Theory ReviewTheory Review

Global Trade and FinanceGlobal Trade and Finance

Our Market International Trade ROW Market

Imports

ExportsROW Sx

US Dm

ROW D

ROW S

US SUS D

Classical trade theory. Smith-Ricardo, Classical trade theory. Smith-Ricardo, Heckscher -Ohlin, Stolper SamuelsonHeckscher -Ohlin, Stolper Samuelson

How to trade beyond the Production-How to trade beyond the Production-Possibilities CurvePossibilities Curve

Trading along TT’, the UK and SA can consume outside their PPC.

England South Africa.

.

..T

T’

T

T’.C .

Social choice (the CIC) will determine whether the UK and SA will consume at C or D.

CICCIC

Review Characteristics of Review Characteristics of MarketsMarkets

Pure Comp?Pure Comp?Ease of entry, no L-R pure NR, many Ease of entry, no L-R pure NR, many

sellers, no differentiationsellers, no differentiation

Review Characteristics of Review Characteristics of MarketsMarkets

Monopoly?Monopoly?Single seller, first-mover econs of scale or Single seller, first-mover econs of scale or

barriers (barriers (e.g., a franchise)e.g., a franchise), regulation , regulation usual.usual.

Review Characteristics of Review Characteristics of MarketsMarkets

Oligopoly?Oligopoly?Few sellers, interdependence, policy Few sellers, interdependence, policy

uncertainty, struggle for market share, uncertainty, struggle for market share, differentiation, non-price competition.differentiation, non-price competition.

Review Characteristics of Review Characteristics of MarketsMarkets

Monopolistic competition?Monopolistic competition?Ease of entry so no L-R pure NR, unless Ease of entry so no L-R pure NR, unless

entry limited through licensing, entry limited through licensing, differentiation to tilt D curve down, differentiation to tilt D curve down, appeal to preferencesappeal to preferences

Review Characteristics of Review Characteristics of MarketsMarkets

Ease of EntryEase of Entry ?? PC,PC, MC MC

Product Differentiation?Product Differentiation? MC,MC, OligOlig

Interdependence and uncertainty?Interdependence and uncertainty?OligopolyOligopoly

No interdependence?No interdependence?(No bus policy interaction) in MC(No bus policy interaction) in MC

Profitability “slack”, even in long term?Profitability “slack”, even in long term? Monop, Olig, Licensed MCMonop, Olig, Licensed MC

Modern Trade TheoryModern Trade TheoryCompare modern and classical Compare modern and classical

theoriestheories

What role did international trade What role did international trade theory play in the classical theory play in the classical perception of the domestic economy?perception of the domestic economy?

Was this realistic?Was this realistic?In Britain?In Britain?In the U.S.?In the U.S.?

Classical Trade TheoryClassical Trade Theory

Pure CompetitionPure Competition

Trade Sector on peripheryTrade Sector on peripheryPursuit of comparative advantagePursuit of comparative advantagewith inter-industry tradewith inter-industry trade

Domestic MarketsDomestic Markets

Why did the modern theory develop?Why did the modern theory develop?What are it’s two pillars?What are it’s two pillars?

Global marketsGlobal marketsA role for governmentA role for government

Classical TheoryClassical Theory

Pure CompetitionPure Competition Economies of (trade Economies of (trade assumption)assumption) ScaleScale

Natural (domestic) Natural (domestic) monopoliesmonopolies

RegulationRegulationTrade Sector onTrade Sector onPeripheryPeriphery

GlobalGlobalMarketsMarkets

Domestic MarketsDomestic Markets

What did Krugman see as the What did Krugman see as the possibilities for government possibilities for government intervention?intervention?

Modern TheoryModern Theory

Economies of ScaleEconomies of Scale

““Productive” (?) possibilitiesProductive” (?) possibilities

for government interventionfor government intervention1. Optimal Tariffs1. Optimal Tariffs

2. Supporting Investments/2. Supporting Investments/

Promoting exportsPromoting exports

Global MarketsGlobal Markets

Monopolistic CompetitionMonopolistic Competition

OligopolyOligopoly

MonopolyMonopoly

One more time, what is intra-industry One more time, what is intra-industry trade?trade?

How do you calculate it?How do you calculate it?

Two-way trade = IITTwo-way trade = IIT

Total trade = IIT + Inter-industry Total trade = IIT + Inter-industry tradetrade

IIT = 1 - sum of |X-M| sum of X + M

X $100 mil perfume, M $50 mil.X $100 mil perfume, M $50 mil.IIT = 1 – (50/150) = 1 – 0.33 = .66IIT = 1 – (50/150) = 1 – 0.33 = .66

One more time, what is intra-industry One more time, what is intra-industry trade?trade?

How do you calculate it?How do you calculate it?Two-way trade = IITTwo-way trade = IITTotal trade = IIT + Inter-industry Total trade = IIT + Inter-industry

tradetrade

IIT = 1 - sum of |X-M| sum of X + M

M $60 b cars, X $40 bM $60 b cars, X $40 bIIT = 1 – (20/100) = 1 – 0.2 = .80IIT = 1 – (20/100) = 1 – 0.2 = .80

Why has it grown?Why has it grown?

Global MarketsGlobal Markets

Growth of intra-industry Growth of intra-industry tradetrade

A response to preferencesA response to preferences

expressed in international expressed in international tradetrade

demands.demands.

Monopolistic CompetitionMonopolistic Competition

OligopolyOligopoly

MonopolyMonopoly

Trade Policy: Tariffs (normal and Trade Policy: Tariffs (normal and optimal), Quotas, and VERs.optimal), Quotas, and VERs.

A quota is much like a tariff. C represents internal redistribution from the consumer to whomever gets the import licenses.

P

Q

Sd

Sd plus quota

PD w/ quota

PROW

Dd

a b d

S1 D1S0 D0

a = Change from CS to PS

b = “Production effect”

c = Quota rents

d = “Consumption effect”

c

Show the idea of VERs.