Unit 4: Other Theories of International National Income - the total money of

Trade income accruing to a country from

economic activities in a year’s time. It
Introduction includes payments made to all resources in
the form of wages, interest, rent and profit.
The US-China Role in Business and
Trade and how it affects India. Gross National Income is the total value
●​ US-China role in International of goods and services produced within a
Business and Trade country plus income from abroad (minus
●​ In 2018, China surpassed the US as subsidies).​
the top trading partner in the world
as the number had seen a steep GNI = goods/services produced +
decline to mere 30%. foreign income.

Effects of US-China trade war to India Effects of Rising Real Income

Benefits:
1.​ Trade diversion and increased More real income → more demand; less
exports income → less demand.
2.​ Strengthening India's “Make India “ -​ When real income rises, demand for
initiative goods increases, leading to higher
3.​ Enhanced trade relations with other sales and profits. When it falls,
nations. demand and profits decline.
4.​ Competitive edge in global market.
According to Roland Jones and Paul
Challenges: Samuelson
1.​ Volatility in global markets.
2.​ Uncertainty in the WTO and global ●​ More capital → more production of
trade rules. manufactured goods.
3.​ Dependence on Chinese raw ●​ More land → more food production.
materials.
4.​ Pressure from the US on-trade These are at least two reasons why
policies. trade has an important influence upon
the income distribution:
Lesson 4.1 The Specific Factor Model 1.​ Resources cannot be transferred
Trade raises the real incomes of trading immediately and without cost from
countries. one industry to another
2.​ Industries use different factors and a
Real income is simply inflation- adjusted change in the production mix a
income. It measures the amount of country offers will reduce the
disposable income available to consumers. demand for some of the production
Real income represents purchasing power. factors whereas for others, it will
 increase the demand for such is used only for food and capital is used only
production factors. for manufactured products.

The law of diminishing marginal returns is a

Factor Of Production- is any resources theory in economics that predicts that after
that is used by firms to produce goods and some optimal level of capacity is reached,
services adding an additional factor of production
Goods are produced using a mix of the will actually result in smaller increases in
factors of production- land, labor and output
capital.

Heckscher-Ohlin Theory
Countries export goods that use their
abundant production factors and import LESSON 4.2: STANDARD MODEL OF
goods they lack factors for. TRADE

Specific factor Model Developed by: Paul Krugman &

The Specific factor Model was originally Maurice Obstfeld.
advanced by Jacob Viner, and it is a variant
Purpose: To provide a more general
of the Ricardian model. The Ricardian model
and realistic explanation of
of trade was developed by English political
international trade by integrating the
economist Davide Ricardo in his magnum
core ideas of specialization and
opus On the Principle of Political Economic
factor endowments.
and Taxation (1817). It is the first formal
model of international trade A general framework for analyzing
international trade.
The modern version of the Ricardian model
assumes that owners (countries) of factors Focuses on how differences in
of production for products that are in preferences (demand) and
demand would receive an increasing part of production possibilities (supply)
the world’s global income. drive trade.

The SF model is sometimes referred to as Determines:

The Ricardi- viner model
●​ Equilibrium Relative
Jones and Samuelson say that products like Prices
food (X) are made by using territory (T) and ●​ Terms of Trade
labor (L), while manufactured products (Y) ●​ National Welfare
use capital (K) and labor (L). Labor (L) is a
The Standard Model synthesizes
mobile factor, one that can be used in both
key ideas from earlier theories:
food and manufactured products. Territory
and capital are specific factors, territory (T)
 Ricardian Model: Key Point: The optimal production point is
Specialization based on where the isovalue line is tangent to the
comparative advantage. PPF. This is the point where the country
maximizes the value of its output(best
Heckscher-Ohlin (H-O) production point)
Model: Trade based on
differences in factor
endowments (capital, labor,
etc.).

It goes beyond these by adding

global supply and demand, which
makes it more flexible and applicable
to real-world scenarios.

Production Possibility Frontier (PPF)

PPF: Shows trade-offs between

producing (Food and Cloth) a country can
produce with its available resources.

Isovalue Lines: These lines represent Relative Supply: The total quantity
combinations of goods that have the of one good (e.g., Cloth) supplied by
same/constant total market value. all countries relative to the total
quantity of another good (e.g.,
Shape: Smooth curve (not straight) Food), at any given price ratio.
→ reflects opportunity cost.
The Curve: The RS curve is
The formula for a given value V is: upward-sloping.

V = (PC × QC) + (PF × ○​ Higher PC/PF → more

QF)· cloth, less food produced.
V= value of output
As the relative price of Cloth (PC/PF)
PC= price of cloth
increases, producers will shift their
resources from producing Food to
QC= quantity of cloth producing Cloth to earn higher

PF= price of food

QF= quantity of food

profits.

Market Equilibrium

●​ Equilibrium = AD ∩ AS​

Equilibrium: The point where the

global Relative Supply (RS) and
Relative Demand (RD) curves
intersect.

Determines:​

Relative Demand: The total ○​ Output (GDP)​

quantity of one good (e.g., Cloth)
demanded by all consumers relative ○​ Price level
to the total quantity of another good
(e.g., Food), at any given price ratio. Significance: This intersection
determines the world equilibrium
The Curve: The RD curve is relative price (PC/PF). This is the
downward-sloping. price at which the global market for
both goods is in balance.
○​ Higher PC/PF →
consumers shift from ●​ In real life → equilibrium constantly
cloth to food. shifts.

As the relative price of Cloth (PC/PF)

increases, consumers will substitute
away from the now-more-expensive
Cloth and demand relatively more of
the cheaper Food.

●​

Terms of Trade (TOT)

●​ Formula: TOT = PE/PI

 PE= Price of Exports welfare.)​

PI= Price of Imports.​

Key Relationships in the Model

●​ Example: This flowchart shows how a country's ability

to produce goods, combined with global
Country A exports shoes (PS) and market forces, ultimately leads to a better
imports garments (PG). Its Terms of Trade standard of living through trade.
is TOTA=Price of shoes/Price of Garments.
If the price of shoes rises while the price of
garments stays the same, Country A's TOT
improves, meaning it can now buy more
garments for the same number of shoes.

Welfare and the Terms of Trade

The Impact on a Country's Welfare

An improvement in a country's TOT

allows it to purchase more imports
for the same amount of exports.

Crucial Relationship: An increase in 1. Production Possibility

TOT directly leads to a rise in a Frontier (PPF): This is the starting
country's welfare. point. It represents a country's
maximum production of two goods,
○​ TOT ↑ → More imports given its resources and technology.
from the same exports →
Welfare ↑ (TOT increases: 2. Relative Supply & Relative
The country's exports can Demand: The PPF determines the
buy more imports. This is an country's relative supply. This
improvement in its terms of curve, along with the relative
trade and increases national demand curve, determines the
welfare.)​ global equilibrium price for the two
goods.
○​ TOT ↓ → Exports buy
fewer imports → Welfare 3. Terms of Trade: This is the ratio
↓ (TOT decreases: The of a country's export prices to its
country's exports can buy import prices. The global equilibrium
fewer imports. This is a price from the previous step
deterioration in its terms of determines this ratio for a trading
trade and decreases national country.
 4. Consumption Possibilities: theory, but consistent with the Leontief
The terms of trade allow a country Paradox.
to trade its goods at a different ratio
than its production abilities. This Other Country Studies
expands its consumption
possibilities beyond its PPF. ●​ East Germany (1961): Consistent
with H-O​
5. Welfare: The expanded
consumption possibilities directly ●​ Canada (1961): Inconsistent with
lead to a higher level of economic H-O → supported paradox​
welfare for the country.
●​ India (1962): Exports consistent
with H-O, but trade with U.S. fit
paradox​

●​ Korea (1966–72): Consistent with

LESSON 4.3 LEONTIF PARADOX H-O

The Leontief Paradox

In 1953, Wassily Leontief studied U.S.

trade and found unexpected results.
Although the U.S. was the most
capital-abundant country, it exported
labor-intensive goods and imported
capital-intensive goods. This contradiction
became known as the Leontief Paradox.

●​ Swerling (1953): 1947 not a

typical year​

●​ Leontief (1956): Imports still more

capital-intensive​

●​ Baldwin (1971): 1962 data

confirmed the paradox

Japan’s Trade (1959)

Japan was labor-abundant but exported

capital-intensive goods and imported
labor-intensive goods. Inconsistent with H-O