and its excess demand for the commodity, and (3) in Panel B the supply and demand for the quantity traded of the commodity, its equilibrium price, and why a price above or below the equilibrium price will not persist. At any other price, QD QS, and P will change to P2.
Ans. See Figure 2 on page 74.
The equilibrium relative commodity price for commodity X (the traded commodity
exported by Nation 1 and imported by Nation 2) is P2 and the equilibrium quantity
of commodity X traded is Q2.
4. a) Identify the conditions that may give rise to trade between two nations.
b) What are some of the assumptions on which the Heckscher-Ohlin theory is based?
c) What does this theory say about the pattern of trade and effect of trade on factor prices?
Ans. a) Trade can be based on a difference in factor endowments, technology, or tastes between two nations. A difference either in factor endowments or technology results in a different production possibilities frontier for each nation, which, unless neutralized by a difference in tastes, leads to a difference in relative commodity price
and mutually beneficial trade. If two nations face increasing costs and have identical production possibilities frontiers but different tastes, there will also be a difference in relative commodity prices and the basis for mutually beneficial trade between the two nations. The difference in relative commodity prices is then translated into a difference in absolute commodity prices between the two nations, which is the immediate cause of trade.
b) The Heckscher-Ohlin theory (sometimes referred to as the modern theory – as
opposed to the classical theory - of international trade) assumes that nations have the same tastes, use the same technology, face constant returns to scale (i.e., a given percentage increase in all inputs increases output by the same percentage) but differ widely in factor endowments. It also says that in the face of identical tastes or demand conditions, this difference in factor endowments will result in a difference in relative factor prices between nations, which in turn leads to a difference in relative commodity prices and trade. Thus, in the Heckscher-Ohlin theory, the international difference in supply conditions alone determines the pattern of trade. To be noted is that the two nations need not be identical in other respects in order for international trade to be based primarily on the difference in their factor endowments.
c) The Heckscher-Ohlin theorem postulates that each nation will export the commodity intensive in its relatively abundant and cheap factor and import the commodity intensive in its relatively scarce and expensive factor. As an important corollary, it adds that under highly restrictive assumptions, trade will completely eliminate the pretrade relative and absolute differences in the price of homogeneous factors among nations. Under less restrictive and more usual conditions, however, trade will reduce, but not eliminate, the pretrade differences in relative and absolute factor prices among nations. In any event, the Heckscher-Ohlin theory does say something very useful on how trade affects factor prices and the distribution of income in each nation. Classical economists were practically silent on this point.
5. consumers demand more of commodity X (the L-intensive commodity) and less of commodity Y (the K- intensive commodity). Suppose that Nation 1 is India, commodity X is textiles, and commodity Y is food. Starting from the no-trade equilibrium position and using the Heckscher-Ohlin model, trace the effect of this change in tastes on India's
(a) relative commodity prices and demand for food and textiles,
(b) production of both commodities and factor prices, and
(c) comparative advantage and volume of trade.
(d) Do you expect international trade to lead to the complete equalization of relative commodity and factor prices between India and the United States? Why?
Ans. a. The change in tastes can be visualized by a shift toward the textile axis in India's indifference map in such a way that an indifference curve is tangent to the steeper segment of India's production frontier (because of increasing opportunity costs) after the increase in demand for textiles. This will cause the pretrade relative commodity price of textiles to rise in India.
b. The increase in the relative price of textiles will lead domestic producers in India to shift labor and capital from the production of food to the production of textiles. Since textiles are L-intensive in relation to food, the demand for labor and therefore the wage rate will rise in India. At the same time, as the demand for food falls, the demand for and thus the price of capital will fall. With labor becoming relative more expensive, producers in India will substitute capital for labor in the production of both textiles and food.
Even with the rise in relative wages and in the relative price of textiles, India still remains the L-abundant and low-wage nation with respect to a nation such as the United States. However, the pretrade difference in the relative price of textiles between India and the United States is now somewhat smaller than before the change in tastes in India. As a result the volume of trade required to equalize relative commodity prices and hence factor prices is smaller than before. That is, India need now export a smaller quantity of textiles and import less food than before for the relative price of textiles in India and the United States to be equalized. Similarly, the gap between real wages and between India and the United States is now smaller and can be more quickly and easily closed (i.e., with a smaller volume of trade).
c. Since many of the assumptions required for the complete equalization of relative commodity and factor prices do not hold in the real world, great differences can be expected and do in fact remain between real wages in India and the United States. Nevertheless, trade would tend to reduce these differences, and the H-O model does identify the forces that must be considered to analyze the effect of trade on the differences in the relative and absolute commodity and factor prices between India and the United States.
5. (a) Explain why the Heckscher-Ohlin trade model needs to be extended.
(b) Indicate in what important ways the Heckscher-Ohlin trade model can be extended.
(c) Explain what is meant by differentiated products and intra-industry trade.
Ans. (a) The Heckscher-Ohlin trade model needs to be extended because, while generally correct, it fails to explain a significant portion of international trade, particularly the trade in manufactured products among industrial nations.
(b)The international trade left unexplained by the basic Heckscher-Ohlin trade mode can be explained by
(1) economies of scale,
(2) intra-industry trade, and
(3) trade based on imitation gaps and product differentiation.
(c)Differentiated products refer to similar, but not identical, products (such as cars,
typewriters, cigarettes, soaps, and so on) produced by the same industry or broad
product group. Intra-industry trade refers to the international trade in differentiated
products.
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