Week5 Itl

Chapter 5
The Standard
Trade Model
Slides adapted from Bishop but modified

by Lim
Slides prepared by Thomas Bishop Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
Introduction
•  We have thus far covered the Ricardian model and
the Heckscher-Ohlin model.
•  The Ricardian model conveys the idea of

comparative advantage but does not allow us to
talk about the distribution of income.
•  The H-O model focuses on resource differences,

with a key implication that trade can affect income
distribution.
•  This chapter develop a standard model of trade in

which the Ricardian and H-O models can be
regarded as special cases.
Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-2

•  The standard trade model takes the common
features from the Ricardian and H-O models.
1.  Differences in labor productivity (Ricardian) and resources

(H-O) between countries cause productive differences,
leading to gains from trade.
2.  These productive differences are represented as

differences in production possibility frontiers (the
question of “what an economy can produce?”).
3.  A country s PPF determines its relative supply function (x-

axis: Relative Prices; y-axis: Relative Quantity).
4.  National relative supply functions (Home + Foreign)

determine a world relative supply function.
5.  World equilibrium is determined by the intersection of

world relative demand and world relative supply functions
(RS = RD).

PPF, Relative Prices & Relative Supply
•  Assume that each country produces 2 goods, cloth

and food.
•  In general, each country’s PPF is a smooth line (see

Fig 4-2 taken from slide 16 of Week 3-4 lecture).
•  Why PPF for Ricardian model is a straight line? It

assumes only one factor of production- labor.
•  But Ricardian model is really an extreme case.
•  PPF describes what an economy can produce.

Fig. 4-2: The PPF with Factor Substitution
Still, the opportunity cost of cloth

in terms of food rises as the
economy produces more cloth
and less food.
Bowed Shaped


•  To determine what the economy does produce, we
must determine the prices of goods.
•  In general, the economy should produce at the point

that maximizes the value of production, V:
V = PCQC + PFQF
¨  PC is the price of cloth and PF is the price of food.

¨  When V is constant, the line is defined as isovalue line.
¨  The slope of the isovalue line equals – (PC /PF)
¨  If relative prices change, the slope changes. For instance, if
PC increases, the slope becomes steeper (higher value).
¨  The economy produces at the point that maximizes V, where
PPF touches the highest possible isovalue line.

Fig. 5-1: What an economy does produce?

•  As noted, production choices (or relative supply Qc/
QF) is determined by PPF and relative prices (via the
slope of isovalue line, Pc/PF).
•  How an increase in the relative price of cloth (PC)

affects relative supply?
•  When PC é, PC/PF é, implying the slope of isovalue

line will be steeper (now VV2) than before (VV1).
•  The point of production shifts from Q1 to Q2, with

more cloth and less food.
•  Hence, when PC é, PC/PF é, the relative supply of

cloth (Qc/QF) é (implying an upward sloping RS
curve).
5-8
Fig. 5-2: Relative Price and Relative Supply
5-9
Relative Prices & Relative Demand
•  The value of the economy s consumption is
constrained to equal the value of the economy s
production.
¨  PC DC + PF DF = PC QC + PF QF = V
•  But what determines consumption choices

(demand)?
(1) Consumer preferences (indifference curves)
(2) Relative prices of output (slope of isovalue line, Pc/PF)
•  Each consumer has his or her own preferences, but

we assume that the preferences of an average
consumer represent all consumers.
5-10
•  Consumer preferences are represented by
indifference curves: combinations of goods that
make consumers equally satisfied (indifferent).
¨  Indifference curves are downward sloping to represent the

fact that if an average consumer has less cloth, he or she
could have more food and still be equally satisfied.
¨  Indifference curves farther from the origin represent larger

quantities of food and cloth, and hence a higher level of
satisfaction.
¨  Indifference curves are flatter when moving to the right to

represent the fact that as more cloth and less food is
consumed, an extra m2 of cloth relative to an extra calorie of
food becomes less valuable.

Fig. 5-3: Consumption Choices and Consumer Preferences
What the economy does
produce?
The economy produces at point Q,

where the PPF is tangent to the
highest possible isovalue line.
What the economy does

consume?
The economy consumes at point D,

where the isovalue line is tangent
to the highest possible indifference
curve.
What happens when

consumption is not equal to
production (mix)?
Cloth: QC > DC Export Cloth

Food: Q F < DF Import Food
5-12
Fig. 5-4: Consumption Choices and Relative Prices
As noted earlier, consumption choices
(demand) are also determined by relative
prices of output (Pc/PF)
When PC é, PC/PF é, implying the slope of

isovalue line will be steeper (now VV2) than
before (VV1).
The point of production shifts from Q1 to Q2,

with more cloth and less food produced.
The point of consumption also shifts from D1

to D2, with the economy moving to a higher
i n d i ff e r e n c e c u r v e ( h i g h e r l e v e l o f
satisfaction).
At D2, the consumption of both cloth and

food é.
However, DC é < DF é, hence the relative

demand of cloth (Dc/DF) ê (implying an
downward sloping RD curve).
5-13
The move from D1 to D2 reflects 2 effects:
(1) Income effect

¨  The change in welfare (income) when the price of one good changes
relative to the price of another
¨  It is represented by moving to another indifference curve
¨  A higher price for cloth exports means that more food can be
imported.
(2) Substitution effect

¨  The substitution of one good for another when the price of the good
changes relative to the other
¨  It is represented by moving along a given indifference curve
¨  A higher relative price of cloth makes consumers willing to buy less
cloth and more food.
At D2, the consumption of both cloth and food é. This

implies that income effect dominates substitution effect!
5-14
Welfare and the Terms of Trade
•  The terms of trade refers to the price of exports
relative to the price of imports.
•  When price of exports é, it means that the country

can afford to buy more imports, hence an increase in
the terms of trade increases a country s welfare.
•  Assume Home: Export Cloth; Foreign: Export Food.
•  When PC é, PC/PF é (implying PF/PC ê)
•  Terms of trade (PEX/PIM) for Home é, Welfare é
•  Terms of trade (PEX/PIM) for Foreign ê, Welfare ê

Determining Equilibrium Relative Prices
•  To determine the equilibrium price of cloth relative to
the price of food (PC/PF) in our model, we again use
relative supply (RS) and relative demand (RD).
¨  Relative supply (RS) considers world supply of cloth relative

to that of food at each relative price (RS is upward sloping,
see slide 8).
¨  Relative demand (RD) considers world demand of cloth

relative to that of food at each relative price (RD is downward
sloping, see slide 13).
¨  In a two country model, world quantities are the sum of

quantities from Home and Foreign countries.

Fig. 5-5: World Relative Supply and Demand
The higher PC/PF is, the

larger the world supply of
cloth relative to food, and
the lower the world
demand of cloth relative to
food.
Equilibrium relative price is

determined by the
intersection of the world
RS and RD curves, i.e. at
Point 1.
5-17
Effects of Economic Growth: A Shift of
the RS Curve
•  Is economic growth in China good for the standard of
living in the U.S.?
•  Is growth in a country more or less valuable when it is

integrated in the world economy?
•  The standard trade model gives us precise answers

to these questions.
•  Economic growth means an outward shift of PPF.
•  But the shift of PPF is biased, expanding

disproportionately in the direction of one good.
5-18
•  Growth is usually biased: it occurs in one sector more
than others, causing relative supply (RS) to change.
¨  For instance, rapid growth has occurred in U.S. computer

industries but relatively little growth has occurred in U.S.
textile industries.
¨  According to the Ricardian model, technological progress in

one sector causes biased growth.
¨  According to the Heckscher-Ohlin model, an increase in

resources (e.g., an increase in the labor force, arable land, or
the capital stock) causes biased growth (see slides 37-39 in
Week 3-4 lecture) .

Fig. 5-6: Biased Growth
5-20
•  In both figures, the economy is able to produce more
cloth and more food.
•  Assuming constant PC/PF (i.e., constant slope for

isovalue line):
¨  Figure 5-6a: Growth biased toward cloth, Cloth é, Food ê
¨  Figure 5-6b: Growth biased toward food, Food é, Cloth ê
How does biased growth shifts the RS curve? How

does this shift further affect the terms of trade?

Fig. 5-7a: Growth and Relative Supply
If biased growth occurs in the cloth

industry, suppliers are more able and
willing to sell cloth relative to food, so that
the relative supply curve shifts right to
represent an increase in the supply of
cloth relative to the supply of food.
In the new trade equilibrium, the relative

quantity of cloth bought and sold
increases, and the price of cloth relative
to the price of food ê from (PC/PF)1 to
(PC/PF)2.
If Home exports cloth and imports food,

the price of exports relative to the price of
imports (PEX/PIM) for Home ê.
In other words, the terms of trade for

Home ê.

Fig. 5-7b: Growth and Relative Supply
If biased growth occurs in the food

industry, suppliers are more able and
willing to sell food relative to cloth, so that
the relative supply curve shifts left to
represent a decrease in the supply of
cloth relative to the supply of food.
In the new trade equilibrium, the relative

quantity of cloth bought and sold
decreases, and the price of cloth relative
to the price of food é from (PC/PF)1 to
(PC/PF)2.
If Home exports cloth and imports food,

the price of exports relative to the price of
imports (PEX/PIM) for Home é.
In other words, the terms of trade for

Home é.

•  In summary,
¨  Figure 5-7a Cloth-biased growth:

RS shifts to the right, PC/PF ê, and terms of trade for Home ê.
¨  Figure 5-7b Food-biased growth:

RS shifts to the left, PC/PF é, and terms of trade for Home é.

In general,
(1) Export-biased growth (growth that expands a country s PPF

disproportionally in that country s export sector)
-  RS shifts to the right, PEX ê, Terms of trade ê
-  Reduce a growing country’s welfare (increase the welfare of the rest
of the world)
(2) Import-biased growth (growth that expands a country s PPF

disproportionally in that country s import sector)
-  RS shifts to the left, PEX é, Terms of trade é
-  Improve a growing country’s welfare (reduce the welfare of the rest
of the world)
To relate with slide 24, just look from the perspective of Home.
Export-biased growth = Cloth-biased growth
Import-biased growth = Food-biased growth
5-25
Case Study
•  Has growth in Asia reduced the welfare of high

income countries?
•  The standard trade model predicts that import biased

growth in China reduces the U.S. terms of trade and
the standard of living in the U.S. Is this prediction
supported by the data?
Find out the answers from textbook, page 97-99.

International Transfer of Income: A
Shift of the RD Curve
•  Relative world demand for goods may shift due to
changing tastes, technology or international transfer
of income.
•  Transfers of income sometimes occur from one

country to another.
¨  War reparations (e.g. payments demanded of Germany after
World War I) or foreign aid may influence demand of traded
goods and therefore relative demand.
¨  International loans may also influence relative demand in the
short run, before the loan is paid back.
How do transfers of income across countries affect

relative demand and the terms of trade?
5-27
•  The shift in the RD curve (if it occurs) is the only effect
of a transfer of income.
•  The RS curve does not shift as long as only income is

being transferred, and not physical resources.
•  Thus, the transfer is a purely demand-side issue.
•  Assume Home transfers income to Foreign. RD

curve does not necessarily shift when:
¨  Foreign allocates the extra income it receives between cloth
and food in the same proportions that Home reduces its
spending (to generate the transfers)
¨  World spending on cloth and food will not change
¨  RD curve will not shift, PC/PF will remain constant, and hence
no terms of trade effect.
5-28
•  If the 2 countries allocate their change in spending
(Home: Reduced spending; Foreign: Increased
spending) in different proportions,
¨  World spending on cloth and food will change
¨  RD curve will shift, PC/PF will change, and hence there will be
a terms of trade effect.
¨  But the shift of RD curve (right or left) depends on the
marginal propensity to consume (MPC) in both countries.
5-29
Illustration
•  Assume Transfer = RM1000
MPCcloth(Home) = 0.8 MPCcloth (Foreign) = 0.2
•  How much does demand of Cloth decrease in Home

when it reduces its income through a transfer?
¨  If Home has a higher MPCcloth, demand of its own goods
(Cloth) will fall more than demand of imports (Food)
¨  Cloth ê RM800; Food ê RM200
•  How much does demand of Cloth increase in Foreign

when it receives a transfer of income from Home?
¨  If Foreign has a lower MPCcloth, demand of imports (Cloth) will
rise less than demand of its own goods (Food)
¨  Cloth é RM200; Food é RM800
5-30
•  What is the net effect on world relative demand of
cloth?
¨  Demand for Cloth decreases (Cloth ê RM600)
¨  Demand of Food increases (Food é RM600)
¨  The ratio DC/DF ê (just check what will happen if the initial
ratio is 1600/1000)
¨  This means that the RD curve shifts to the left
See Figure 5-8!
5-31
Fig. 5-8: Effects of a Transfer on the Terms of Trade
If MPC cloth (Home) > MPC cloth

(Foreign), a transfer of income by
Home to Foreign shifts the RD
curve to the left.
The equilibrium relative price of

cloth decreases from (PC/PF)1 to
(PC/PF)2.
Since Home exports cloth and

imports food, the price of exports
relative to the price of imports
(PEX/PIM) for Home ê.
In other words, the terms of trade

for Home ê (while improving
Foreign terms of trade).
5-32
If MPCcloth(Home) < MPCcloth(Foreign), what is the
effect of income transfer by Home to Foreign on
terms of trade?
•  The RD curve will shift to the right.
•  The equilibrium relative price of cloth increases
•  Since Home exports cloth and imports food, the price

of exports relative to the price of imports (PEX/PIM) for
Home é.
•  In other words, the terms of trade for Home é (while

worsening Foreign terms of trade).
5-33
In general,
(1) A transfer worsens the donor’s terms of trade if the

donor has a higher MPC on its export good than the
recipient.
(2) A transfer improves the donor’s terms of trade if the

donor has a lower MPC on its export good than the
recipient.
5-34
Case Study
•  During the 1997-1998 Asian financial crisis, several

Asian nations experienced a sudden reversal of
international capital flows.
•  Why the large outward transfers did not lead to drastic

deterioration of Asian terms of trade?
Find out the answers from textbook, page 102-103.

Tariffs and Export Subsidies:
Simultaneous Shifts in RS and RD
•  Import tariffs are taxes levied on imports.
•  Export subsidies are payments given to domestic

producers that export.
•  The price changes caused by both policies change

both the RS and RD curves.
•  This influence the terms of trade and therefore

national welfare.

•  Import tariffs and export subsidies drive a wedge
between prices in world markets (or external prices)
and prices in domestic markets (or internal prices).
¨  Since exports and imports are traded in world markets, the

terms of trade measures relative external prices (and not
internal prices).
¨  We want to know how these policies affect RS and RD as a

function of external prices.

Import Tariffs
•  If Home imposes a tariff on food imports, the internal

price of food relative to the price of cloth (PF /PC) faced
by Home producers and consumers rises (higher than
the external PF /PC on the world market).
¨  Likewise, the internal price of cloth relative to the price of food

(PC /PF) falls (lower than the external PC /PF on the world
market).
¨  At any given external PC /PF, Home producers will receive a

lower relative price of cloth, and therefore will be more willing
to switch to food production: production of cloth QC will
decrease (RS curve shifts to the left, see Figure 5-9).

¨  At any given external PC /PF, Home consumers will pay a
lower relative price of cloth, and therefore will be more willing
to switch to cloth consumption: consumption of cloth will
increase (RD curve shifts to the right, see Figure 5-9).
¨  At the new equilibrium point where RS2 = RD2 (Point 2, see

Figure 5-9), the external relative price of cloth rises from (PC/
PF)1 to (PC/PF)2.
¨  Since Home exports cloth and imports food, the price of

exports relative to the price of imports (PEX/PIM) for Home é.
¨  In other words, the terms of trade for Home é (while

worsening Foreign terms of trade).

Fig. 5-9: Effects of a Tariff on the Terms of Trade

•  When Home imposes an import tariff, its terms of
trade increases and the welfare of the country may
increase.
•  The magnitude of this terms of trade effect depends

on the size of the domestic country relative to the
world economy.
¨  If the country is small part of the world economy (like

Luxembourg or Paraguay), its tariff policies will not have
much effect on world relative supply and demand, and thus
on the terms of trade.
¨  But for large countries (like the U.S.), an import tariff rate will
improve its terms of trade at the expense of foreign countries.

Export Subsidies
•  If the domestic country imposes a subsidy on cloth
exports, the internal price of cloth relative to the price
of food (PC /PF) faced by Home producers and
consumers rises (higher than the external PC /PF on
the world market).
¨  At any given external PC /PF, Home producers will receive a
higher relative price of cloth when they export, and therefore
will be more willing to switch to cloth production for export:
production of cloth QC will increase (RS curve shifts to the
right, see Figure 5-10).
¨  At any given external PC /PF, Home consumers must pay a

higher relative price of cloth to producers who have the option
of exporting, and therefore will be more willing to switch to
food consumption: consumption of cloth will decrease (RD
curve shifts to the left, see Figure 5-10).

¨  At the new equilibrium point where RS2 = RD2 (Point 2, see
Figure 5-10), the external relative price of cloth decreases
from (PC/PF)1 to (PC/PF)2.
¨  Since Home exports cloth and imports food, the price of

exports relative to the price of imports (PEX/PIM) for Home ê.
¨  In other words, the terms of trade for Home ê (while

improving Foreign terms of trade).

Fig. 5-10: Effects of a Subsidy on the Terms of Trade

Implications: Distribution of Income across Countries
•  The two-country, two-goods model predicts that:
¨  When Home imposes an import tariff, its terms of trade

increases and the welfare of the country may increase (at the
expense of Foreign).
¨  When Home imposes an export subsidy, its terms of trade

deteriorates and the welfare of the country may decrease (to
the benefit of Foreign).
In the case of U.S., are foreign tariffs always bad for the
country, and foreign export subsidies always beneficial?

•  But the model has ignored the effects of tariffs and
subsidies that occur in a world with many countries
and many goods:
¨  A foreign country may subsidize the export of a good that the

US also exports
•  For instance, the EU subsidizes agricultural exports, which
American farmers also export
•  According to theory (see slide 45), when EU imposes an export
subsidy, its terms of trade deteriorates to the benefit of Foreign
(in this case, it is beneficial to US)
•  In reality, this export subsidy by EU will hurt the US terms of
trade (inconsistent with prediction)
•  This is because the external price for this agricultural export will
decrease in the world market (see slides 42-44)
•  Since US also exports agricultural good, the price of exports
relative to the price of imports (PEX/PIM) for US ê

¨  A foreign country may impose a tariff on an imported good
that the US also imports
•  For instance, the EU imposes a tariff on automobile imports,
which American also imports
•  According to theory (see slide 45), when EU imposes an import
tariff, its terms of trade improves at the expense of Foreign (in
this case, it is bad for US)
•  In reality, this import tariff by EU may instead increase the US
terms of trade (inconsistent with prediction)
•  This is because the external price for this import will decrease in
the world market (see slides 38-41)
•  Since US also imports automobile, the price of exports relative
to the price of imports (PEX/PIM) for US é

To qualify our conclusions from a two-country model, we
have to rephrase:
•  Export subsidies by foreign countries on goods that

¨  the U.S. imports reduce the world price of U.S. imports and
increase the terms of trade for the U.S. (theory)
¨  the U.S. also exports reduce the world price of U.S. exports
and decrease the terms of trade for the U.S. (exception)
•  Import tariffs by foreign countries on goods that

¨  the U.S. exports reduce the world price of U.S. exports and
decrease the terms of trade for the U.S. (theory)
¨  the U.S. also imports reduce the world price of U.S. imports
and increase the terms of trade for the U.S. (exception)

Implications: Distribution of Income within Countries
•  Because of changes in relative prices, import tariffs

and export subsidies have effects on income
distribution among producers within a country.
•  Generally, a domestic import tariff increases income

for domestic import-competing producers by allowing
the price of their goods to rise to match increased
import prices, and it shifts resources away from the
export sector (it hurts the export sector).
•  Generally, a domestic export subsidy increases

income for domestic exporters, and it shifts resources
away from the import-competing sector (it hurts the
import sector).
5-49

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Chapter 5

Slides adapted from Bishop but modified

• The Ricardian model conveys the idea of

• The H-O model focuses on resource differences,

• This chapter develop a standard model of trade in

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-2

1. Differences in labor productivity (Ricardian) and resources

2. These productive differences are represented as

3. A country s PPF determines its relative supply function (x-

4. National relative supply functions (Home + Foreign)

5. World equilibrium is determined by the intersection of

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-3

• Assume that each country produces 2 goods, cloth

• In general, each country’s PPF is a smooth line (see

• Why PPF for Ricardian model is a straight line? It

• But Ricardian model is really an extreme case.

• PPF describes what an economy can produce.

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-4

Still, the opportunity cost of cloth

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-5

• In general, the economy should produce at the point

¨ PC is the price of cloth and PF is the price of food.

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-6

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-7

• How an increase in the relative price of cloth (PC)

• When PC é, PC/PF é, implying the slope of isovalue

• The point of production shifts from Q1 to Q2, with

• Hence, when PC é, PC/PF é, the relative supply of

• But what determines consumption choices

• Each consumer has his or her own preferences, but

¨ Indifference curves are downward sloping to represent the

¨ Indifference curves farther from the origin represent larger

¨ Indifference curves are flatter when moving to the right to

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-11

The economy produces at point Q,

What the economy does

The economy consumes at point D,

What happens when

Cloth: QC > DC Export Cloth

When PC é, PC/PF é, implying the slope of

The point of production shifts from Q1 to Q2,

The point of consumption also shifts from D1

At D2, the consumption of both cloth and

However, DC é < DF é, hence the relative

(1) Income effect

(2) Substitution effect

At D2, the consumption of both cloth and food é. This

• When price of exports é, it means that the country

• Assume Home: Export Cloth; Foreign: Export Food.

• When PC é, PC/PF é (implying PF/PC ê)

• Terms of trade (PEX/PIM) for Home é, Welfare é

• Terms of trade (PEX/PIM) for Foreign ê, Welfare ê

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-15

¨ Relative supply (RS) considers world supply of cloth relative

¨ Relative demand (RD) considers world demand of cloth

¨ In a two country model, world quantities are the sum of

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-16

The higher PC/PF is, the

Equilibrium relative price is

• Is growth in a country more or less valuable when it is

• The standard trade model gives us precise answers

• Economic growth means an outward shift of PPF.

• But the shift of PPF is biased, expanding

•  The Ricardian model conveys the idea of

•  The H-O model focuses on resource differences,

•  This chapter develop a standard model of trade in

1.  Differences in labor productivity (Ricardian) and resources

2.  These productive differences are represented as

3.  A country s PPF determines its relative supply function (x-

4.  National relative supply functions (Home + Foreign)

5.  World equilibrium is determined by the intersection of

•  Assume that each country produces 2 goods, cloth

•  In general, each country’s PPF is a smooth line (see

•  Why PPF for Ricardian model is a straight line? It

•  But Ricardian model is really an extreme case.

•  PPF describes what an economy can produce.

•  In general, the economy should produce at the point

¨  PC is the price of cloth and PF is the price of food.

•  How an increase in the relative price of cloth (PC)

•  When PC é, PC/PF é, implying the slope of isovalue

•  The point of production shifts from Q1 to Q2, with

•  Hence, when PC é, PC/PF é, the relative supply of

•  But what determines consumption choices

•  Each consumer has his or her own preferences, but

¨  Indifference curves are downward sloping to represent the

¨  Indifference curves farther from the origin represent larger

¨  Indifference curves are flatter when moving to the right to

•  When price of exports é, it means that the country

•  Assume Home: Export Cloth; Foreign: Export Food.

•  When PC é, PC/PF é (implying PF/PC ê)

•  Terms of trade (PEX/PIM) for Home é, Welfare é

•  Terms of trade (PEX/PIM) for Foreign ê, Welfare ê

¨  Relative supply (RS) considers world supply of cloth relative

¨  Relative demand (RD) considers world demand of cloth

¨  In a two country model, world quantities are the sum of

•  Is growth in a country more or less valuable when it is

•  The standard trade model gives us precise answers

•  Economic growth means an outward shift of PPF.

•  But the shift of PPF is biased, expanding

¨  For instance, rapid growth has occurred in U.S. computer

¨  According to the Ricardian model, technological progress in

¨  According to the Heckscher-Ohlin model, an increase in

•  Assuming constant PC/PF (i.e., constant slope for

¨  Figure 5-7a Cloth-biased growth:

¨  Figure 5-7b Food-biased growth:

•  Has growth in Asia reduced the welfare of high

•  The standard trade model predicts that import biased

•  Transfers of income sometimes occur from one

•  The RS curve does not shift as long as only income is

•  Thus, the transfer is a purely demand-side issue.

•  Assume Home transfers income to Foreign. RD

•  How much does demand of Cloth decrease in Home

•  How much does demand of Cloth increase in Foreign

•  The RD curve will shift to the right.

•  The equilibrium relative price of cloth increases

•  Since Home exports cloth and imports food, the price

•  In other words, the terms of trade for Home é (while

•  During the 1997-1998 Asian financial crisis, several

•  Why the large outward transfers did not lead to drastic

•  Import tariffs are taxes levied on imports.

•  Export subsidies are payments given to domestic

•  The price changes caused by both policies change

•  This influence the terms of trade and therefore

¨  Since exports and imports are traded in world markets, the

¨  We want to know how these policies affect RS and RD as a

•  If Home imposes a tariff on food imports, the internal

¨  Likewise, the internal price of cloth relative to the price of food

¨  At any given external PC /PF, Home producers will receive a

¨  At the new equilibrium point where RS2 = RD2 (Point 2, see

¨  Since Home exports cloth and imports food, the price of

¨  In other words, the terms of trade for Home é (while

•  The magnitude of this terms of trade effect depends

¨  If the country is small part of the world economy (like

¨  At any given external PC /PF, Home consumers must pay a