Global Value
Chains
,Lecture 1:
Missing elements in traditional
trade theory
Traditional Trade Theory
Comparative advantage: countries are born different
1. Ricardian comparative advantage
Has proven to work and explain trade.
- Comparative advantage: countries are born differently, creates incentives to trade
between each other.
- Differences are in productivity/technology.
- Unit labour requirement: number of hour of units of labour to produce one unit of
the good.
- Portugal more efficient in wine (lower unit labour requirement), as compared to the
production of cloth.
- Relative concept: always compare 2 countries and 2 products
- Find relative price of cloth in both countries Pc/Pw. In autarky this would be the
price we see in each country (because of perfect competition in labour market).
Cloth will be less expensive in England, the country whose comparative advantage is
for cloth.
- There is perfect competition in labour market. The labour can work in both sectors.
- Opportunity cost for wine: amount of cloth country gives up to produce one
additional unit of wine. Have a CA for the product for which you have a lower
opportunity cost. In autarky the opportunity cost is equal to the relative price.
Slide 5: trade graph:
- Price becomes in between 2 relative prices. Price of comparative advantage goods
goes up.
- Line on graph is production possibility frontier: all combinations that can be
consumed and produced in country given that units of labour = 60 rico/slope is
opportunity cost or relative price for good on x axis
- Indifference curve gives preference of consumers. Gives you quantity produced and
consumed in equilibrium.
- Dashed line: project slope of production possibility frontier of other country on you
graph. The 2 prices in the countries are different because the sloped are different.
- Trade creates new line/price in the middle meets higher indifference curve
welfare improved, consumption possibilities expand. That is the benefit of
international trade.
- The 2 countries fully specialize
, - Wage goes up when demand for labour goes up. Global demand for the product has
gone up and there will be a reallocation of workers. In Portugal wage in the wine
sector has gone up wage in specializing sector goes up
- This whole logic is still there even if one country is more productive in absolute
terms for all goods.
2. Heckscher-Ohlin model
- Still comparative advantage (but different!), 2 countries and 2 products
- Difference: 2 factors of production (labour and capital), same technology for
producing goods, distribution effects: who is losing and winning
- Difference between countries is factor endowment
- Lot of one factor, specialize in industry that is intensive in that factor of production
- Abundance of factor means that product intensive in this factor is cheaper
- In China labour is cheaper than land because labour is abundant
- Price equals cost, again perfect competition
Slide 10: graph:
- Production possibility frontier is a curve because there is substitution between 2
factors, at certain point not as efficient to use an additional workers to make
additional unit diminishing returns in production
- The relative price is not constant
- Curve for EU shifted (tilt) towards food production: cheaper to produce food
because factors of production land is more abundant and thus cheaper
- Once open op to trade, there is again a shift in the slope
- New equilibrium is no longer on production possibility frontier but is on new
line/slope
- Increase in the production of food in EU and but decrease of consumption of food
(different from previous model) because price of food in Europe goes up
- In China the production of food goes down and the consumption goes up, the
indifference curve is shifted to the right so the welfare is increased
Distribution effects of trade?
Stolper-Samuelson theorem: EU: relative price of food goes up, r/w in EU goes up, in
Europe landowners (abundant factor) will win and workers will lose from trade. Gives
distribution effects from international trade.
Rybczynski theorem: if in China number of workers goes up, output of the product that is
intensive in that factor (cloth) increases (labour intensive industry) and output of food
decreases (interesting outcome of theorem) even if might think that some extra workers will
work in food.
3. Krugman model
- Explains intra-industry trade, introduces idea of firms (instead of countries)
- Comparative advantage notion in less present in this theory, compared to the 2
theories seen previously
, - Before: trading completely different goods incentives for trade higher when
countries are more different BUT see that lot of trade between similar countries
(similar factor endowments and technology).
- New: taste for variety, consumer prefers to consume higher number of varieties
(how utility is higher).
- Still no intermediate input trade but trade in different variants of the final good.
- Higher qi’s (consumption of a good produced by firm i), higher variety, higher utility
for consumer
- Sigma is elasticity of substitution between different varieties (>1)
- Increasing returns to scale, cost to produce an output: fixed cost (to set up) and
marginal cost (c) the more you sell, the more you spread fixed costs
- Market equilibrium: zero profit condition: when profits are zero, no incentives for
additional firms to enter market
- N* is the number of varieties produced in equilibrium. With N+1 varieties, the profits
will be negative.
- Number of varieties produced in autarky is dependent on size of country
- Move from perfect competition to monopolistic competition: due to fixed cost, price
is not equal to marginal cost zo have zero profits but higher. This is due to increasing
returns of scale.
- Marginal costs are symmetric so the same for each firm
- Product differentiation is horizontal:
o Horizontal product differentiation: ex: 10 brands of cereals
o Vertical product differentiation: one is input for other, same production line
- Consumers consume an equal amount of each of the products
Trade:
- One big global market, increase total number of varieties for consumers. So
consumer’s wealth is increased.
- Firms increase sale and income. Incentives are for firm to have as high as possible
sales, having a larger market available.
- Equilibrium varieties is lower than sum of varieties of 2 countries, because of
increase in competition (small producers don’t survive because price in the market
went down)
- Lower price because price is equal to AC and AC went down because of increased
economies of scale and the firms’ Q’s will go up. Markups are lower because of
competition utility increase for consumers because can consume more variety
and prices are lower.
4. Melitz model
- Introduce firm heterogeneity: each firm has different productivity (f i) and marginal
cost (ci)
- More productive firms have lower marginal cost
- In order to start producing firm needs to pay a fixed cost. Stochastic draw to find out
how productive is after paying the fixed costs.
Chains
,Lecture 1:
Missing elements in traditional
trade theory
Traditional Trade Theory
Comparative advantage: countries are born different
1. Ricardian comparative advantage
Has proven to work and explain trade.
- Comparative advantage: countries are born differently, creates incentives to trade
between each other.
- Differences are in productivity/technology.
- Unit labour requirement: number of hour of units of labour to produce one unit of
the good.
- Portugal more efficient in wine (lower unit labour requirement), as compared to the
production of cloth.
- Relative concept: always compare 2 countries and 2 products
- Find relative price of cloth in both countries Pc/Pw. In autarky this would be the
price we see in each country (because of perfect competition in labour market).
Cloth will be less expensive in England, the country whose comparative advantage is
for cloth.
- There is perfect competition in labour market. The labour can work in both sectors.
- Opportunity cost for wine: amount of cloth country gives up to produce one
additional unit of wine. Have a CA for the product for which you have a lower
opportunity cost. In autarky the opportunity cost is equal to the relative price.
Slide 5: trade graph:
- Price becomes in between 2 relative prices. Price of comparative advantage goods
goes up.
- Line on graph is production possibility frontier: all combinations that can be
consumed and produced in country given that units of labour = 60 rico/slope is
opportunity cost or relative price for good on x axis
- Indifference curve gives preference of consumers. Gives you quantity produced and
consumed in equilibrium.
- Dashed line: project slope of production possibility frontier of other country on you
graph. The 2 prices in the countries are different because the sloped are different.
- Trade creates new line/price in the middle meets higher indifference curve
welfare improved, consumption possibilities expand. That is the benefit of
international trade.
- The 2 countries fully specialize
, - Wage goes up when demand for labour goes up. Global demand for the product has
gone up and there will be a reallocation of workers. In Portugal wage in the wine
sector has gone up wage in specializing sector goes up
- This whole logic is still there even if one country is more productive in absolute
terms for all goods.
2. Heckscher-Ohlin model
- Still comparative advantage (but different!), 2 countries and 2 products
- Difference: 2 factors of production (labour and capital), same technology for
producing goods, distribution effects: who is losing and winning
- Difference between countries is factor endowment
- Lot of one factor, specialize in industry that is intensive in that factor of production
- Abundance of factor means that product intensive in this factor is cheaper
- In China labour is cheaper than land because labour is abundant
- Price equals cost, again perfect competition
Slide 10: graph:
- Production possibility frontier is a curve because there is substitution between 2
factors, at certain point not as efficient to use an additional workers to make
additional unit diminishing returns in production
- The relative price is not constant
- Curve for EU shifted (tilt) towards food production: cheaper to produce food
because factors of production land is more abundant and thus cheaper
- Once open op to trade, there is again a shift in the slope
- New equilibrium is no longer on production possibility frontier but is on new
line/slope
- Increase in the production of food in EU and but decrease of consumption of food
(different from previous model) because price of food in Europe goes up
- In China the production of food goes down and the consumption goes up, the
indifference curve is shifted to the right so the welfare is increased
Distribution effects of trade?
Stolper-Samuelson theorem: EU: relative price of food goes up, r/w in EU goes up, in
Europe landowners (abundant factor) will win and workers will lose from trade. Gives
distribution effects from international trade.
Rybczynski theorem: if in China number of workers goes up, output of the product that is
intensive in that factor (cloth) increases (labour intensive industry) and output of food
decreases (interesting outcome of theorem) even if might think that some extra workers will
work in food.
3. Krugman model
- Explains intra-industry trade, introduces idea of firms (instead of countries)
- Comparative advantage notion in less present in this theory, compared to the 2
theories seen previously
, - Before: trading completely different goods incentives for trade higher when
countries are more different BUT see that lot of trade between similar countries
(similar factor endowments and technology).
- New: taste for variety, consumer prefers to consume higher number of varieties
(how utility is higher).
- Still no intermediate input trade but trade in different variants of the final good.
- Higher qi’s (consumption of a good produced by firm i), higher variety, higher utility
for consumer
- Sigma is elasticity of substitution between different varieties (>1)
- Increasing returns to scale, cost to produce an output: fixed cost (to set up) and
marginal cost (c) the more you sell, the more you spread fixed costs
- Market equilibrium: zero profit condition: when profits are zero, no incentives for
additional firms to enter market
- N* is the number of varieties produced in equilibrium. With N+1 varieties, the profits
will be negative.
- Number of varieties produced in autarky is dependent on size of country
- Move from perfect competition to monopolistic competition: due to fixed cost, price
is not equal to marginal cost zo have zero profits but higher. This is due to increasing
returns of scale.
- Marginal costs are symmetric so the same for each firm
- Product differentiation is horizontal:
o Horizontal product differentiation: ex: 10 brands of cereals
o Vertical product differentiation: one is input for other, same production line
- Consumers consume an equal amount of each of the products
Trade:
- One big global market, increase total number of varieties for consumers. So
consumer’s wealth is increased.
- Firms increase sale and income. Incentives are for firm to have as high as possible
sales, having a larger market available.
- Equilibrium varieties is lower than sum of varieties of 2 countries, because of
increase in competition (small producers don’t survive because price in the market
went down)
- Lower price because price is equal to AC and AC went down because of increased
economies of scale and the firms’ Q’s will go up. Markups are lower because of
competition utility increase for consumers because can consume more variety
and prices are lower.
4. Melitz model
- Introduce firm heterogeneity: each firm has different productivity (f i) and marginal
cost (ci)
- More productive firms have lower marginal cost
- In order to start producing firm needs to pay a fixed cost. Stochastic draw to find out
how productive is after paying the fixed costs.
