Ebook Integrated Equilibrium in a Four good Heckscher Ohlin Ricardo model
The integrated equilibrium has been widely used as an analytical tool in international trade theory since its popularisation by Dixit and Norman (1980), although the idea can be traced back to at least Samuelson (1949). It starts from an integrated world economy with free movement of goods and factors of production, then divides the world economy into countries, restricting the movement of factors of production, and asking whether free trade in goods alone can replicate the resource allocation and goods and factor prices that characterise the integrated equilibrium. Importantly, in a competitive model with perfect markets, the integrated equilibrium set of prices and quantities represents the most efficient allocation of resources in the world economy, in the sense that total world income is maximised. Whilst the original formulation of the integrated equilibrium was based on a perfectly competitive, comparative advantage framework, Helpman and Krugman (1985) show that it can also be used in models of international trade based on increasing returns and product differentiation, which has been used in explaining patterns of intra industry trade (that is, trade in similar goods).
However, increasing returns to scale and product differentiation are not the only ways of modelling intra%industry trade. In an important paper, Davis (1995) showed that intra-industry trade can be the outcome of a model based on constant returns to scale and comparative advantage. The basic idea of the Davis Heckscher Ohlin Ricardo (HOR) model is that, when there are three goods, two of which are intra industry in the sense of sharing identical production techniques, and one of the trading partners has an absolute (technological) advantage in producing one of these intra industry goods, then if this country has sufficient factor endowments, it will produce the entire worlds output of that good. However, the remaining resources may result in the other country producing most of the worlds output of the other intra industry good. There will then be two-way trade in this intra industry good.
Davis (1995) showed that the integrated equilibrium can be replicated when the country that has a technological advantage in producing one of the intra industry goods, is able to produce the entire integrated equilibrium supply of that good. However, what Davis (1995) did not show, is that the integrated equilibrium depends on consumer demand. We develop a simple, four good version of the HOR model, and show that the demand for the technologically differentiated good relative to the demand for the technologically undifferentiated good within the same intra industry pair, is what determines the dimensions of the integrated equilibrium. This has implications for whether or not the division of factors of production across countries maximises world income. As an immediate corollary, our model shows how the Heckscher Ohlin and the Ricardian models can be obtained as special cases of the more general HOR model, depending on the relative demands for the technologically differentiated versus the technologically undifferentiated goods.
We then use our four good setup to explore trade patterns within the integrated equilibrium. Trade patterns in our four good model are determinate, but different from those in Davisls (1995) three good model, and this difference is driven by the introduction of the fourth good, which is technologically differentiated across countries. In particular, under certain conditions, greater similarity in relative endowments across countries may lead to increasing trade volumes, as this may lead to greater differentiation in industrial structure across countries because of specialisation in production resulting from Ricardian technological differences.
Our results highlight the crucial role of demand in international trade. Often, demand is pushed into the background, with models focussing more on the endowments/technology/market structure side of the story. However, several models have given demand a key role, for example the early work of Linder (1961), Markusen (1986), Flam and Helpman (1987) on international trade between similar and dissimilar countries. More recently, the work of Chung (2003) and Mitra and Trindade (2005) have used demand conditions to provide an explanation for Treflerls (1995) celebrated Vcase of the missing tradeV, and to argue for the role of within country inequality in determining the pattern of trade, respectively. More closely related to the present paper is Balboni (2005), who independently develops a demand side to the HOR model, but his paper is focussed on developing an explanation for vertical intra industry trade in a three good model, whereas our objective is to develop a four good model to explain integrated equilibrium and the pattern of trade.
Download
PDF Ebook Integrated Equilibrium in a Four good Heckscher Ohlin Ricardo model
Posted in :
