Unit 1: International Trade Theory
Countries engage in international trade for two basic reasons, each of which contributes to the country's gain from trade. First, countries trade because they are different from one another. Nations, like individuals, can benefit from their differences by reaching agreements in which each party contributes its strengths and focuses on producing goods in which each is especially efficient. Second, countries trade to achieve economies of scale in production. That is, if each country produces only a limited range of goods, it can produce each of these goods at a larger scale and hence more efficiently than if it tried to produce everything. In the real world, patterns of international trade reflect the interaction of both of these motives.
This unit will help you develop the tools you need to understand how differences between countries give rise to trade between them and why this trade is mutually beneficial. After a brief introduction to the general topic of international trade, we will begin by analyzing how comparative advantage acts as a trade pattern determinant. You will also be introduced to the Ricardian model of trade. The unit will then discuss capital as a factor of production, covering the Heckscher-Ohlin model of trade. We will investigate which factors gain and lose from trade in the short-run as well as in the long-run before learning how economies of scale, technology, demand, and transport costs contribute to patterns of trade. The unit will conclude with a discussion of the reasons behind intra-industry trade, taking note of what new trade theories have to say about it.
Completing this unit should take you approximately 12 hours.
Upon successful completion of this unit, you will be able to:
- define international economics, and distinguish between international trade and international finance;
- discuss the importance of trade in the world and how this has changed over the past decades;
- discuss the General Agreement on Tariffs and Trade (GATT): specifically its genesis, basic provisions, and allowable exceptions;
- discuss the World Trade Organization (WTO);
- define comparative advantage and opportunity cost as well as explain how these relate to one another;
- explain how nations gain from trade in the Ricardian model;
- list several reasons why international trade takes place;
- list and explain the four main theorems in the Heckscher-Ohlin model;
- explain how trade affects income distribution within a country;
- discuss the empirical evidence regarding the Heckscher-Ohlin model;
- define the terms of trade;
- identify and describe the income effect and the substitution effect caused by a change in relative prices;
- discuss the effects of economic growth on a country's terms of trade and welfare;
- define intra-industry trade;
- describe how the gains from trade differ when the model allows for economies of scale;
- define monopolistic competition, and explain how this leads to gains from trade; and
- explain the effects of international labor mobility on a country's real wages.
1.1: Introduction
In this subunit, we will discuss the distinction between international and domestic economic issues, explain the seven themes that recur in international economics and discuss their significance, and distinguish between the trade and monetary aspects of international economics.
Read sections 1.1 through 1.3.
1.2: World Trade: An Overview
This subunit will explain why the value of trade between any two countries depends on the size of those countries' economies. It will also discuss how distance and borders reduce trade, describe the fluctuations in the traded share of international production, and examine why there have been two ages of globalization. This unit will also discuss how the mix of internationally-traded goods and services has changed over time.
1.3: Labor Productivity and Comparative Advantage: The Ricardian Model
In this subunit, we will learn how the Ricardian model (the most basic model of international trade) works and how it illustrates the principle of comparative advantage. We will also demonstrate gains from trade and refute common fallacies about international trade. Finally, we will take a look at empirical evidence that wages reflect productivity and that trade patterns reflect relative productivity.
Read these slides and take notes.
1.4: Resources, Comparative Advantage, and Income Distribution
In this subunit, we will learn how differences in resources can lead to international trade, discuss why trade creates both losers and winners, and define gains from trade when there are losers. We will also discuss the reasons why trade is a politically contentious issue and weigh arguments for free trade in light of the fact that owners of scarce factors are predicted to be worse off without compensation.
1.5: The Standard Trade Model
This subunit will demonstrate how the components of the standard trade model, production possibilities frontiers, isovalue lines, and indifference curves fit together in order to illustrate how trade patterns are established by a combination of supply-side and demand-side factors. We will also discuss how changes in the terms of trade, economic growth, and transfers between nations affect the welfare of nations engaged in international trade. Then, we will examine the effects that tariffs and subsidies have on trade patterns and the welfare of trading nations as well as on the distribution of income within countries.
1.6: Economies of Scale, Imperfect Competition, and International Trade
In this subunit, we will describe why international trade often occurs due to increasing returns to scale and imperfect competition. We will also identify the source of intra-industry trade and determine how it differs from inter-industry trade. Then, we will detail the "dumping" arguments used by domestic industries as a basis for protectionism and explain the relationship between dumping and price discrimination. Lastly, we will discuss the role of external economies and knowledge spillovers in shaping comparative advantage and international trade patterns.
Read these slides and take notes.
1.7: International Factor Movements
In this subunit, we will discuss the causes of as well as the winners and losers in migration and labor mobility between nations; describe the concept of intertemporal comparative advantage and explain how it relates to international capital flows, international lending, and foreign investment; and examine theories that seek to explain the existence of multinational firms and the motivation behind foreign direct investment across economies.
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