International Trade: Theory and Policy Lecture 8 November, 2016 Instructor: Natalia Davidson Lecture is prepared by Prof. Sergey Kadochnikov, Natalia Davidson 1
Topic 6. Differences between countries in relative endowment of specific production factors as the reason for international trade: the Ricardo-Viner model 6. 1. Fundamental assumptions and specific features of the Ricardo-Viner model. 6. 2. Interrelation between change in the production factor quantities and final goods output. 6. 3. The pattern of international trade in the Ricardo-Viner model. 6. 4. Interrelation between change in final goods prices and production factor prices.
Topic 6. The Ricardo-Viner model Source: Feenstra, Taylor, Chapter 3, p. 71.
Topic 6. The Ricardo-Viner model Source: Feenstra, Taylor, Chapter 3, p. 72.
Topic 6. The Ricardo-Viner model Source: Feenstra, Taylor, Chapter 3, p. 73.
(6. 1. ) Structure of the Ricardo-Viner (R-V) model of international trade • • Structure of the world economy: Ø 2 countries (h, f); Ø All final goods are tradable; Ø Production factors are immobile between the countries. Structure of the production sector: Ø 2 industries that produce 2 final homogeneous goods (X, Y); Ø 3 production factors, 1 is a homogeneous, non-specific resource, mobile between industries (for example, labor - L), and 2 homogeneous, specific resources (for example, capital specific for each industry - Rx, Sy), immobile between industries; Ø Countries differ in absolute endowment of specific resource; endowment of mobile resource is the same for two countries: for example, Rxf>Rxh, Syf<Syh, Lf=Lh; Ø Specific features of the production technology: § CRS (an essential feature of functional dependence between production quantity and the quantity of the resources used in production); § Technologies differ among the industries, but not among the countries. • • Structure of the household sector: Ø Tastes are identical and homogeneous among the households and the countries. Market structure: Ø Perfect competition on the markets of production factors and of final goods.
(6. 1. ) Exogenous parameters of the R-V model (1) Exogenous parameters of the model : Ø Production technology - production functions : § Хh = fxh(Rxh, Lxh) = ARxh Lxh(1 - ); Yh = fyh(Syh, Lyh) = BSyh Lxh(1 - ); § Хf = fxf(Rxf, Lxf) = ARxf Lxf(1 - ); Yf = fyf(Syf, Lyf) = BSyf Lxf(1 - ); where А В, . Ø Resource endowment in each economy: Rxh, Rxf, Syh, Syf, Lh, Lf; Ø Preferences of representative household in each of the economies – utility functions: § Ui = Ui (Xi, Yi); i = h, f; Ø Market structure on the final goods markets – perfect competition. Ø Market structure on the resource market – perfect competition.
(6. 1. ) Endogenous parameters of the R-V model (2) Endogenous parameters of the model : Ø Equilibrium production and consumption of final goods in closed economies – Xha, Yha, Xfa, Yfa; Ø Equilibrium price ratios for final goods in closed economies – Pxha/Pyha, Pxfa/Pyfa; Ø Equilibrium production of final goods in the open economy – Xph*, Yph*, Xpf*, Ypf*; Ø Equilibrium consumption of final goods in the open economy – Xсh*, Yсh*, Xсf*, Yсf*: § If (Xc*-Xp*)>0 or (Yc*-Yp*)>0 – the good is imported; § If (Xc*-Xp*)<0 or (Yc*-Yp*)<0 – the good is exported; Ø Equilibrium world price ratio for final goods – Px*/Py*.
(6. 1. ) Specific features of the Ricardo-Viner (R-V) model (1) The Ricardo-Viner model – a version of neoclassical general economic equilibrium model. (2) The main differences of R-V model from the other international trade models are connected to the production sector. (3) The Ricardo-Viner model is a model of medium term (среднесрочного) adjustment of the economy to the exogenous shocks *. * Why ? (What are specific features of short, medium and long term adjustment? )
(6. 1. ) Specific features of the Ricardo-Viner (R-V) model Source: Markusen, Chapter 9, pp. 130– 131. Source: Feenstra, Taylor, Chapter 3, p. 60.
(6. 2. ) Interrelation between change in the production factor quantities and final goods output in the Ricardo-Viner model • Graphical illustration 1 – interrelation between changes in quantities of specific resources and production quantities Figure 1. Changes in quantities of the specific factor in the specific factor model Figure 1 a. Total product and marginal product curves for labor Source: Markusen, Chapter 9, pp. 130– 131.
(6. 2. ) Interrelation between change in the production factor quantities and final goods output in the Ricardo-Viner model • Graphical illustration 1 – interrelation between changes in quantities of specific resources and production quantities: conclusion Ø Exogenous increase in the supply of a specific factor will lead to an increase in the output of the commodity that uses this factor, and a decrease in the output of the other commodity; Ø Besides, any expansion of the endowment of a specific factor at constant commodity prices will lower the real return to both specific factors and increase the real return to the mobile factor; Ø The key feature is immobility of the resource between industries (the resource is specific), not resource intensity. Source: Markusen, Chapter 9, pp. 135– 136.
(6. 2. ) Interrelation between change in the production factor quantities and final goods output in the Ricardo-Viner model • Graphical illustration 2 – interrelation between changes in quantities of mobile (non-specific) resource and production quantities Ø Graphical illustration using a diagram with two curves representing marginal revenues of production factors. Figure 2. Endowment changes in the specific factor model Source: Markusen, Chapter 9, pp. 135– 136. Small open economy. Commodity prices are fixed. Point C: free trade equilibrium. 1) Increase in the endowment of S (factor specific to Y) => growth of MPLY=> growth of wy => labor flows to Y => Shift from point C to point T. 2) Increase in labor supply (mobile factor) Shift from point C to point Z. “? ” Logic behind this shift? Hint: think about (1) ratio K/L => MP => real returns; (2) nominal wage and prices => real returns.
(6. 2. ) Interrelation between change in the production factor quantities and final goods output in the Ricardo-Viner model • Graphical illustration 2 – interrelation between changes in quantities of mobile (non-specific) resource and production quantities: conclusion Ø Exogenous increase in the supply of mobile factor will lead to an increase in the output of both commodities; Ø Besides, an increase in the endowment of the mobile factor will reduce its own real income and increase the real income of both specific factors. Look at Figures 1 and 2 and tell, if the Rybczynsky theorem holds in the Ricardo-Viner model? Explain why.
(6. 3. ) The pattern of international trade (структура международной торговли) in the Ricardo-Viner model • The main assumption for simplification of the international trade structure analysis in the Ricardo-Viner model: Ø Countries differ in absolute endowment of specific production factors, mobile resource endowment being the same: for example, Rxf>Rxh, Syf<Syh, Lf=Lh.
(6. 3. ) The pattern of international trade in the Ricardo-Viner model • Graphical illustration 3 – structure of international trade in the Ricardo-Viner model Ø Using the diagram with two curves representing marginal revenues of production factors. Use the logic of Figure 1 to explain this diagram. Hint: logic of Rybczynsky theorem and Heckscher-Ohlin theorem. Figure 1: increase in resource R specific to X… Which sector is ‘better off’ in the economy and can trade internationally? Figure 3. The pattern of international trade in the specific factor model Source: Markusen, Chapter 9, p. 131 and Feenstra, Taylor, Chapter 3, p. 59.
(6. 3. ) The pattern of international trade in the Ricardo-Viner model • Graphical illustration 3 – structure of international trade in the Ricardo-Viner model Ø Using the diagram with 4 quadrants /More detail at the exercise session/ Figure 4. Production possibility curve for the specific factor model Source: Markusen, Appendix, pp. 452– 453. Explain the graph.
(6. 3. ) The pattern of international trade (структура международной торговли) in the Ricardo-Viner model • The pattern of international trade in the Ricardo-Viner model: conclusion Ø In the specific-factors model, each country will export the good with the absolutely abundant stock of specific capital, assuming identical endowments of labor, the mobile factor; Ø With differences in labor endowments, trade patterns will depend on the nature of the production functions and on the allocation of capital (that is, on the stocks of specific factors); Ø Unlike the Heckscher-Ohlin-Samuelson model, trade structure in the Ricardo. Viner model depends on the immobile (specific) resource, not on the resource intensity *. * Which good is exported in the Heckscher-Ohlin-Samuelson model? What about Ricardo-Viner model?
(6. 4. ) Interrelation between change in final goods prices and production factor prices • Graphical illustration - interrelation between change in final goods prices and mobile / specific production factor prices Ø Using the diagram with two curves representing marginal revenues of production factors; Ø Using the diagram with 4 quadrants /Exercise session/; Figure 5. Autarky and free trade equilibria in the specific factor model Source: Markusen, Chapter 9, p. 131 and Feenstra, Taylor, Chapter 3, p. 59.
(6. 4. ) Interrelation between change in final goods prices and production factor prices • Graphical illustration - interrelation between change in final goods prices and mobile / specific production factor prices: conclusions Ø Exogenous increase in the commodity relative price results into - increase in real return (real price) of the specific factor used in production of this commodity, - decrease in real price of the other specific factor and - has an indefinite impact on the real return of the mobile factor; Ø The conclusions depend on the factor mobility versus factor specificity, rather than factor intensities as in the H-O-S model.
(6. 4. ) Interrelation between change in final goods prices and production factor prices • Does the Stolper-Samuelson theorem hold in the Ricardo-Viner model? Ø The essential difference between medim- and long term effects from trade liberalization policy measures from the view point of gains and losses for the owners of production factors. Explain this statement. • Does the factor price equalization theorem hold in the Ricardo-Viner model? Ø It does not hold. Formulate factor price equalization theorem. Explain why it does not hold. Source: Markusen, Chapter 9, pp. 137.
Homework (1) Exercise session 5 (2) Think about topics for reports during exercise sessions; work on presentation of the paper Office hours: Friday 13: 50 – 14: 30, room 216. E-mail: natalya. davidson@gmail. com (Наталья Борисовна Давидсон) 22
Topic 7. International trade under increasing returns to scale and imperfect competition on the markets
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