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International trade and investment lecture 1
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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 1
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International movements of factors of production:international labour mobility, international lending and Foreign Direct Investment.
The gravity model:
The flow of trade (T) from country i to country j includes three explanatory variables.
Model of Ricardo:
One factor of production → labour.
Differences in labour productivity lead to comparative advantages, specialisation of countries
and international trade. International trade increases welfare not only of the world as a
whole, but also of all countries individually.
Comparative advantages are the drivers of trade rather than the absolute advantages that
were at the centre of the trade theory of Adam Smith.
Adam Smith: exchanging goods on the world market in which the domestic country is more
productive for goods in which the foreign country is more productive.
Assumptions:
- 2 countries: Home (H) and Foreign (F)
- 2 products: cheese (C) and wine (W)
- 1 factor of production: labour (L), which is mobile within countries but not between
countries (international labour immobility)
- Perfect competition in the output and factor markets
The production possibility frontier = specifies the maximum amount of each of the two
products that can be produced with the available labour supply (L) in the country in question.
It illustrates the trade-off between producing the two goods. Derived from the following
equation:
The wage is →
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