Economic Growth And International Trade

Economic Growth and
International Trade
Chapter 7

ANHUI UNIVERSITY OF FINANCE & ECONOMICS

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1 Introduction
We will
 Extend our trade model to include such changes as
factor endowments, technology and tastes, and their
effects on the nation's offer curve, the volume and
terms of trade, and the gains from trade.
 Discuss Rybczynski theorem.
 Define different types of technical progress and
their effects on the nation's production frontier.
 Examine the effect of growth and change in tastes
in both nations on the trade volume and terms of
trade.

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Key Terms
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Comparative static
Dynamic analysis
Balanced growth
Immiserizing growth
Labor/capital saving technical progress
Protrade production and consumption
Neutral technical progress
Normal goods
Rybczynski theorem
Wealth effect

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2 Static, Comparative Static
and Dynamic Analysis
Static Analysis
Up to the present, we only have static
analysis except the analysis of product cycle
and technological gap models.
Comparative Static Analysis
It analyzes the effect on the equilibrium
position resulting from a change in underlying
economic conditions and without regard to the
transitional period and process of adjustment.
Dynamic Analysis
It deals with the time path and the process of
adjustment itself.

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3 Growth of Factors
Capital:
It refers to all man-made means of production,
such as machinery, factories, office buildings,
transportation and communications and also the
education and training of the labour force, all of
which greatly enhance the nation's ability to
produce goods and services.
Assumptions:
All labor and capital are homogeneous.
X is L-intensive and Y is K-intensive.
Nations experience growth in the production
of X and Y under constant returns to scale.

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3.1 Balance Growth


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3.2 Unbalance Growth


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3.3 K and L Growth Over Time
When both L and K grow at the same rate and we have
constant returns to scale in the production of both
commodities, the productivity and the returns of L and K
remain the same after growth as they were before growth
took place.
If the dependency rate, the ratio of dependents to the
total population, also remains unchanged, real per capita
income and the welfare of the nation tend to remain
unchanged.
If only L grows or L grows proportionately more than
K, K/L will fall, the productivity of L and the returns to L
and real per capita income will also fall. If on the other
hand, only K grows or K grows proportionately more than
L, K/L will rise, the productivity of, the returns to L and
real per capita income will also rise.

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3.4 The Rybczynski Theorem


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3.5 Technical Progress & PPF
All types of technical progress cause the PPF to shift
outwards. The type and degree of the shift depend on the type
and rate of technical progress in either or both commodities.
With the same rate of
neutral technical progress in
the production of both
commodities, the PPF will shift
out evenly in all directions at
the same rate at which
technical progress takes place.
The slope of the nation's old
and new PPF will be the same
at any point where they are cut
by a ray from the origin.

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3.6 Neutral Technical Progress
X doubles for each level of Y.

If the technical progress only takes place in the L and
K in the production of X or Y, the production frontier will
extend along the axis which shows the quantity of X or Y.

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3.7 Summary of Technical
Progress
In the absence of trade,
all types of technical progress
tend to increase the nation’s
welfare. The reason is that
with higher production
frontier and the same L and
population, each citizen could
be better off after growth
than before by an
appropriate redistribution
policy.

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4 Pro-and Anti-trade Production
If the output of the nation’s

exportable commodity grows
proportionately more than the
output of its importable
commodity at constant relative
commodity prices, then growth
leads to a greater than
proportionate expansion of
trade. It is called protrade
production. Otherwise it is
antitrade production.
Neutral trade production:
The expansion of output leads
to the same rate of expansion of
trade.

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4.1 Pro-and Anti-trade
Consumption

The nation’s consumption
of its importable commodity
increases proportionately
more than the nation’s
consumption of its exportable
commodity at constant prices,
the consumption leads to a
greater than proportionate
expansion of trade and it is
called protrade consumption.
Otherwise it is antitrade or
neutral consumption.


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4.2 Effects of Growth on Trade
What happens to the volume of trade in the process of
growth depends on the net result of these production and
consumption effects.
 If production and consumption are both protrade, the
volume of trade expands proportionately faster than
output.
 If production and consumption are both antitrade, the
volume of trade expands proportionately less than
output and may even decline absolutely.
 If production is protrade and consumption is antitrade,
or vice versa, the volume of trade can not be decided. It
depends on the net effect of the two opposing forces.
 If production and consumption are both neutral, the
volume of trade expands at the same rate as output.



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4.3 Illustration of Factor Growth
and Trade: The Small Country
Case

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4.3 Illustration of Factor Growth
and Trade: The Small Country
Case


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4.4 Technical Progress, Trade &
Welfare

Neutral expansion of production and
consumption leads to the same rate of expansion of
trade. With neutral production and protrade
consumption, the volume of trade would expand
proportionately more than production. With neutral
production and antitrade consumption, the volume
of trade would expand proportionately less than
production.
However, regardless of what happens to the
volume of trade, the welfare of the representative
citizens will increase with constant L and population
and constant terms of trade.


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5 Growth and Trade: The Large
Country Case
Terms-of-trade effect of growth:
If growth expands the volume of trade at constant
prices (constant exchange rate), then the terms of trade
tend to deteriorate.(Why?) On the other hand, if growth
reduces the volume of trade at constant price (constant
exchange rate), the nation's terms of trade tend to
improve. This is referred to as the terms-of-trade effect
of growth.
Wealth effect of growth:
The wealth effect is the change in the output per
worker or per person as a result of growth. A positive
wealth effect (higher productivity of labor) tends to
increase the nation's welfare. Otherwise, the nation's
welfare tends to decline or remain unchanged.

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5 Growth and Trade: The Large
Country Case
The effect of growth on the nation's welfare depends
on the net result of the terms of trade effect and a wealth
effect. If both are positive, the nation's welfare will
definitely increase.
If both are unfavorable, the welfare will definitely
decline. If the wealth effect and the terms of trade effect
move in opposite directions, the nation's welfare may
deteriorate, improve or remain unchanged, depending
on the relative strength of these two opposing forces.
If wealth effect(positive) is greater than the terms of
trade effect(negative), the welfare increases. If wealth
effect(positive) is smaller than the terms of trade effect
(negative), the welfare decreases.

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5.1 Illustration of Growth and
Trade in a Large Nation


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5.2 Growth and Trade: The
Large Country Case

Large Country Case

Small Country Case


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5.3 Immiserizing Growth


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5.4 Conditions for Immiserizing
Growth
When growth tends to increase nation 1’s
exports substantially at constant terms of
trade.
Nation 1 is large so that the attempt to
expand its exports substantially will cause a
deterioration in its terms of trade.
The income elasticity of nation 2’s demand
for nation 1’s export is very low, so that nation
1’s terms of trade will deteriorate substantially.
Nation 1 is so heavily dependent on trade
that a substantial declining in its terms of trade
will lead to a reduction in national welfare.

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5.5 Illustration of Beneficial
Growth and Trade


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5.6 Growth Increasing Terms of
Trade and Welfare


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6 Growth & Trade in Both Nations


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Through time not only do economies grow,
but national tastes also change.
Growth affects a nation’s offer curve through
the effect that growth has on the nation’s
production frontier. Similarly, a change in tastes
affects a nation’s offer curve through the effect
that the change in tastes has on the nation’s
indifference map.
With growth or change in tastes in both
nations, both nations’ offer curves will shift,
changing the volume or the terms of trade.

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Regardless of its source, a shift in a nation’s
offer curve toward the axis measuring its
exportable commodities tends to expand trade at
constant exchange rates and reduce the nation’s
terms of trade. Opposite shifts in the nation’s
offer curve tend to reduce the volume of trade at
constant exchange rates and improve the
nation’s terms of trade.
For a given shift in its offer curve, the nation’s
terms of trade will change more, the greater the
curvature is of its trade partner’s offer curve.


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7 Questions for Discussion
• What effect do the various types of factor
growth have on the growing nation’s
production frontier?
• Explain neutral, labour saving and capital
saving technical progress?
• What are protrade or antitrade production and
consumption?
• What are the effects of different technical
progress in the large and small nation?


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Economic Growth And International Trade

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