International Economics: Theory and

Policy
Eleventh Edition

Chapter 6
The Standard
Trade Model

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Introduction (1 of 2)
• Standard trade model is a general model that includes
Ricardian, specific factors, and Heckscher-Ohlin models as
special cases.

• What are the basics of trade in

- Ricardian model?
- Specific Factors and Heckscher-Ohlin models?

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Introduction (2 of 2)
• Differences in labor services, labor skills, physical
capital, land, and technology between countries cause
differences in production possibility frontiers.
• Each country’s PPF is a smooth curve.
• A country’s PPF determines its relative supply function.
• National relative supply functions determine a world
relative supply function, which along with world relative
demand determines the equilibrium under international
trade.

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Production Possibilities and Relative
Supply (1 of 2)
• What a country produces depends on the relative prices

• An economy chooses its production level to maximize the

value of its output V  PCQC  PF QF ,

 PC 
– The slope of an isovalue line equals   .
 PF 
– Produce at point where PPF is tangent to isovalue line.

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Production Possibilities and Relative
Supply (2 of 2)
How an Increase in the Relative Prices Affects
Relative Supply?

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Relative Prices and Demand (1 of 6)
• The value of the economy’s consumption must equal the
value of the economy’s production.
PC DC  PF DF  PCQC  PF QF  V

• Assume that the economy’s consumption decisions may

be represented as if they were based on the tastes of a
single representative consumer.
• An indifference curve represents combinations of two
goods that leave the consumer equally well off (indifferent).

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Relative Prices and Demand (2 of 6)
• Indifference curves
– are downward sloping — if you have less cloth, then
you must have more food to be equally satisfied.
– become flatter when they move to the right — with
more cloth and less food, an extra yard of cloth
becomes less valuable in terms of how many calories
of food you are willing to give up for it.

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Relative Prices and Demand (3 of 6)
• Consumption choice is based on preferences and relative
price of goods:
– Consume where the isovalue line is tangent to the
indifference curve.
• Economy exports cloth — the quantity of cloth produced
exceeds the quantity of cloth consumed — and imports
food.

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Production, Consumption, and Trade in
the Standard Model

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Relative Prices and Demand (4 of 6)
• Relative prices and relative demand
PC
– An increase in the relative price of cloth causes
PF
consumption choice to shift upward

DC
– Demand for cloth relative to food falls.
DF
as the relative price of cloth to food rises.

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Relative Prices and Demand (5 of 6)
• An economy that exports cloth is better off when the price
of cloth rises relative to the price of food:
– the isovalue line becomes steeper and a higher
indifference curve can be reached.
• A higher relative price of the exporting good means that
more units of the other good can be imported for every unit
of export.

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Effects of a Rise in the Relative Price and
Gains from Trade

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Relative Prices and Demand (6 of 6)

• If the economy cannot trade:

– The relative price is determined by the intersection of

relative demand and relative supply for that country.

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Unequal Gains from Trade across the
Income Distribution (1 of 2)
• Gains from trade due to imports becoming cheaper relative
to exports are unevenly distributed across consumers due
to differing consumption patterns.
• The distribution of income is one of the major sources of
divergence in consumption patterns.
• Consumers with lower income spend relatively more of
their income on food and some manufactured goods (such
as apparel), whereas consumers with higher income spend
relatively more on services.

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Unequal Gains from Trade across the
Income Distribution (2 of 2)
• Because food and manufactured goods are traded much
more heavily than services, poorer consumers benefit
much more from lower import prices than richer
consumers.
• Estimated gains from trade are 35% higher for a consumer
at the 10th percentile of a country’s income distribution
relative to the 90th Percentile (average across 40
countries).

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The Welfare Effects of Changes in the
Terms of Trade

• The terms of trade refers to the price of exports relative

to the price of imports.
• Do you think an increase in the terms of trade increases a
country’s welfare or decreases it???
• Why???

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A Real World Example

• Developing countries experienced increases in their terms

of trade during the 2000s commodity price boom.
• Fuel
• Precious Metals
• Industrial Metals
• Chemicals

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A Real World Example
• Increased growth of the BRIC Countries increased demand for
electrical goods which affected the price of some metals such as
copper
• Mining countries like the Democratic Republic of the Congo
Global Copper Prices

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A Real World Example
• The 2006 flooding of the Cigar Lake Mine in Saskatchewan

• Interest in nuclear power by the UK government between 2006 and 2008

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A Real World Example

• How about the price of manufactured goods?

• In the past two decades, a rise in globalization has

reduced the price of manufactured goods.
• Industrialized countries' advantage over developing
countries is becoming less significant.

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Determining Relative Prices
• To determine the relative prices, use:

– World relative supply

– World relative demand

– World quantities are the sum of quantities from the two

countries in the world:
QC  QC   and

DC  DC  .
Q F  QF 
 DF  DF  
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Equilibrium Relative Price with Trade
and Associated Trade Flows

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Equilibrium Relative Price with Trade
and Associated Trade Flows

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