Global Business Environment

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1 Global Business Environment Di erences and Scale Francesco Franco Nova SBE April 23, 2014 Francesco Franco Global Business Environment 1/21

2 International Trade Trade Model Mixture of: The Ricardian model. Production possibilities are determined by the alloca- tion of a single resource, labor, between sectors. This model conveys the essential idea of comparative advantage but does not allow us to talk about the distribution of income. The specific factors model. This model includes multiple factors of production, but some are specific to the sectors in which they are employed. It also captures the short-run consequences of trade on the distribution of income. The Heckscher-Ohlin model. Di erences in resources drive trade patterns. This model also captures the long-run consequences of trade on the distribution of income. Francesco Franco Global Business Environment 2/21

3 International Trade Trade Model In spite of the di erences in their details, our models share a number of features: 1 The productive capacity of an economy can be summarized by its production possibility frontier, and di erences in these frontiers give rise to trade. 2 Production possibilities determine a country s relative supply schedule. 3 World equilibrium is determined by world relative demand and a world relative supply schedule that lies between the national relative supply schedules Francesco Franco Global Business Environment 3/21

4 International Trade Trade Model A model with all these ingredents can be used to establish 1 how changes in the terms of trade and economic growth a ect the welfare of nations engaged in international trade. 2 Understand the e ects of tari s and subsidies on trade patterns and the wel- are of trading nations and on the distribution of income within countries. Francesco Franco Global Business Environment 4/21

5 International Trade Trade Model Food production, Q F Q Isovalue lines TT Cloth production, Q C Figure : Relative prices and output V = P C Q C + P F Q F 1 2 Francesco Franco Global Business Environment 5/21

6 International Trade Trade Model Food production, Q F Relative price of cloth, P C RS Q 1 F Q 1 (P C ) 2 2 Q 2 F Q 2 VV 1 (P C ) 1 (P C ) 1 1 VV 2 (P C ) 2 TT Q 1 C (a) Q 2 C Cloth production, Q C (Q 1 C /Q1 F ) (Q 2 C /Q 2 F ) (b) Relative quantity of cloth, Q C /Q F Figure : Relative prices and output Francesco Franco Global Business Environment 6/21

7 International Trade Trade Model Demand: P C D C + P F D F = V Quantity of food, Q F Indifference curves D Food imports Q Isovalue line Cloth exports TT Quantity of cloth, Q C Figure : production and consumption Francesco Franco Global Business Environment 7/21

8 International Trade Trade Model Quantity of food, Q F Relative price of cloth, P C D 2 RS D D Q 1 3 Q 2 TT VV 1 (P C ) 1 VV 2 (P C ) 2 Quantity of cloth, Q C RD Relative quantity of cloth, Q C /Q F (a) Production and Consumption (b) Relative Supply and Demand Figure 6-4 Figure : An increase in P C Francesco Franco Global Business Environment 8/21

9 International Trade Trade Model Relative price of cloth, P C RS * RS WORLD RS (P C ) 1 1 RD Relative quantity of cloth, (Q C /Q F ) (a) Relative Supply and Demand Quantity of food, Q F VV 1 (P C ) 1 Home Quantity of food, Q F Foreign D F D Q * F Q * Home s food imports Foreign s food exports Q D * Q D * F F Quantity Quantity VV 1 (P C ) 1 Francesco Franco Global Business Environment 9/21

10 Trade model Bias growth Bias growth: technological progress in one sector expands output in that sector increase in a country supply of a factor of production Francesco Franco Global Business Environment 10/21

11 Trade model Bias growth Export-biased growth tends to worsen a growing country s terms of trade, to the benefit of the rest of the world import-biased growth tends to improve a growing country s terms of trade at the rest of the world s expense immiserizing growth in the developing World Import tari s an export subsidies (maybe for distributional and protection but ultimately a ect terms of trade) Francesco Franco Global Business Environment 11/21

12 Tari s and Export Subsidies E ects The distinctive feature of tari s and export subsidies is that they create a di erence between prices at which goods are traded on the world market and prices at which those goods can be purchased within a country. The direct e ect of a tari is to make imported goods more expensive inside a country than they are outside the country. An export subsidy gives producers an incentive to export Francesco Franco Global Business Environment 12/21

13 Tari s and Export Subsidies E ects for a big country or trading block Figure : E ects pf a Fodd Tari on the Terms of Trade Francesco Franco Global Business Environment 13/21

14 Scale and Scope 1 international trade often occurs from increasing returns to scale (instead of di erences) 2 Understand the di erences between internal and external economies of scale 3 sources of external economies 4 roles of external economies and knowledge spillovers in shaping comparative advantage and international trade patterns. Francesco Franco Global Business Environment 14/21

15 Scale and Scope External economies of scale occur when the cost per unit depends on the size of the industry but not necessarily on the size of any one firm Internal economies of scale occur when the cost per unit depends on the size of an individual firm but not necessarily on that of the industry Francesco Franco Global Business Environment 15/21

16 Scale and Scope External economies Marshall, industrial districts: the ability of a cluster to support specialized suppliers the way that a geographically concentrated industry allows labor market pooling and the way that a geographically concentrated industry helps foster knowledge spillovers. Francesco Franco Global Business Environment 16/21

17 Scale and Scope External economies: forward-falling supply curve Price, cost (per widget) P 1 1 AC D Q 1 Quantity of widgets produced, demanded Figure : External economies Francesco Franco Global Business Environment 17/21

18 Scale and Scope External economies Lock in e ects Dynamic increasing returns Interregional trade Francesco Franco Global Business Environment 18/21

19 Scale and Scope External economies Figure 7-4 The Importance of Established Advantage Price, cost (per button) The average cost curve for Vietnam, AC VIETNAM, lies below the average cost curve for China, AC CHINA. Thus Vietnam could potentially supply the world market more cheaply than China. If the Chinese industry gets established first, however, it may be able to sell buttons at the price P 1, which is below the cost C 0 that an individual Vietnamese firm would face if it began production on its own. So a pattern of specialization established by historical accident may persist even when new producers could potentially have lower costs. C 0 P 1 1 Q 1 2 D WORLD AC CHINA AC VIETNAM Quantity of buttons produced and demanded Figure : Dynamics Francesco Franco Global Business Environment 19/21

20 Scale and Scope External economies Figure : Dynamics Francesco Franco Global Business Environment 20/21

21 Readings *Krugman, Obstfeld and Melitz, chapter 6-7 *Elhanan Helpman, Understanding Global Trade, Harvard University Press 2011 chap 4 Francesco Franco Global Business Environment 21/21

Chapter 6. The Standard Trade Model

Chapter 6. The Standard Trade Model Chapter 6 The Standard Trade Model Preview Relative supply and relative demand The terms of trade and welfare Effects of economic growth, import tariffs, and export subsidies International borrowing and