Intro to the discussion of trade theories.

1. Bases for
trade
jhuato.sfc@gmail.com

2. Goals
 Examine fundamental bases (or reasons)
why economies trade
 Define the concepts of commercial
advantage (absolute and comparative or
relative)
 Understand the model of trade based on
increasing MRT and differences in
preferences (demand patterns)

3. Bases for trade
Fundamental reasons for trade between countries
arise from:
1. Differences in the preferences for the goods
(with same cost structure, but increasing costs)
2. Differences in the cost structure of the goods
(with same preferences)
The analytical apparatus we studied help us
highlight these bases for trade. Case (1), we‟ll study
it next. Case (2), we‟ll study with the help of the
Ricardian, Hecksher-Ohlin, and “modern” models of
trade.

4. Trade theories („models‟):
 Same cost structure (with increasing costs)
and different preferences (demand
patterns)
 Different cost structures:
 Ricardian model (technology)
 Hecksher-Ohlin model (resource
endowment)
 Modern theories (scale, increasing returns,
monopolistic competition)

5. Commercial advantage
 Absolute advantage (AA): H is said to enjoy
an absolute advantage over F if it can
produce more than F of at least one good.
 Relative or comparative advantage (CA): H is
said to enjoy a relative advantage in the
production of good 1 over F if the MRTH12 <
MRTF12.
 Corollary: If H has a comparative advantage
in good 1 over F, then F has a comparative
advantage in good 2 over H, i.e. MRTH21 >
MRTF21.

6. Trade patterns
 If a country has a CA in a certain good (and
therefore a comparative disadvantage in the
other good), then that economy will have
gain from trade if it specializes in the
production of such good and exports it to the
other economy.
 Thus, determining the CA of an economy
allows us to predict its trade patterns: which
good it exports and which one it imports.

7. Differences in preferences: no
trade

8. Differences in preferences:
with trade

9. Key points
 Note that H has a CA in the production of good 1
(and F in good 2), not because of differences in
production possibilities (which are the same for both
countries), but because – as a result of the different
preferences – at the output and consumption
bundle chosen in autarky, MRT12 < MRT*12, i.e. H can
produce good 1 more cheaply than F at their
respective chosen bundles, and so it makes sense for
them to produce more of the good they have a CA
in, and then trade it for the other good.
 This is the only case that we‟ll consider in which CA
results not from the production possibilities, but from
the different type of preferences between the two
countries.