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International trade and investment lecture 6
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International trade and investment lecture Krugman, P.R., Obstfeld, M. and Melitz, M.J. (2018), International Trade. Theory and Policy, 11th edition Week 3
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Standard trade model:The effect on world RD and thus on the terms of trade depends on the consumption patterns
in Home and Foreign.
The central vehicle is the Marginal Propensity to Spend (MPS), i.e. on the way consumption
is allocated across the two goods.
A) The consumption patterns in Home and Foreign are identical.
B) The consumption pattern in Home differs from the consumption pattern in Foreign.
⇒ imply that Home and Foreign on the margin spend different amounts on
each of two goods / MPS for each of the two goods differ across countries.
→ The transfer will then lead to a shift in (world) RD and thus will have an
effect on the terms of trade of Home and Foreign.
The two welfare effects of a transfer (zie figuur):
1. Consumption possibilities due to the transfer in the donor country decrease. Thus:
welfare of the donor country decreases. And vice versa.
2. The terms of trade of the donor worsens if the donor has a higher MPS for its export
good than the receiving country. Welfare of the donor will then also be negatively
affected through the worsening of its terms of trade and welfare of the receiving
country will be positively affected even further by the improvement in its terms of
trade.
- The terms of trade of the donor improve if the donor has a lower MPS for its export
good than the receiving country.
The sum of these two welfare effects generally will be positive for the receiving country.
However, the total effect for the receiving country may be negative if the welfare decrease
due to the worsening terms of trade is larger than the welfare increase due to the increased
consumption possibilities = paradox of immiserising transfers (not really relevant).
Import tariff = tax to support the domestic import-competing sector by making foreign
products more expensive (the country is importing).
→ The price of imported food increases due to the imposition of the import tariff.
However, also the price by domestic producers of food will increase.
→ The internal relative price of food in Home increases and the internal relative
price of cloth in Home thus decreases. Consequences: Production of food in
Home increases and production of cloth in Home decreases. Consumption of food
in Home decreases and consumption of cloth in Home increases.
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