Standard Trade Model - International Economics - Lecture Slides, Slides of Economics

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Basics of Two-Country Trade:

The Standard Trade Model

Trade Between Two Countries

Japan Europe World Trade P D S D S D S J E 10 0 11 0 9 0 20 11 9 9 0 10 2 8 2 18 10 6 8 0 9 4 7 4 16 9 3 7 0 8 6 6 6 14 8 0 6 0 7 8 5 8 12 7 - 5 0 6 10 4 10 10 6 - 4 1 5 12 3 13 8 4 - 3 2 4 14 2 16 6 2 - 2 3 3 16 1 19 4 0 - 1 4 2 18 0 22 2 -2 - 0 5 1 20 0 25 1 -4 -

Trade Between Two Countries

• When two countries begin trading…

– the country with the higher autarky price

imports the good, and

– the country with the lower autarky price

exports the good

– global quantity demanded = global quantity

supplied

– exports = imports (in quantity and market

value)

Graphical analysis of two-country trade

• Now, let us review our numerical analysis using graphs! - Economists love graphs!

Japan: The Exporting Country Price of Steel 0 Quantity of Steel Domestic supply Price after trade World price Domestic Exports demand Price before trade Domestic quantity demanded Domestic quantity supplied

Europe: The Importing Country

Price

of Steel

0 Quantity

Price

after

trade

World

price

of Steel

Domestic

supply

Domestic

demand

Imports

Domestic

quantity

supplied

Domestic

quantity

demanded

Price

before

trade

Prices: nominal and relative

• So far, I have been not been fully clear

about how prices are measured

• When the price of a good is measured in

currency units, it is called a nominal price

– Example: the nominal price of ice cream is

$4.00 per quart

– Example: the nominal price of coffee is $1.

per cup

Prices: nominal and relative

• When the price of one good is measured in

units of another good, it is called a relative

price

• Example: suppose the nominal price of ice cream is $4.00 per quart and the nominal price of coffee is $1.00 per cup.
• Then the relative price of ice cream is 4 cups of coffee per quart.
• And the relative price of coffee is ¼ quarts of ice cream per cup

• In my lectures on international trade, when I

say “price” I mean “relative price”

Price Europe + Japan = World Quantity As we saw before, if the autarky equilibrium price is not the same for both countries, trade will occur when trade is allowed. That is, dissimilarity = trade****.

Dissimilarity = Trade

• Trade will occur if the pre-trade (or

autarky) relative price of one good in terms

of the other is not the same for the two

countries.

• The free trade relative price will be neither

higher than the two autarky prices, nor lower.

• Therefore, when the autarky relative prices are

unequal, the free trade relative price must be

different from the autarky relative price for at

least one of the two countries.

Effect of Trade on Prices

• When autarky ends and free trade begins,

the relative price of any given good will

• increase in the country where it used to be cheaper in autarky, and
• decrease in the country where it used to be more expensive in autarky

• This follows from the fact that the free trade

relative price of any traded good, in general,

lies somewhere between the two autarky

relative prices

Effect of Trade on Production

• If the price of good X (relative to good Y )

increases, then, in a country that is

otherwise unchanged,

– the production of X will increase and

– the production of Y will decrease

• See “Production Possibilities and Relative Supply” on page 89 and Figure 5-2 of KO.

Effect of Trade on Consumption

• The effect of an increase in the price of

beef (relative to steel) on the consumption

of beef works through two channels:

– Substitution effect: buy less of whatever has

become more expensive and more of

whatever has become less expensive

– Income effect: if a change in a price makes

you richer , buy more of all things, across the

board; if a change in price makes you poorer ,

buy less of all things, across the board

Effect of Trade on Consumption

• Consider an increase in the price of beef

(relative to steel)

– Substitution effect: buy less beef and more

steel

– Income effect:

• if you export beef, hooray, you are now richer! So

buy more of both beef and steel

• If you import beef, you are poorer. So, buy less of

both beef and steel