2.1 Theories of international trade: comparative advantage, factor endowments, and new trade theory

International trade theories explain why countries engage in trade and how it benefits them. Comparative advantage, factor endowments, and new trade theory each offer unique insights into trade patterns and economic gains.

These theories build on each other, addressing limitations and adding complexity. Together, they provide a framework for understanding global trade flows, specialization, and the impacts of trade on different industries and economies.

Comparative Advantage in International Trade

Concept and Principles of Comparative Advantage

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• Comparative advantage defines a country's ability to produce goods or services at lower opportunity costs than other countries
• David Ricardo developed the theory demonstrating mutual trade benefits even when one country produces all goods more efficiently
• Opportunity cost represents the value of foregone alternatives when making economic choices
• Specialization based on comparative advantage increases overall production and consumption for trading partners
• Production possibility frontiers and consumption possibility frontiers illustrate gains from trade
• Comparative advantage explains trade engagement and export-import decisions among countries
• Real-world factors (transportation costs, trade barriers, product quality differences) impact realization of comparative advantage

Application and Limitations of Comparative Advantage

• Comparative advantage guides countries in determining which goods to produce and trade
• Theory assumes perfect competition and mobility of factors of production
• Ignores economies of scale and product differentiation
• Does not account for technological differences or innovation between countries
• Assumes constant returns to scale in production
• Neglects the impact of government policies and interventions on trade patterns
• Fails to explain intra-industry trade (exchange of similar products between countries)

Examples and Calculations

• Numerical example: Country A and B producing computers and wheat
  • Country A: 10 computers or 80 bushels of wheat
  • Country B: 8 computers or 40 bushels of wheat
• Opportunity cost calculation
  • Country A: 1 computer = 8 bushels of wheat
  • Country B: 1 computer = 5 bushels of wheat
• Country B has a comparative advantage in computer production
• Real-world example: Japan specializing in electronics, Brazil in coffee production

Heckscher-Ohlin Model and Trade Patterns

Factor Endowments and Trade Predictions

• Heckscher-Ohlin model extends comparative advantage by considering factor endowments
• Factor endowments refer to relative abundance of production factors (labor, capital, land)
• Model predicts countries export goods intensively using abundant factors and import goods using scarce factors
• Heckscher-Ohlin theorem states capital-abundant countries export capital-intensive goods, labor-abundant countries export labor-intensive goods
• Factor price equalization suggests free trade leads to convergence in relative factor prices across countries
• Stolper-Samuelson theorem explains trade impact on income distribution within countries

Empirical Tests and Refinements

• Leontief Paradox challenged the Heckscher-Ohlin model's predictions
• Leontief found US (capital-abundant country) exported labor-intensive goods contrary to model expectations
• Refinements to address paradox include:
  • Considering human capital as a separate factor of production
  • Incorporating technological differences between countries
  • Accounting for natural resource endowments
• Neo-factor proportions model integrates multiple factors and their intensities in production

Examples and Applications

• United States exporting capital-intensive goods (aircraft, high-tech equipment)
• China exporting labor-intensive goods (textiles, electronics assembly)
• Australia exporting land-intensive goods (agricultural products, minerals)
• Factor intensity reversal example: Textile production capital-intensive in developed countries, labor-intensive in developing countries

New Trade Theory and Intra-Industry Trade

Key Concepts and Contributions

• New trade theory addresses limitations of traditional theories by incorporating imperfect competition and economies of scale
• Focuses on explaining intra-industry trade unaccounted for by comparative advantage or factor endowments
• Economies of scale (internal and external) explain country specialization in narrow product ranges within industries
• Monopolistic competition central to new trade theory explaining product differentiation and market share capture
• Introduces "home market effects" where countries with large domestic markets become net exporters of those goods
• Gravity model predicts trade flows based on economic size and distance between countries
• Highlights trade benefits beyond comparative advantage (increased product variety, pro-competitive effects)

Implications for International Trade

• Explains trade patterns between similar countries (developed economies)
• Accounts for industry concentration in specific locations (Silicon Valley for tech industry)
• Provides rationale for government intervention in trade (strategic trade policy)
• Explains the existence of multinational corporations and foreign direct investment
• Offers insights into the effects of trade on market structure and competition
• Predicts gains from trade even in absence of comparative advantage

Examples and Applications

• Automobile industry intra-industry trade between US and Japan
• Wine trade between France and Italy (similar products, different varieties)
• Aircraft manufacturing concentration (Boeing in US, Airbus in Europe)
• Consumer electronics industry demonstrating product differentiation and economies of scale

Theories of International Trade: A Comparison

Strengths and Limitations of Each Theory

• Comparative advantage focuses on productivity differences and opportunity costs
• Heckscher-Ohlin model emphasizes factor endowments as trade basis
• New trade theory explains intra-industry trade and economies of scale effects
• Comparative advantage limited in explaining trade between similar countries
• Factor endowments theory struggles with Leontief Paradox and some observed patterns
• New trade theory offers insights into industry concentration and imperfect competition

Integrated Approach to Trade Analysis

• Multiple trade theories often necessary to explain complex real-world patterns
• Comprehensive approach combines elements from various theories
• No single theory accounts for all observed international trade patterns
• Integration of theories provides more nuanced understanding of trade impacts on industries and countries

Real-World Applications and Examples

• US-China trade explained by combination of factor endowments and new trade theory
• European Union internal trade patterns reflect aspects of all three theories
• Global value chains incorporate elements of comparative advantage and new trade theory
• High-tech industry trade patterns demonstrate interplay of factor endowments and economies of scale