Theories of International Trade III

1
Theories of International Trade III
ECON 665 Lecture 4

• Modern Extensions of Classical Trade Theory

2
Beyond Bartering

• The Ricardian and Smithian Classical trade
  theories relied on a barter description.
• But in reality, there are wages, exchange rates,
  and transaction costs that must be considered.
• Furthermore, there are usually more than two
  goods that must be considered.

3
Classic Export Condition

• There are three primary factors of production
  that determine costs technology, capital (K),
  and labor (L).
• Capital and technology determine the amount of
  time it takes a worker to do a job (labor time).
• Wages determine the cost per hour of labor (labor
  costs).
• If a represents labor time and w represents labor
  costs, then
• a1 w1 cost of production in country 1

4
Classic Export Condition

• For two countries (1 and 2), country 1 will
  export if
• a1 w1 lt a2 w2
• This can be rewritten as
• (a1 w1)/a1 lt (a2 w2)/a1
• w1 lt (a2/a1) w2
• w1/ w2 lt a2/a1
• which can also be written as
• a1/ a2 lt w2/w1
• This is called the classic export condition.
• According to it, country 1 will export a good if
  the condition is true.

5
Classic Export Condition

• What about exchange rates (such as /)?
• Exchange rates tell us how much a wage in country
  1 is worth in country 2s currency.
• If we are given w1 and the exchange rate, then
• w1 (country 2s currency/country 1s currency)
  w2
• tells us what wage must exist in country 2 for
  labor costs to be the same in both countries.

6
Classic Export Condition

• However, if
• w1 (country 2s currency/country 1s currency)
  lt w2
• then country 1 will have the lower labor costs.
• This suggests that we can rewrite the classic
  export condition as (substituting e for the
  exchange rate)
• a1 (w1e) lt a2 w2
• simplifying to
• (w1e)/ w2 lt a2/a1

7
Classic Export Condition

• As many of us know, its not free to ship a good.
• Therefore, we must incorporate transportation
  costs (tc).
• Transportation costs represent the labor time it
  takes to move a good from country 1 to country 2.
  
• If a person in country 2 wants to decide if he or
  she should purchase a good from country 1, the
  person in country 2 should add the transportation
  time (tc) to the time it takes to produce a good
  in country 1 (a).
• In other words, country 2 should consider the
  total time it takes from the moment a good is
  ordered from country 1, to the moment it can be
  consumed in country 2.
• This modifies the classic export condition once
  again
• (w1e)/ w2 lt a2/(a1 tc)

8
Examples using the Classic Export Condition

• Should country 1 export good x if
• w1 4
• w2 5
• e 2
• a1 2
• a2 6
• tc 1
• What is the highest wage that can be offered in
  country 1 for country 1 to still export good x
  (hint solve for w1)?
• What is the highest that transportation costs can
  be for country 1 to still export good x (hint
  solve for tc)?

9
Multiple Goods

• Actually quite simple. While holding e and tc
  constant, compare relative wage (w1/w2) to
  relative labor hours requirements (a2/a1) for
  various products.
• If (w1e)/ w2 lt a2/(a1 tc) holds, then country 1
  should export the good.