COMPARATIVE ADVANTAGE TRADE

Transcription

1 Lectures, 1 COMPRTIVE DVNTGE TRDE WHY TRDE? Economists recognize three basic reasons. i Comparative advantage trade to exploit differences between countries; ii Increasing returns to scale trade to concentrate on fewer things and to do them better; iii Imperfect competition trade to expose firms to more competition to force them to behave mere efficiently. In a comparative-advantage world countries trade to exploit their differences: technology; factor endowments; tastes; and also man-made differences such as those due to government policies. Key assumptions: (i) perfect competition in all markets; (ii) no externalities of production or of consumption. This rules out economies of scale and imperfect competition. (Worry about this later). Engaging in trade is costly, so it makes sense only if it confers gains. So let's start by looking at the nature of possible gains from trade. I THE GINS FROM TRDE rgument is obvious for a single individual: Distinguish production gain and consumption gain from trade. Figure 1-1

2 Comparative dvantage Page 8 General Case Will compare an autarky equilibrium with a free-trade one. utarky Trade NOTTION x x production bundle d d consumption bundle v v factors used p p commodity price vector w w factor reward vector (1) x = d (autarky) (2) px = pd (balanced trade) (3) px - wv px - wv [=0] (profit maximization) Expression (3) depends on perfect competition (which gives an analogous expression for each firm in the economy) and on no externalities in production (which allows us to add up over all firms). Substituting (1) and (2) into (3) gives: (I) pd - wv < pd - wv The algebraic counterpart to the above diagrams. With a single individual we can apply WRP directly. What about a collection of individuals? If (I) held for each individual, the assumption of no externalities in consumption would again allow us to employ the WRP for each. But no reason to expect this. Note that (1) (3) hold for every autarky equilibrium (obtainable for any lump sum redistributions of endowments or of goods) and for every free trade equilibrium. Thus: There is no system of autarky lump sum redistributions that would leave everyone better off than in any free trade equilibrium otherwise the analog of (I) would be violated for each individual and therefore in the aggregate as well.

3 Wilfred J. Ethier Page 9 (N.B.: These are transfers within a country, not between countries). Or to phrase it somewhat differently: The Basic GINS FROM TRDE In any trading equilibrium, gainers must gain at least as much as losers lose, relative to autarky. This is the basic gains-from-trade argument. Note the three basic qualifications: i There may be losers as well as gainers. ii The gainers may or may not outnumber the losers. iii The comparison is between free trade (or at least some trade) and autarky, not between free trade and restricted trade. From this we might conjecture: GINS FROM TRDE II For each situation obtainable under autarky, there exists some system of lump-sum taxes and subsidies that makes everyone at least as well off with free trade. [Briefly discuss formal issues involved here (e. g., Grandmont and McFadden, " Technical Note on Classical Gains from Trade," JOURNL OF INTERNTIONL ECONOMICS, May 1972, pp ; paper by Otani in same issue; Kemp and Wan, INTERNTIONL ECONOMIC REVIEW, 1972). The basic issue is the existence of the desired free-trade equilibrium with transfers. We cannot simply appeal to the Second Theorem of Welfare Economics because we need to rule out international transfers. Note that the italicized statement what was actually demonstrated is a statement about nonexistence, whereas the assertion in the box is about existence. Will not discuss these issues.]

4 Comparative dvantage Page 10 II THE PRINCIPLE OF COMPRTIVE DVNTGE We are now ready to turn to comparative advantage. For simplicity, we suppose factors are inelastically supplied, i.e., v is fixed. Principle of Comparative dvantage Suppose two goods ( and B) and two countries (home, H, and foreign, F). If in the absence of free trade, P B /P is less in H than in F, we say: H has a comparative advantage over F in B relative to. In this case, with free trade: 1 Neither country will reduce production of the good in which it has a comparative advantage nor produce more of the other good. 2 Neither country will import the good in which it has a comparative advantage. 3 ll exchanges will take place at terms between the relative autarky prices in H and F inclusively. In addition, we have the welfare implications: 4 In each country gainers gain at least as much as losers lose, relative to autarky. 5 The free-trade equilibrium is globally constrained-pareto-efficient (the constraint being that factors are internationally immobile). Usual textbook explanation of comparative advantage General Principle of Comparative dvantage. Suppose there are two countries (H and F), no externalities, and unique, competitive autarky equilibria in each country. If they move to a competitive free-trade equilibrium where, for some social welfare index consistent with autarky and free-trade consumption, u(d) u(d ) in each country:

5 W ilfred J. Ethier Page In each country, 2. If M denotes the home net import vector, 3. The trade and autarky price vectors satisfy 4. World output will be constrained Pareto-efficient. 5. In each country gainers gain at least as much as losers lose. Proof of the Comparative dvantage Theorem ssertion 4 follows from basic welfare economics, and 5 is the gains from trade theorem. Thus we need prove 1, 2, and 3. We have by profit maximization. Thus so that This gives the first assertion. Have, for the home country: a a a a a a p d p d = p x p x. Thus Now by balanced trade. Thus

6 Comparative dvantage Page 12 Similarly for the foreign country, But M = -M* so (1) and (2) imply that This proves the second assertion, and the third likewise follows. III THE GENERL EQUILIBRIUM OF INTERNTIONL TRDE a Walras' Law where B, denote demands and b, a supplies. There are no other sources of or ways to dispose of income. lternatively, b International Equilibrium c Elasticity Have M(p) = B(p, e) - b(p), where e = + pb. If y = a + pb, then e = y by the budget constraint. (We will not be addressing issues concerned with internal distribution, so you may as well take u as a scalar, rather than as a vector of utilities of individual households).

7 W ilfred J. Ethier Page 13 Differentiate the definition of M(p): Now, the Slutsky equation is: Substituting: or, Discuss income and substitution effects. The substitution effects are unambiguously negative. Since e/ p = B, y/ p = b and M = B - b, or or e = c + s + m = c /(M/B) + s /(X/a) + m which are defined accordingly from the preceding expression (where c and s are conventional elasticities). lso s =(p/m)(db/dp) = -(da/db) (db/dp)(p/x) = -(p/x)(da/dp) = [(1/p)/X][da/d(1/p)]. e is the elasticity of the M(p) curve:

8 Comparative dvantage Page 14 Here, e = BC/B at B. Could as well define the elasticity of export supply: Figure 1 10 ^ ^ ^ ^ ^ Now from Walras's Law, M + p = X, or 1 + (M/p) = ^ ^ X/p Thus: f = e - 1. So, f = c + s + (m-1), where m-1 can be interpreted as the marginal propensity to export. Summary on elasticities: e = c + s + m (= (B/M)c + (a/x)s + m) where e - (p/m)(dm/dp) c - (p/m)( B/ p u) (consumption substitution elasticity) s [(1/p)/X][da/d(1/p)] (production substitution elasticity) m p( B/ E) (marginal propensity to import) f = c + s + (m-1) where f [(1/p)/X][dX/d(1/p)] = e - 1 g = f/e = (e-1)/e where g [M/X][dX/dM] d The Marshall-Lerner condition Let á denote a shift parameter. Then the basic comparative statics of international equilibrium pm(p,á) = M*(1/p) is given by:

9 W ilfred J. Ethier Page 15 Thus low elasticities (i.e. values of e + e* not much above unity) imply that exogenous shocks induce price volatility, and that the exercise of market power becomes more tempting (individual agents have no market power, by assumption, but individual countries may: here the second distinguishing feature of international trade theory that there is more than one sovereign government becomes important). Discuss with respect to perceived problems of primary-good exporters. Discuss DC DC trade vs. DC LDC trade, etc. Circumstances tending toward satisfaction of the M-L condition, also written as: So optimism is associated with: (1) high total elasticities (2) high substitution elasticities (3) low trade volumes (4) high marginal preferences for imported goods (5) small international differences in spending propensities.