International Trade in the Specific Factors Model

International Trade in the Specific Factors Model
We just saw how changes in relative prices have strong repercussions for the distribution
of income, creating both winners and losers. We now want to link this relative price
change with international trade, and match up the predictions for winners and losers with
the trade orientation of a sector.
For trade to take place, a country must face a world relative price that is different from
the relative price that would prevail in the absence of trade. Figure 4-9 shows how this relative
price was determined for our specific factors economy. In Figure 4-10, we also add a
relative supply curve for the world.
Why might the relative supply curve for the world be different from that for our specific
factors economy? The other countries in the world could have different technologies, as in
the Ricardian model. Now that our model has more than one factor of production, however,
the other countries could also differ in their resources: the total amounts of land, capital,
and labor available. What is important here is that the economy faces a different relative
price when it is open to international trade.
Relative price
of cloth, PC / PF
Relative quantity
of cloth, QC / QF
(PC /PF)1
(PC /PF)2 2
1
RS
RSWORLD
RDWORLD
Figure 4-10
Trade and Relative Prices
The figure shows the relative supply
curve for the specific factors
economy along with the world
relative supply curve. The differences
between the two relative
supply curves can be due to either
technology or resource differences
across countries. There are no differences
in relative demand across
countries. Opening up to trade
induces an increase in the relative
price from (PC/PF)1 to (PC/PF)2.
CHAPTER 4 Specific Factors and Income Distribution 63
The change in relative price is shown in Figure 4-10. When the economy is open to
trade, the relative price of cloth is determined by the relative supply and demand for the
world; this corresponds to the relative price . If the economy could not trade, then
the relative price would be lower, at .3 The increase in the relative price from
to induces the economy to produce relatively more cloth. (This is also
shown as the move from point 1 to point 2 along the economy’s production possibility
frontier in Figure 4-8.) At the same time, consumers respond to the higher relative price of
cloth by demanding relatively more food. At the higher relative price , the economy
thus exports cloth and imports food.
If opening up to trade had been associated with a decrease in the relative price of cloth,
then the changes in relative supply and demand would be reversed, and the economy would
become a food exporter and a cloth importer. We can summarize both cases with the intuitive
prediction that—when opening up to trade—an economy exports the good whose relative
price has increased and imports the good whose relative price has decreased.