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CHAPTER7

ECONOMICGROWTHANDINTERNATIONALTRADE

OUTLINE

7.1Introduction

7.2GrowthofFactorsofProduction

7.2aLaborGrowthandCapitalAccumulationOverTime

7.2bTheRybczynskiTheorem

7.3TechnicalProgress

7.3aNeutral,Labor-Saving,andCapital-SavingTechnicalProgress

7.3bTechnicalProgressandtheNation'sProductionFrontier

CaseStudy7-1:ChangesinRelativeResourceEndowmentsofVariousCountriesandRegions

CaseStudy7-2:ChangeinCapital-LaborRationsinSelectedCountries

7.4GrowthandTrade:TheSmallCountryCase

7.4aTheEffectsofGrowthonTrade

7.4bIllustrationofFactorGrowth,Trade,andWelfare

7.4cTechnicalProgress,Trade,andWelfare

CaseStudy7-3:GrowthofOutputperWorkerfromCapitalDeepening,TechnologicalChange,andImprovementsinEfficiency

7.5GrowthandTrade:TheLarge-CountryCase

7.5aGrowthandtheNation'sTermsofTradeandWelfare

7.5bImmiserizingGrowth

7.5cIllustrationofBeneficialGrowthandTrade

CaseStudy7-4:Growth,Trade,andtheGiantsoftheFuture

7.6Growth,ChangeinTastes,andTradeinBothNations

7.6aGrowthandTradeinBothNations

7.6bChangeinTastesandTradeinBothNations

CaseStudy7-5:ChangeintheRevealedComparativeAdvantageofVariousCountriesorRegions

CaseStudy7-6:Growth,Trade,andWelfareintheLeadingIndustrialNations

Appendix: A7.1FormalProofofRybczynskiTheorem

A7.2GrowthwithFactorImmobility

A7.3GraphicalAnalysisofHicksianTechnicalProgress

KeyTerms

Comparativestatics Antitradeproductionandconsumption

Dynamicanalysis Neutralproductionandconsumption

Balancedgrowth Normalgoods

Rybczynskitheorem Inferiorgoods

Labor-savingtechnicalprogress Terms-of-tradeeffect

Capital-savingtechnicalprogress Wealtheffect

Protradeproductionandconsumption Immiserizinggrowth

LectureGuide

Thisisnotacorechapteranditisoneofthemostchallengingchaptersininternationaltrade

theory.Itisincludedformoreadvancedstudentsandforcompleteness.

IfIweretocoverthischapter,Iwouldpresenttwosectionsineachofthreelectures.

Timepermitting,Iwould,otherwisecoverSections1and2,payingspecialattentiontothe

Rybczynskitheorem.

AnswertoProblems

1.a>SeeFigure1.

b>SeeFigure2

c>SeeFigure3.

2.SeeFigure4.

3.a>SeeFigure5.

b>SeeFigure6.

c>SeeFigure7.

4.CompareFigure5toFigure1.

CompareFigure6toFigure3.Notethatthetwoproductionfrontiershavethesamevertical

orYinterceptinFigure6butadifferentverticalorYinterceptinFigure3.

CompareFigure7toFigure2.Notethatthetwoproductionfrontiershavethesame

horizontalorXinterceptinFigure7butadifferenthorizontalorXinterceptinFigure2.

5.SeeFigure8onpage66.

6.SeeFigure9.

7.SeeFigure10.

8.SeeFigure11.

9.SeeFigure12.

10.SeeFigure13onpage67.

11.SeeFigure14.

12.SeeFigure15.

TheUnitedStateshasbecomethemostcompetitiveeconomyintheworldsincetheearly

1990’swhilethedatainTable7.3referstothe1965-1990period.

.

ThedatainTable7.4seemtoindicatethatChinahadacomparativeadvantagein capital-intensivecommoditiesandacomparativedisadvantageinunskilled-labor intensivecommoditiesin1973.Thiswasverylikelyduetothemanytraderestrictionsandsubsidies,whichdistortedthecomparativeadvantageofChina.Itstruecomparativeadvantagebecameevidentby1993afterChinahadstartedtoliberalizeitseconomy.

App.1a.SeeFigure16.

1b.Forproductionandconsumptiontoactuallyoccuratthenew equilibriumpointafterthedoublingofKinNation2,wemustassumeeitherthancommodityXisinferiororthatNation2istoosmalltoaffecttherelativecommoditypricesatwhichittrades.

1c.Px/Pymustrise<i.e.,Py/Pxmustfall>asaresultofgrowthonly.

Px/Pywillfallevenmorewithtrade.

1.IfthesupplyofcapitalincreasesinNation1intheproductionofcommodityY

only,theVMPLycurveshiftsup,andwrisesinbothindustries.Somelaborshifts

totheproductionofY,theoutputofYrisesandtheoutputofXfalls,rfalls,and

Px/Pyislikelytorise.

2.CapitalinvestmentstendtoincreaserealwagesbecausetheyraisetheK/Lratioandtheproductivityoflabor.TechnicalprogresstendstoincreaseK/LandrealwagesifitisL-savingandtoreduceK/LandrealwagesifitisK-saving.

Multiple-ChoiceQuestions

1.Dynamicfactorsintradetheoryrefertochangesin:

a.factorendowments

b.technology

c.tastes

*d.alloftheabove

2.DoublingtheamountofLandKunderconstantreturnstoscale:

a.doublestheoutputoftheL-intensivecommodity

b.doublestheoutputoftheK-intensivecommodity

c.leavestheshapeoftheproductionfrontierunchanged

*d.alloftheabove.

3.DoublingonlytheamountofLavailableunderconstantreturnstoscale:

a.lessthandoublestheoutputoftheL-intensivecommodity

*b.morethandoublestheoutputoftheL-intensivecommodity

c.doublestheoutputoftheK-intensivecommodity

d.leavestheoutputoftheK-intensivecommodityunchanged

4.TheRybczynskitheorempostulatesthatdoublingLatconstantrelativecommodityprices:

a.doublestheoutputoftheL-intensivecommodity

*b.reducestheoutputoftheK-intensivecommodity

c.increasestheoutputofbothcommodities

d.anyoftheabove

5.DoublingLislikelyto:

a.increasestherelativepriceoftheL-intensivecommodity

b.reducestherelativepriceoftheK-intensivecommodity

*c.reducestherelativepriceoftheL-intensivecommodity

d.anyoftheabove

TechnicalprogressthatincreasestheproductivityofLproportionatelymorethanthe

productivityofKiscalled:

*a.capitalsaving

b.laborsaving

c.neutral

d.anyoftheabove

7.A50percentproductivityincreaseintheproductionofcommodityY:

a.increasestheoutputofcommodityYby50percent

b.doesnotaffecttheoutputofX

c.shiftstheproductionfrontierintheYdirectiononly

*d.anyoftheabove

8.DoublingLwithtradeinasmallL-abundantnation:

*a.reducesthenation'ssocialwelfare

b.reducesthenation'stermsoftrade

c.reducesthevolumeoftrade

d.alloftheabove

9.DoublingLwithtradeinalargeL-abundantnation:

a.reducesthenation'ssocialwelfare

b.reducesthenation'stermsoftrade

c.reducesthevolumeoftrade

*d.alloftheabove

If,atunchangedtermsoftrade,anationwantstotrademoreaftergrowth,thenthe

nation'stermsoftradecanbeexpectedto:

*a.deteriorate

b.improve

c.remainunchanged

d.anyoftheabove

Aproportionatelygreaterincreaseinthenation'ssupplyoflaborthanofcapitalislikely

toresultinadeteriorationinthenation'stermsoftradeifthenationexports:

a.theK-intensivecommodity

*b.theL-intensivecommodity

c.eithercommodity

d.bothcommodities

12.Technicalprogressinthenation'sexportcommodity:

*a.mayreducethenation'swelfare

b.willreducethenation'swelfare

c.willincreasethenation'swelfare

d.leavesthenation'swelfareunchanged

13.DoublingKwithtradeinalargeL-abundantnation:

a.increasesthenation'swelfare

b.improvesthenation'stermsoftrade

c.reducesthevolumeoftrade

*d.alloftheabove

14.Anincreaseintastesfortheimportcommodityinbothnations:

a.reducesthevolumeoftrade

*b.increasesthevolumeoftrade

c.leavesthevolumeoftradeunchanged

d.anyoftheabove

15.AnincreaseintastesoftheimportcommodityofNationAandexportinB:

*a.willreducethetermsoftradeofNationA

b.willincreasethetermsoftradeofNationA

c.willreducethetermsoftradeofNationB

d.anyoftheabove

ADDITIONALESSAYSANDPROBLEMSFORPARTONE

AssumethatboththeUnitedStatesandGermanyproducebeefandcomputerchipswiththefollowingcosts:

UnitedStatesGermany

<dollars><marks>

Unitcostofbeef<B> 2 8

Unitcostofcomputerchips<C> 1 2

a>Whatistheopportunitycostofbeef<B>andcomputerchips<C>ineachcountry?

InwhichcommoditydoestheUnitedStateshaveacomparativecostadvantage?

WhataboutGermany?

WhatistherangeformutuallybeneficialtradebetweentheUnitedStatesandGermanyforeachcomputerchiptraded?

HowmuchwouldtheUnitedStatesandGermanygainif1unitofbeefisexchangedfor3chips?

Ans.a>IntheUnitedStates:

theopportunitycostofoneunitofbeefis2chips;

theopportunitycostofonechipis1/2unitofbeef.

InGermany:

theopportunitycostofoneunitofbeefis4chips;

theopportunitycostofonechipis1/4unitofbeef.

b>TheUnitedStateshasacomparativecostadvantageinbeefwithrespectto Germany,whileGermanyhasacomparativecostadvantageincomputerchips.

TherangeformutuallybeneficialtradebetweentheUnitedStatesandGermanyforeachunitofbeefthattheUnitedStatesexportsis

2C<1B<4C

d>BoththeUnitedStatesandGermanywouldgain1chipforeachunitofbeeftraded.

Given:<1>twonations<1and2>whichhavethesametechnologybutdifferentfactorendowmentsandtastes,<2>twocommodities<XandY>producedunderincreasingcostsconditions,and<3>notransportationcosts,tariffs,orotherobstructionstotrade.Provegeometricallythatmutuallyadvantageoustradebetweenthetwonationsispossible.

Note:Youranswershouldshowtheautarky<no-trade>andfree-tradepointsofproductionandconsumptionforeachnation,thegainsfromtradeofeachnation,andexpresstheequilibriumconditionthatshouldprevailwhentradestopsexpanding.>

Ans.:SeeFigure1onpage74.

Nations1and2havedifferentproductionpossibilitiescurvesanddifferentcommunityindifferencemaps.Withthese,theywillusuallyendupwithdifferentrelativecommoditypricesinautarky,thusmakingmutuallybeneficialtradepossible.

Inthefigure,Nation1producesandconsumesatpointAandPx/Py=PAinautarky,

whileNation2producesandconsumesatpointA'andPx/Py=PA'.SincePA<PA',

Nation1hasacomparativeadvantageinXandNation2inY.Specializationin

productionproceedsuntilpointBinNation1andpointB'inNation2,atwhichPB=PB'andthequantitysuppliedforexportofeachcommodityexactlyequalsthequantitydemandedforimport.Thus,Nation1startsatpointAinproductionandconsumptioninautarky,movestopointBinproduction,andbyexchangingBCofXforCEofYreachespointEinconsumption.E>AsinceitinvolvesmoreofbothXandYandliesonahighercommunityindifferencecurve.Nation2startsatA'inproductionandconsumptioninautarky,movestopointB'inproduction,andbyexchangingB'C'ofYforC'E'ofXreachespointE'inconsumption<whichexceedsA'>.

AtPx/Py=PB=PB',Nation1wantstoexportBCofXforCEofY,whileNation2wantstoexportB'C'<=CE>ofYforC'E'<=BC>ofX.Thus,PB=PB'istheequilibriumrelativecommoditypricebecauseitclearsboth<theXandY>markets.

Drawafigureshowing:<1>inPanelAanation'sdemandandsupplycurveforA tradedcommodityandthenation'sexcesssupplyofthecommodity,<2>inPanelCthetradepartner'sdemandandsupplycurveforthesametradedcommodityanditsexcessdemandforthecommodity,and<3>inPanelBthesupplyanddemandforthequantitytradedofthecommodity,itsequilibriumprice,andwhyapriceaboveorbelowtheequilibriumpricewillnotpersist.Atanyotherprice,QDQS,andPwillchangetoP2.

Ans.SeeFigure2onpage74.

TheequilibriumrelativecommoditypriceforcommodityX<thetradedcommodity

exportedbyNation1andimportedbyNation2>isP2andtheequilibriumquantity

ofcommodityXtradedisQ2.

a>Identifytheconditionsthatmaygiverisetotradebetweentwonations.

b>WhataresomeoftheassumptionsonwhichtheHeckscher-Ohlintheoryisbased?

c>Whatdoesthistheorysayaboutthepatternoftradeandeffectoftradeonfactorprices?

Ans.a>Tradecanbebasedonadifferenceinfactorendowments,technology,ortastesbetweentwonations.Adifferenceeitherinfactorendowmentsortechnologyresultsinadifferentproductionpossibilitiesfrontierforeachnation,which,unlessneutralizedbyadifferenceintastes,leadstoadifferenceinrelativecommodityprice

andmutuallybeneficialtrade.Iftwonationsfaceincreasingcostsandhaveidenticalproductionpossibilitiesfrontiersbutdifferenttastes,therewillalsobeadifferenceinrelativecommoditypricesandthebasisformutuallybeneficialtradebetweenthetwonations.Thedifferenceinrelativecommoditypricesisthentranslatedintoadifferenceinabsolutecommoditypricesbetweenthetwonations,whichistheimmediatecauseoftrade.

b>TheHeckscher-Ohlintheory<sometimesreferredtoasthemoderntheory–as

opposedtotheclassicaltheory-ofinternationaltrade>assumesthatnationshave thesametastes,usethesametechnology,faceconstantreturnstoscale<i.e.,agivenpercentageincreaseinallinputsincreasesoutputbythesamepercentage>butdifferwidelyinfactorendowments.Italsosaysthatinthefaceofidenticaltastesordemandconditions,thisdifferenceinfactorendowmentswillresultinadifferenceinrelativefactorpricesbetweennations,whichinturnleadstoadifferenceinrelativecommoditypricesandtrade.Thus,intheHeckscher-Ohlintheory,theinternationaldifferenceinsupplyconditionsalonedeterminesthepatternoftrade.Tobenotedisthatthetwonationsneednotbeidenticalinotherrespectsinorderforinternationaltradetobebasedprimarilyonthedifferenceintheirfactorendowments.

c>TheHeckscher-Ohlintheorempostulatesthateachnationwillexportthecommodityintensiveinitsrelativelyabundantandcheapfactorandimportthecommodityintensiveinitsrelativelyscarceandexpensivefactor.Asanimportantcorollary,itaddsthatunderhighlyrestrictiveassumptions,tradewillcompletelyeliminatethepretraderelativeandabsolutedifferencesinthepriceofhomogeneousfactorsamongnations.Underlessrestrictiveandmoreusualconditions,however,tradewillreduce,butnoteliminate,thepretradedifferencesinrelativeandabsolutefactorpricesamongnations.Inanyevent,theHeckscher-Ohlintheorydoessaysomethingveryusefulonhowtradeaffectsfactorpricesandthedistributionofincomeineachnation.Classicaleconomistswerepracticallysilentonthispoint.

5. consumersdemandmoreofcommodityX<theL-intensivecommodity>andlessofcommodityY<theK-intensivecommodity>.SupposethatNation1isIndia,commodityX istextiles,andcommodityYisfood.Startingfromtheno-tradeequilibriumpositionandusingtheHeckscher-Ohlinmodel,tracetheeffectofthischangeintastesonIndia's

<a>relativecommoditypricesanddemandforfoodandtextiles,

<b>productionofbothcommoditiesandfactorprices,and

<c>comparativeadvantageandvolumeoftrade.

<d>DoyouexpectinternationaltradetoleadtothecompleteequalizationofrelativecommodityandfactorpricesbetweenIndiaandtheUnitedStates?Why?

Ans. a.Thechangeintastescanbevisualizedbyashifttowardthetextileaxisin India'sindifferencemapinsuchawaythatanindifferencecurveistangenttothesteepersegmentofIndia'sproductionfrontier<becauseofincreasingopportunitycosts>aftertheincreaseindemandfortextiles.ThiswillcausethepretraderelativecommoditypriceoftextilestoriseinIndia.

b.TheincreaseintherelativepriceoftextileswillleaddomesticproducersinIndiatoshiftlaborandcapitalfromtheproductionoffoodtotheproductionoftextiles.SincetextilesareL-intensiveinrelationtofood,thedemandforlaborandthereforethewageratewillriseinIndia.Atthesametime,asthedemandforfoodfalls,thedemandforandthusthepriceofcapitalwillfall.Withlaborbecomingrelativemoreexpensive,producersinIndiawillsubstitutecapitalforlaborintheproductionofbothtextilesandfood.

Evenwiththeriseinrelativewagesandintherelativepriceoftextiles,IndiastillremainstheL-abundantandlow-wagenationwithrespecttoanationsuchastheUnitedStates.However,thepretradedifferenceintherelativepriceoftextilesbetweenIndiaandtheUnitedStatesisnowsomewhatsmallerthanbeforethechangeintastesinIndia.Asaresultthevolumeoftraderequiredtoequalizerelativecommoditypricesandhencefactorprices