SAMENVATTING
INTERNATIONAL TRADE
MODULE 1: INTRODUCTION
International trade is the exchange of goods and services between countries. It enables countries to buy products that they
cannot (efficiently) produce themselves and to market their own products globally. It forms an essential part of the global
economy. How changes in demand for certain skills caused by trade can affect wage structures
Why is international trade important:
- Trade increases countries' economic prosperity.
- Global exports make up a significant share of global GDP.
- A practical example: the ingredients in your meal often come from different countries - trade makes them available.
- Without international trade, consumers would have a more limited supply and prices would be higher.
WHO TRADES WITH WHOM?
The US, for example, trades the most with countries such as Mexico, Canada,
China, Japan, Germany, South Korea, the UK, Taiwan and others.
The volume
of trade depends heavily on:
- Size of economies (GDP): large economies trade more.
- Distance: geographical proximity promotes trade.
- Other factors: such as trade agreements, shared language, historical ties → the gravity model can be used to study
outliers
THE GRAVITY MODEL
The value of trade between any two countries is proportional, other things equal, to the product of the two countries’ GDPs and
diminishes with the distance between the two countries:
1
→ Tij = A x Yia x Yjb x
Dcij
- Tij: value of trade between country i and j
- Yi and Yj: the GDP of both countries
- Dij: distance between countries
- A, a, b, c: parameters
1
,Key features:
- The larger the GDP and the smaller the distance, the more trade.
- Model also takes into account trade barriers and assistances (such as customs tariffs or subsidies).
- The model also helps explain 'exceptions' or outliers in trade relationships.
Why does the gravity model work? Broadly speaking, large economies tend to spend large amounts on imports because they
have large incomes. They also tend to attract large shares of other countries’ spending because they produce a wide range of
products. So, other things equal, the trade between any two economies is larger—the larger is either economy
Example trade barriers:
- Distance: Why does the United States do so much more trade with its North American neighbors than with its European
partners? One main reason is the simple fact that Canada and Mexico are much closer.
1
o Tij = A x Yia x Yjb x : Less tangible factors also play a crucial role.
Dcij
- Barriers: In addition to being U.S. neighbors, Canada and Mexico are part of a trade agreement with the United States,
the North American Free Trade Agreement, or NAFTA, which ensures that most goods shipped among the three
countries are not subject to tariffs or other barriers to international trade.
- Borders: It’s important to note, however, that although trade agreements often end all formal barriers to trade
between countries, they rarely make national borders irrelevant. Even when most goods and services shipped across a
national border pay no tariffs and face few legal restrictions, there is much more trade between regions of the same
country than between equivalently situated regions in different countries.
WHAT DO WE TRADE
Not only food, but especially manufactured goods are the largest trade category. Services are also increasingly traded
internationally, especially thanks to digitalisation (e.g. online education, entertainment, customer services). However, some
services remain locally bound (e.g. hairdressing salon, healthcare). Migration is also seen as a form of international trade (labour
as a tradable service).
Complexity of modern trade
- The structure of trade has changed: there is vertical disintegration, with
production chains spread across multiple countries.
- A single final product may contain components from dozens of countries (e.g.
smartphones or cars).
2
,MODULE 2: THE RICARDIAN MODEL
INTRODUCTION
The Ricardian model is based on the assumption of homo economicus:
- Individuals are rational
- Have complete information
- Maximise their utility
- More consumption = better (monotonicity)
Opportunity costs = the value of what you give up to produce something else.
- If Belgium grows flowers in winter, they could have produced chocolate with the same resources. The opportunity cost
of flowers = how much chocolate you miss out on.
- In Belgium:
o 1,000 tulips → costs the same labour as 100 kg of chocolate
→ Opportunity cost = 1,000 tulips = 100 kg of chocolate
- In the Netherlands:
o 1,000 tulips → costs labour of 50 kg of chocolate
→ Opportunity cost = 1,000 tulips = 50 kg of chocolate
- So the Netherlands has lower opportunity costs for tulip production → better in flower production.
Specialisation and efficiency
- When countries specialise in what they can produce relatively better (with lower opportunity costs), total world output
increases.
- Belgium specialises in chocolate, the Netherlands in flowers → everyone is better off.
Comparative Advantage
- A country has a comparative advantage in the production of a good if:
o The opportunity cost of that good is lower than in other countries.
- Even if a country is better in everything (absolute advantage), specialisation still pays off due to differences in relative
efficiency.
- Key point:
o Comparative advantage determines who produces and exports what, not absolute advantage.
THE RICARDIAN MODEL
A ONE-FACTOR ECONOMY
The Ricardian model is the simplest model of international trade. Key assumptions:
- Only one factor of production: labour
- Labour productivity varies between countries → due to technological differences
- Labour productivity within a country is constant
- Labour supply in each country is fixed
- Two goods are produced: wine and cheese
- Two countries: Home and Foreign
3
, UNIT LABOUR REQUIREMENT (ULR)
A unit labour requirement indicates the constant number of hours of labour required to produce one unit of output
Example:
- 𝑎𝐿𝐶 = 1 hour/pound of cheese
- 𝑎𝐿𝑊 = 2 hours/gallon of wine
1 1
- Labour productivity = = → so lower ULR = higher productivity
ULR 𝑎𝐿𝑤
Opportunity cost in terms of other goods
- To make 1 pound of cheese, you use 1 hour of labour.
- In the same time, you could have made 0.5 gallons of wine → opportunity cost cheese = 0.5 gallons of wine
𝑎𝐿𝑐
→ Opportunity cost cheese =
𝑎𝐿𝑤
PRODUCTION POSSIBILITY FRONTIER (PPF)
There are only a limited number of hours in a day and a limited number of people in the economy: labour supply is finite → you
have to choose how much cheese or wine to make.
- Suppose total labour L = 1,000 hours/year
1
o If all labour goes into cheese → = 1,000 pounds of cheese
𝑎𝐿𝑐
1
o If all labour goes to wine → = 500 gallons of wine
𝑎𝐿𝑤
A production possibility frontier shows the maximum amount of wine that can be produced
once the decision has been made to produce a given amount of cheese, and vice versa.
- Labour constraint: aLcQc + aLwQw = L
L aLc
- Qw = - Qc
aLw aLw
aLc aLc
- Thus, slope = - → opportunity cost of cheese = | − |
aLw aLw
RELATIVE PRICES
Set prices:
- PC = $4/pound cheese
- PW = $7/gallon of wine
PC
→ Relative price of cheese: = barter price of cheese
PW
Profit for labour = price / ULR
- Profit (wage) in cheese sector = $4/1 = $4/hour
- Profit in wine sector = $7/2 = $3.5/hour
→ Workers choose sector with highest wage → specialisation follows.
4
INTERNATIONAL TRADE
MODULE 1: INTRODUCTION
International trade is the exchange of goods and services between countries. It enables countries to buy products that they
cannot (efficiently) produce themselves and to market their own products globally. It forms an essential part of the global
economy. How changes in demand for certain skills caused by trade can affect wage structures
Why is international trade important:
- Trade increases countries' economic prosperity.
- Global exports make up a significant share of global GDP.
- A practical example: the ingredients in your meal often come from different countries - trade makes them available.
- Without international trade, consumers would have a more limited supply and prices would be higher.
WHO TRADES WITH WHOM?
The US, for example, trades the most with countries such as Mexico, Canada,
China, Japan, Germany, South Korea, the UK, Taiwan and others.
The volume
of trade depends heavily on:
- Size of economies (GDP): large economies trade more.
- Distance: geographical proximity promotes trade.
- Other factors: such as trade agreements, shared language, historical ties → the gravity model can be used to study
outliers
THE GRAVITY MODEL
The value of trade between any two countries is proportional, other things equal, to the product of the two countries’ GDPs and
diminishes with the distance between the two countries:
1
→ Tij = A x Yia x Yjb x
Dcij
- Tij: value of trade between country i and j
- Yi and Yj: the GDP of both countries
- Dij: distance between countries
- A, a, b, c: parameters
1
,Key features:
- The larger the GDP and the smaller the distance, the more trade.
- Model also takes into account trade barriers and assistances (such as customs tariffs or subsidies).
- The model also helps explain 'exceptions' or outliers in trade relationships.
Why does the gravity model work? Broadly speaking, large economies tend to spend large amounts on imports because they
have large incomes. They also tend to attract large shares of other countries’ spending because they produce a wide range of
products. So, other things equal, the trade between any two economies is larger—the larger is either economy
Example trade barriers:
- Distance: Why does the United States do so much more trade with its North American neighbors than with its European
partners? One main reason is the simple fact that Canada and Mexico are much closer.
1
o Tij = A x Yia x Yjb x : Less tangible factors also play a crucial role.
Dcij
- Barriers: In addition to being U.S. neighbors, Canada and Mexico are part of a trade agreement with the United States,
the North American Free Trade Agreement, or NAFTA, which ensures that most goods shipped among the three
countries are not subject to tariffs or other barriers to international trade.
- Borders: It’s important to note, however, that although trade agreements often end all formal barriers to trade
between countries, they rarely make national borders irrelevant. Even when most goods and services shipped across a
national border pay no tariffs and face few legal restrictions, there is much more trade between regions of the same
country than between equivalently situated regions in different countries.
WHAT DO WE TRADE
Not only food, but especially manufactured goods are the largest trade category. Services are also increasingly traded
internationally, especially thanks to digitalisation (e.g. online education, entertainment, customer services). However, some
services remain locally bound (e.g. hairdressing salon, healthcare). Migration is also seen as a form of international trade (labour
as a tradable service).
Complexity of modern trade
- The structure of trade has changed: there is vertical disintegration, with
production chains spread across multiple countries.
- A single final product may contain components from dozens of countries (e.g.
smartphones or cars).
2
,MODULE 2: THE RICARDIAN MODEL
INTRODUCTION
The Ricardian model is based on the assumption of homo economicus:
- Individuals are rational
- Have complete information
- Maximise their utility
- More consumption = better (monotonicity)
Opportunity costs = the value of what you give up to produce something else.
- If Belgium grows flowers in winter, they could have produced chocolate with the same resources. The opportunity cost
of flowers = how much chocolate you miss out on.
- In Belgium:
o 1,000 tulips → costs the same labour as 100 kg of chocolate
→ Opportunity cost = 1,000 tulips = 100 kg of chocolate
- In the Netherlands:
o 1,000 tulips → costs labour of 50 kg of chocolate
→ Opportunity cost = 1,000 tulips = 50 kg of chocolate
- So the Netherlands has lower opportunity costs for tulip production → better in flower production.
Specialisation and efficiency
- When countries specialise in what they can produce relatively better (with lower opportunity costs), total world output
increases.
- Belgium specialises in chocolate, the Netherlands in flowers → everyone is better off.
Comparative Advantage
- A country has a comparative advantage in the production of a good if:
o The opportunity cost of that good is lower than in other countries.
- Even if a country is better in everything (absolute advantage), specialisation still pays off due to differences in relative
efficiency.
- Key point:
o Comparative advantage determines who produces and exports what, not absolute advantage.
THE RICARDIAN MODEL
A ONE-FACTOR ECONOMY
The Ricardian model is the simplest model of international trade. Key assumptions:
- Only one factor of production: labour
- Labour productivity varies between countries → due to technological differences
- Labour productivity within a country is constant
- Labour supply in each country is fixed
- Two goods are produced: wine and cheese
- Two countries: Home and Foreign
3
, UNIT LABOUR REQUIREMENT (ULR)
A unit labour requirement indicates the constant number of hours of labour required to produce one unit of output
Example:
- 𝑎𝐿𝐶 = 1 hour/pound of cheese
- 𝑎𝐿𝑊 = 2 hours/gallon of wine
1 1
- Labour productivity = = → so lower ULR = higher productivity
ULR 𝑎𝐿𝑤
Opportunity cost in terms of other goods
- To make 1 pound of cheese, you use 1 hour of labour.
- In the same time, you could have made 0.5 gallons of wine → opportunity cost cheese = 0.5 gallons of wine
𝑎𝐿𝑐
→ Opportunity cost cheese =
𝑎𝐿𝑤
PRODUCTION POSSIBILITY FRONTIER (PPF)
There are only a limited number of hours in a day and a limited number of people in the economy: labour supply is finite → you
have to choose how much cheese or wine to make.
- Suppose total labour L = 1,000 hours/year
1
o If all labour goes into cheese → = 1,000 pounds of cheese
𝑎𝐿𝑐
1
o If all labour goes to wine → = 500 gallons of wine
𝑎𝐿𝑤
A production possibility frontier shows the maximum amount of wine that can be produced
once the decision has been made to produce a given amount of cheese, and vice versa.
- Labour constraint: aLcQc + aLwQw = L
L aLc
- Qw = - Qc
aLw aLw
aLc aLc
- Thus, slope = - → opportunity cost of cheese = | − |
aLw aLw
RELATIVE PRICES
Set prices:
- PC = $4/pound cheese
- PW = $7/gallon of wine
PC
→ Relative price of cheese: = barter price of cheese
PW
Profit for labour = price / ULR
- Profit (wage) in cheese sector = $4/1 = $4/hour
- Profit in wine sector = $7/2 = $3.5/hour
→ Workers choose sector with highest wage → specialisation follows.
4
