International Economics: Theory and Policy, 8/e.


1. INTERNATIONAL TRADE THEORY. 2. World Trade: An Overview. 3. Labor Productivity and Comparative Advantage: The Ricardian Model. 4. Resources, Comparative Advantage, and Income Distribution. 5. The Standard Trade Model. 6. Economies of Scale, Imperfect Competition, and International Trade. 7. International Factor Movements. II. INTERNATIONAL TRADE POLICY. 8. The Instruments of Trade Policy. 9. The Political Economy of Trade Policy. 10. Trade Policy in Developing Countries. 11. Controversies in Trade Policy.


Chapter 2
World Trade: An Overview
• Gravity model:
 influence of an economy’s size on trade  distance and other factors that influence trade

• • • •

Borders and trade agreements Globalization: then and now Changing composition of trade Service outsourcing


S.S. China.Who Trades with Whom? • The 5 largest trading partners with the U. accounted for 56% of the value of U. • The largest 10 trading partners with the U. Mexico Japan and Germany. 3 .S. • The total value imports from and exports to Canada in 2005 was about $500 billion dollars. trade in 2005. in 2005 were Canada.

Fig. Trade with Major Partners.S. 2006 4 . 2-1: Total U.

• Why does the U.S.Size Matters: The Gravity Model • 3 of the top 10 trading partners with the U. and France.  GDP measures the value of goods and services produced in an economy. trade most with these European countries and not other European countries? 5 . UK. in 2005 were also the 3 largest European economies: Germany. • These countries have the largest gross domestic product (GDP) in Europe.S.

6 .  Larger economies generate more income from the goods and services sold.Size Matters: The Gravity Model • In fact. the size of an economy is directly related to the volume of imports and exports.  Larger economies produce more goods and services. so people are able to buy more imports. so they have more to sell in the export market.

and the Value of Their Trade with the United States 7 . 2-2: The Size of European Economies.Fig.

which may influence trade. • • Cultural affinity: if two countries have cultural ties.The Gravity Model Other things besides size matter for trade: • Distance between markets influences transportation costs and therefore the cost of imports and exports. Geography: ocean harbors and a lack of mountain barriers make transportation and trade easier. it is likely that they also have strong economic ties.  Distance may also influence personal contact and communication. 8 .

either of which may impede trade more. Borders: crossing borders involves formalities that take time and perhaps monetary costs like tariffs.   These implicit and explicit costs reduce trade. • 9 .The Gravity Model • Multinational corporations: corporations spread across different nations import and export many goods between their divisions. The existence of borders may also indicate the existence of different languages (see 2) or different currencies.

The Gravity Model • In its basic form. the gravity model assumes that only size and distance are important for trade in the following way: Tij = A x Yi x Yj /Dij • where Tij is the value of trade between country i and country j A is a constant Yi the GDP of country i Yj is the GDP of country j Dij is the distance between country i and country j 10 .

as the figure above representing U. 11 . the gravity model that is commonly estimated is Tij = A x Yia x Yjb /Dijc where a.S. Distance and Borders • Estimates of the effect of distance from the gravity model predict that a 1% increase in the distance between countries is associated with a decrease in the volume of trade of 0.–EU trade flows suggested.The Gravity Model • In a slightly more general form. and c are allowed to differ from 1. the gravity model works fairly well in predicting actual trade flows. b. • Perhaps surprisingly.7% to 1%.

S. • Trade agreements between countries are intended to reduce the formalities and tariffs needed to cross borders. borders increase the cost and time needed to trade.Distance and Borders • Besides distance. 12 . signed a free trade agreement with Mexico and Canada in 1994. the North American Free Trade Agreement (NAFTA). and therefore to increase trade. • The gravity model can assess the effect of trade agreements on trade: does a trade agreement lead to significantly more trade among its partners than one would otherwise predict given their GDPs and distances from one another? Distance and Borders • The U.

and its northern and southern neighbors as a fraction of GDP is larger than between the U.S. and European countries.• Because of NAFTA and because Mexico and Canada are close to the U.S. 13 ..S. the amount of trade between the U.

2-3: Economic Size and Trade with the United States 14 .Fig.

Distance and Borders • Yet even with a free trade agreement between the U. which use a common language. 15 .S. the border between these countries still seems to be associated with a reduction in trade. and Canada.

telegraph.Has the World Become “Smaller”? • The negative effect of distance on trade according to the gravity models is significant. sails. but it has grown smaller over time due to modern transportation and communication. GPS satellites… are technologies that have increased trade. airplanes. • But history has shown that political factors. steam power. personal digital assistants. can change trade patterns much more than innovations in transportation and communication. railroads. fiber optics. automobiles.  Wheels. telephones. fax machines. internet. such as wars. 16 . computers. compasses.

airplanes. GPS satellites… 17 . telegraph.Has the World Become “Smaller”? • There were two waves of globalization. fiber optics. internet. Globalization was interrupted and reversed by wars and depression. computers.  1840–1914: economies relied on steam power. telephones. PDAs. railroads.  1945–present: economies rely on telephones.

 Mineral products (ex. most of the volume of trade is in manufactured products such as automobiles. legal fees. insurance. clothing and machinery.Changing Composition of Trade • What kinds of products do nations currently trade. 18 . petroleum. coal. copper) and agricultural products are a relatively small part of trade. and how does this composition compare to trade in the past? • Today.  Services such as shipping. and spending by tourists account for 20% of the volume of trade.. computers.

19 . manufactured products made up most of the volume of imports and exports for both countries.  In 1910. although manufactured products still represented most of the volume of exports. the U.  In 1910.Changing Composition of Trade • In the past. mainly imported and exported agricultural products and mineral products.S. a large fraction of the volume of trade came from agricultural and mineral products. Britain mainly imported agricultural and mineral products.  In 2002.

Table 2-4: Manufactured Goods as a Percent of Merchandise Trade 20 .

 In 1960.Changing Composition of Trade • Low and middle-income countries have also changed the composition of their trade. about 58% of exports from low and middle-income countries were agricultural products and only 12% of exports were manufactured products.  In 2001. about 65% of exports from low and middle-income countries were manufactured products. and only 10% of exports were agricultural products. 21 .

 Service outsourcing can occur for services that can be performed and transmitted electronically. • For example.Developing-Country Exports Service Outsourcing • Service outsourcing occurs when a firm that provides services moves its operations to a foreign location. a firm may move its customer service centers whose telephone calls can be transmitted electronically to foreign location. 22 .

however.  Most jobs.Service Outsourcing Service outsourcing is currently not a significant part of trade. 23 . about 12% of manufacturing jobs are “tradeable” and thus have the potential to be outsourced. are non-tradeable because they need to be done close to the customer. but about 19% of service jobs are “tradeable” and thus have the potential to be outsourced.  In comparison.

S. China. are Canada. geography. and the existence of borders influence trade. Modern transportation and 24 • • • • . and Germany. Besides size and distance. multinational corporations. The largest economies in the EU undertake the largest fraction of the total trade between the EU and the U.S. culture. Mexico. Japan.Summary • The 5 largest trading partners with the U. The gravity model predicts that the volume of trade is directly related to the GDP of each trading partner and is inversely related to the distance between them.

25 . Today. most trade is in manufactured goods. but political factors have influenced trade more in history.• communication have increased trade. while historically agricultural and mineral products made up most of trade.

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