Lecture 1def

Master in Human Development and Food Security
2014-2015
International Economics
Lecture 1
Dr. Silvia Nenci

University of Roma Tre
silvia.nenci@uniroma3.it
Silvia Nenci
Trade Issues’ Outline
First lecture:
• Introduction to International Trade
• Stylized facts
• Reasons for trade
• The law of comparative advantage
• The Ricardian Model
Silvia Nenci
The basics of world trade
Movements of goods and services (imports &
exports)
Trade balance: difference between a country’s total
value of exports and its total value of imports
• Trade surplus
surplus: when countries export more than they
import (i.e. China)
• Trade deficit:
deficit when countries import more than they
export (i.e. the USA)
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The evolution of international trade:
some key facts
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Is trade today different from the past?
Yes
1. There is more international trade today than in the
past
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The Volume of World Trade, 1850-2010
(in log scale)

Sources: Irwin & O’Rourke, 2011
Silvia Nenci
Percentage Change in World Trade
Volume, 1850-2010
U.S. Recession (1958) Volcker disinflation (1981-82)

U.S. Civil War (1861-62)
OPEC oil shock (1974)
Financial crisis (2009 - )

Great Depression (1930-32)
Notes: The declines in 1892, 1908, 1930-32, and 2009 were associated with financial or banking crises on a global scale
Sources: Irwin & O’Rourke, 2011

Silvia Nenci
Great Depression and world trade:
the Contracting Spiral of World Trade
January 1929-June 1933 (in
millions of U.S. (gold)
dollars)
Source: Eichengreen&Irwin, 1995

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Two waves of globalization
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Is trade today different from the past?
Yes
1. There is more international trade today than in the
past
2. And the type of trade has also changed
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The Changing Face of U.S. Import and Export
Industries
Goods category:
• foods, feeds, and
beverages;
• Industrial supplies and
materials (raw materials
and basic processed
goods – steel, textiles,
etc)
• Capital goods (durable
goods, i.e.aircraft, cars,
computers, machinery,
etc)
• Finished consumer goods
Figure 1.1 The Changing Face of U.S. Import and Export Industries, 1925–2009
Feenstra and Taylor: International Economics, Second Edition Silvia Nenci
Copyright © 2011 by Worth Publishers
What do we export today?
The types of goods traded have changed drastically over the last decades
Source: WTO, 2013

Silvia Nenci
World Trade Flows:
players and destinations
The amount of
trade is illustrated
by the width of the
lines
Main trends:
1. the leading role of Europe in world trade (31%); possible
reasons?
2. the large amount of trade flows at regional level (within
Europe, within the Americas (11%) and between Asian
countries);
3. a relevant trade link between the United States and Europe
(about 37%); why?
Figure 1.2 World Trade in Goods, 2006 ($ billions) 4. the important share of world trade coming from Asia; why?
Feenstra and Taylor: International Economics, Second Edition 5. the marginal position of Africa (that accounts for only 2.5%
Copyright © 2011 by Worth Publishers of World trade), and its close relationship with European
Silvia Nenci
countries.
Shares of World Trade
Table 1.1 Shares of World Trade, Accounted for by Selected Regions, 2006
Feenstra and Taylor: International Economics, Second Edition
Silvia Nenci
The Network of World Trade in Goods, 2007
(major two export partners)
Note: For each country, only the export flows toward the first and second trade partner are considered. The size of the circle
corresponding to a country is proportional to the number of receiving links
Source: De Benedictis, Nenci, Santoni, Tajoli, Vicarelli, 2013
Silvia Nenci
Barriers to trade
All factors that influence (restrict) the amount of goods
and services shipped across international borders
Main barriers are:
• Tariffs: A tax on a good coming into a country
• Quotas: Physical restriction on the number of goods
coming into a country
• Non-Tariff Barriers: Any methods not covered by a tariff,
most usually (ex: standards on fuel emissions from cars;
documentation required to sell drugs in different countries,
ingredients in products ; etc)
• Rules • Legislation
• Regulations • Exacting Standards or Specifications
• Voluntary Export Restraints (VERs)
Silvia Nenci
Average Worldwide Tariffs, 1860–2000
Figure 1.4 Average Worldwide Tariffs, 1860–2000

Feenstra and Taylor: International Economics, Second Edition
Silvia Nenci
Tariffs in modern history
Source: Nenci (2011) adapted from Coatsworth and Williamson (2002) and World Bank (2003)
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Who are the main players
in international trade? -1
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Who are the main players
in international trade? -2
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Trade in intermediates
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summing up
International trade has grown tremendously in the last 30 years, much
faster than global output
• World merchandise and commercial services trade have increased by
about 7 per cent per year on average
New players have risen to prominence in world trade, most notably large
developing countries and rapidly industrializing Asian economies
The composition of trade has changed (i.e. the product breakdown of
merchandise trade and the relative importance of commercial services
trade)
Countries have become less specialized over time in terms of their exports
and therefore more similar in terms of their export composition.
Trade has tended to become more regionalized since 1990, particularly in
Asia, but intra-regional trade shares in Europe and North America have
remained steady or declined.
Silvia Nenci
summing up -2
Trade is essentially a North
North--North phenomenon (60-70%)
Countries trade also in similar goods
Trade is not only between producers and final consumers:
• Intra-firm trade (30%), intermediate products (35%), final products
(35%), according to WTO’s estimates
Countries do not trade, firms do
do. But very few of them do it.
Silvia Nenci
Why do countries trade?
Silvia Nenci
Several reasons
• Differences in the technology used

• Differences in the total amount of resources (labor,
capital, land)
• The proximity of countries to each other (i.e., how
close they are to one another)
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Reasons for Trade
Resources
• Geography includes the natural resources
(such as land and minerals) found in a
country, as well as its labor resources (labor
of various education and skill levels) and
capital (machinery and structures).
• A country’s resources are often collectively
called its factors of production, the land,
labor, and capital used to produce goods and
services.
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers Silvia Nenci

Reasons for Trade
Proximity
• The closer countries are the lower the costs of
transportation. For example, the largest
trading partner of most European countries is
another European country.
• Sometimes neighboring countries take

advantage of their proximity by joining into a
free-trade area, in which the countries have no
restrictions on trade between them.

Why countries trade
An overview of trade theories:
Silvia Nenci
Reasons for Trade
Absolute Advantage
When a country has the best technology for producing a
good, it has an absolute advantage in the production of
that good
Comparative Advantage
Absolute advantage is not a good explanation for trade
patterns. Instead, comparative advantage is the
primary explanation for trade among countries.

The law of Comparative Advantage
•The law of comparative advantage is the basis for trade

•A country has a Comparative Advantage if it produces
a particular good or service at a lower opportunity cost
than another country.
•It means that it can produce a product with the highest
relative efficiency given all the other products that could
be produced.
Silvia Nenci
Where do the USA’s snowboards come from?
• In 2005 the United States imported (i.e.,

purchased from other countries) $59
million of snowboards from 20 different
countries.
countries
• China exported (i.e., sold to another

country) more than $18 million worth of
snowboards to the United States in 2005
and $21 million in 2009.
Silvia Nenci
U.S. Imports of Snowboards, 2005 and 2009
The table shows that the value of imports to the United States
has fallen in recent years and, in snowboards at least, has
become more focused on exports from China and Taiwan.
Silvia Nenci
Hence the US import snowboards from:
• Canada probably because of proximity

• and from Austria because of cold climates and
mountains makiing snowbording vary popular.
But why from Germany and China?
Silvia Nenci
The Ricardian Model
Silvia Nenci
David Ricardo (1772-1823) and
Mercantilism
• Mercantilists believed that exporting was good
because it generated gold and silver for the
national treasury and that importing was bad because it
drained gold and silver from the national treasury.
• To ensure that a country exported a lot and imported only a
little, the mercantilists were in favor of high tariffs.
• Ricardo was interested in showing that countries could
benefit from international trade without having to use
tariffs.
• Many of the major international institutions in the world
today are founded at least in part on the idea that free trade
between countries brings gains for all trading partners.
The Ricardian model
The Ricardian model focuses on technology to explain trade
patterns
In a model where labour is the only factor of production,
differences in technology are represented by differences in
labour productivity
In a simplified world of 2 countries and 2 goods, Ricardo
shows that even when one of the two countries has an
absolute advantage in the production of both goods, i.e. it can
produce more output with one unit of labour in both goods,
there is scope for mutually beneficial trade if both
countries specialize in the goods where the opportunity
cost is lower (and the comparative advantage greater)
relative to other countries
Silvia Nenci
Technology differences as an explanation
for trade
We focus on technology differences across countries
as an explanation for trade.
This explanation is often called the Ricardian model.
This model explains how the level of a country’s
technology affects wages and, in turn, helps to
explain how a country’s technology affects its trade
pattern.
We also explain the concept of comparative
advantage and why it works as an explanation for
trade patterns.

Ricardian model
Assumptions
2 goods (wheat & cloth)
2 countries (Home & Foreign)
1 production factor (L)
production function:
• fixed coefficient
• different across countries
perfect competition
terms of trade are given (relative prices)
Silvia Nenci
Ricardian Model
2 countries (Home & Foreign), 2 commodities (wheat & cloth)
The Home Country
We will assume that labor is the only resource used to
produce both goods.
The marginal product of labor (MPL) is the extra output

obtained by using one more unit of labor.
At Home, one worker produces 4 bushels of wheat, so MPLW

= 4.
Alternatively, one worker can produce 2 yards of cloth, so
MPLC = 2.
Marginal product of labor
The home country has an absolute advantage in the production of both goods, but
both countries have a comparative advantage
Ricardian Model
The Home Country
Home Production Possibilities Frontier
Using the marginal products for producing wheat and cloth, we
can graph Home’s production possibilities frontier (PPF).
The slope of the PPF is also the opportunity cost of wheat
wheat, the
amount of cloth that must be given up to obtain one more unit of
wheat.
Assume there are 25 workers in Home:
• If all the workers were employed in wheat, the country could
produce 100 bushels (25*4).
• If they were all employed in cloth they could produce 50 yards
(25*2).
The PPF connects these two points.
Ricardian Model
The Home Country - Home Production Possibilities Frontier
½ yard of cloth is the opportunity cost of obtaining 1 more bushel of wheat and is the slope of the PPF
FIGURE 2-1
The Home PPF is a straight

line between 50 yards of
cloth and 100 bushels of
wheat.
The slope of the PPF equals
the negative of the
opportunity cost of wheat.
Equivalently, the magnitude
of the slope can be expressed
as the ratio of the marginal
products of labor for the two
goods.
Silvia Nenci
Ricardian Model
1. Home equilibrium in the absence of trade
With this PPF, what combination of wheat and cloth
will Home actually produce?
It depends on the country’s demand for each of the

2 goods
Silvia Nenci
Ricardian Model
Home Indifference Curve
There are several ways to represent demand in the Home
economy, but we will start by using indifference curves.
• Each indifference curve shows the combinations of two
goods, such as wheat and cloth, that a person or economy
can consume and be equally satisfied.
• All points on an indifference curve have the same level of
utility.
• Points on higher indifference curves have higher utility.
• Indifference curves are often used to show the preferences
of an individual.

Ricardian Model: Home Indifference Curve
The PPF acts like a budget constraint, the country will produce at the point of highest utility subject to the
limits imposed by its PPF
FIGURE 2-2 Home Equilibrium with No Trade
Points A and B lie on the same

indifference curve and give
the Home consumers the level
of utility U1.
The highest level of Home
utility on the PPF is obtained
at point A, which is the no-
trade equilibrium.
Point D is also on the PPF but
would give lower utility.
Point C represents a higher
utility level but is off of the
PPF, so it is not attainable in
the absence of international
trade.
Silvia Nenci
Ricardian Model
Opportunity Cost and Prices
Whereas the slope of the PPF reflects the opportunity
cost of producing one more bushel of wheat, under
perfect competition the opportunity cost of wheat should
also equal the relative price of wheat.
Price reflects the opportunity cost of a good.

Ricardian Model
Wages
• In competitive markets, labor hired up to the point where
wage equals P • MPL for each industry.
• If we assume the labor mobility between industries, and that
workers will choose to work in the high-wage industry, then
wages will be equalized across the 2 industries

Ricardian Model
Wages
We can use the equality of the wage across industries to obtain the
following equation:
PW • MPLW = PC • MPLC
By rearranging terms, we see that
PW/PC = MPLC/MPLW
The right-hand side of this equation is the slope of the production

possibilities frontier (the opportunity cost of obtaining one more
bushel of wheat).
The left-hand side of the equation is the relative price of wheat.
Ricardian Model
The Foreign Country
• Assume a Foreign worker can produce 1 bushel of wheat or 1
yard of cloth.
• It has an absolute disadvantage in producing both goods as
compared to Home
• MPL*W = 1, MPL*C = 1

Marginal product of labor
The Foreign country has an absolute disadvantage in producing both goods as

compared to Home.
Silvia Nenci
Ricardian Model
The Foreign Country
• Assume a Foreign worker can produce 1 bushel of wheat or 1
yard of cloth. It has an absolute disadvantage in producing
both goods as compared to Home
• MPL*W = 1, MPL*C = 1
• Assume there are 100 workers available in Foreign.
• If all workers were employed in wheat they could produce
100 bushels (1x100).
• If all workers were employed in cloth they could produce 100
yards (1x100).

Ricardian Model
The Foreign Country - Foreign Production Possibilities Frontier
FIGURE 2-3
The Foreign PPF is a

straight line between
100 yards of cloth and
100 bushels of wheat.
The slope of the PPF
equals the negative of
the opportunity cost of
wheat, that is, the
amount of cloth that
must be given up (1
yard) to obtain 1 more
bushel of wheat.
wheat
Silvia Nenci
Ricardian Model
The Foreign Country -Comparative Advantage

FIGURE 2-4
Foreign Equilibrium
with No Trade The
highest level of
Foreign utility on the
PPF is obtained at
point A*, which is the
no-trade
equilibrium.
In Foreign, the relative price of wheat is P*w/P*c=1 while in Home is Pw/Pc=1/2

Determining the Pattern of International
Trade -1
International Trade Equilibrium
What happens when goods are traded between Home
and Foreign?
The pattern of exports and imports will be determined by
the opportunity costs of production in each country—
their comparative advantage.

Ricardian Model: Comparative Advantage
Opportunity cost
• The opportuniy costs of wheat in terms of cloth is: 2/4=1/2 in Home and
1/1=1 in Foreign, while the opportuniy costs of cloth in terms of wheat is
4/2=2 in Home and 1/1=1 in Foreign
• A country has a comparative advantage in a good when it has a lower
opportunity cost of producing than another country.
• By looking at the chart we can see that Foreign has a comparative
advantage in producing cloth. Home has a comparative advantage in
producing wheat
Trade -2
The relative price of cloth in Foreign is PC/PW = 1.
The relative price of cloth in Home is PC/PW = 2.
The difference in prices across countries create an
opportunity for trade
Therefore Foreign would want to export its cloth to
Home
The opposite is true for wheat.
Home will export wheat and Foreign will export
cloth.
Both countries export the good for which they have
the comparative advantage
Trade -3
The two countries are in an international trade equilibrium

when the relative price of wheat is the same in the two
countries.
• This means that the relative price of cloth is also the same in
both countries.

International Trade Equilibrium - Change in
Production and Consumption
FIGURE 2-5 (2 of 3) Home Equilibrium with Trade (continued)
As wheat is exported,
Home moves up the
world price line BC.
Home consumption
occurs at point C, at the
tangent intersection with
indifference curve U2,
since this is the highest
possible utility curve on
the world price line.

International Trade Equilibrium - Change in
Production and Consumption
FIGURE 2-5 (3 of 3) Home Equilibrium with Trade (continued)
Given these levels of

production and
consumption, we can see
that total exports are 60
bushels of wheat in
exchange for imports of 40
yards of cloth and also that
Home consumes 10 fewer
bushels of wheat and 15
more yards of cloth relative
to its pre-trade levels.

International Trade Equilibrium
FIGURE 2-5 (revisited) International Trade
Home obtains a higher
utility with international
trade than in the absence of
international trade (U2 is
higher than U1); the finding
that Home’s utility
increases with trade is our
first demonstration of the
gains from trade, by which
we mean the ability of a
country to obtain higher
utility for its citizens under
free trade than with no
trade.

International Trade Equilibrium - Pattern of
Trade and Gains from Trade
FIGURE 2-6 (2 of 2) Foreign Equilibrium with Trade (continued)
Foreign consumption
occurs at point C*, and total
exports are 40 yards of cloth
in exchange for imports of
60 bushels of wheat.
Relative to its pre-trade
wheat and cloth
consumption (point A*),
Foreign consumes 10 more
bushels of wheat and 10
more yards of cloth.

Pattern of Trade and Gains from Trade
• Each country is exporting the good for which it has the

comparative advantage.
• This confirms that the pattern of trade is determined by
comparative advantage.
advantage
• This is the first lesson of the Ricardian model.
• There are gains from trade for both countries.
countries
• This is the second lesson of the Ricardian model

KEY POINTS of the Ricardian Model
1. the pattern of trade is determined by comparative

advantage.
• A country has comparative advantage in producing a good
when the country’s opportunity cost of producing the good
is lower than the opportunity cost of producing the good in
another country.
• Even countries with poor technologies can export the goods
in which they have comparative advantage
2. There are gains from trade for both countries.
• By exporting the good in which a country has the lowest
opportunity cost, the country could benefit from
participating in international trade (i.e. more consumption)

Comparative Advantage
Can Comparative Advantage Be Created? The Case of

“Icewine”
• In some cases, a country can export

a good without having any advantage
in the natural resources needed to produce it.
• One example is “icewine,” which is a type of wine invented in Germany

(it is produced by allowing grapes to freeze on the vine) but now also
produced in the Niagara Falls region of Canada and the United States

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Lecture 1def

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Master in Human Development and Food Security

Dr. Silvia Nenci

(in log scale)

U.S. Recession (1958) Volcker disinflation (1981-82)

Financial crisis (2009 - )

Sources: Irwin & O’Rourke, 2011

Source: Eichengreen&Irwin, 1995

Source: WTO, 2013

Figure 1.4 Average Worldwide Tariffs, 1860–2000

• Differences in the technology used

Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers Silvia Nenci

• Sometimes neighboring countries take

Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers Silvia Nenci

Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers Silvia Nenci

•The law of comparative advantage is the basis for trade

• In 2005 the United States imported (i.e.,

• China exported (i.e., sold to another

• Canada probably because of proximity

But why from Germany and China?

Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers Silvia Nenci

The marginal product of labor (MPL) is the extra output

At Home, one worker produces 4 bushels of wheat, so MPLW

The Home PPF is a straight

It depends on the country’s demand for each of the

Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers Silvia Nenci

Points A and B lie on the same

Price reflects the opportunity cost of a good.

Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers Silvia Nenci

Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers Silvia Nenci

By rearranging terms, we see that

The right-hand side of this equation is the slope of the production

Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers Silvia Nenci

The Foreign country has an absolute disadvantage in producing both goods as

Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers Silvia Nenci

The Foreign PPF is a

The Foreign Country -Comparative Advantage

In Foreign, the relative price of wheat is P*w/P*c=1 while in Home is Pw/Pc=1/2

Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers Silvia Nenci

The two countries are in an international trade equilibrium

Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers Silvia Nenci

Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers Silvia Nenci

Given these levels of

Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers Silvia Nenci

Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers Silvia Nenci

Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers Silvia Nenci

• Each country is exporting the good for which it has the

Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers Silvia Nenci

1. the pattern of trade is determined by comparative

Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers Silvia Nenci

Can Comparative Advantage Be Created? The Case of

• In some cases, a country can export

• One example is “icewine,” which is a type of wine invented in Germany

Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers Silvia Nenci

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In Foreign, the relative price of wheat is Pw/Pc=1 while in Home is Pw/Pc=1/2