This document provides an overview of international trade models and how they can be applied to analyze economic growth and international borrowing/lending. It discusses how balanced and biased economic growth can impact trade patterns and welfare. Biased growth that shifts production more towards a country's export good can lower its terms of trade and immiserize it. The standard trade model is modified to analyze intertemporal trade, where countries can borrow goods today in exchange for goods tomorrow. This allows specialization across time without sacrificing current consumption.

1. Learning Unit 10
Applications of Standard Trade Model
ECON452
International Economics

2. Objectives
1. Explain how changes in the terms of trade and economic growth
affect the welfare of nations engaged in international trade
2. Determine an equilibrium pattern of trade in general equilibrium
models
3. Explain an effect of terms of trade on a nation’s welfare
4. Apply the standard trade model to illustrate international
borrowing and lending, where goods are exchanged over time.

3. Offer Curve
• Offer curves (reciprocal demand curve): shows the willingness of the
nation to import and export at various relative commodity prices.
• Offer curves incorporate elements of both demand (preferences
represented by indifference curves) and supply (production
possibilities frontier).
• Offer curve diagram is used to determine an equilibrium trade in both
goods at the same time – General eqquilibrium.

4. Offer Curve Diagram – Set Up
• On the offer curve diagram, an amount of
export and import of each good is
measured along each axis – export and
import are a difference between
production and consumption.
• Home and Foreign trade cloth and food.
– Amount of export and import of cloth along
the horizontal axis.
– Amount of export and import of food along the
vertical axis.

5. Production, Consumption, and Trade
• For a given relative price (PC/PF),
Home chooses its production (Q)
and consumption (D). Then,
– Home’s export of cloth (Tc) = QC – QD
– Home’s import of food (TF) = DF – QF
• This corresponds to (T) on the
Offer curve diagram.
– Slope of OT line is equal to the
relative price of cloth:
TF/TC = (DF – QF)/( QC – QD) = PC/PF
Tc
Tc
TF
TF

6. Deriving Offer Curve
• As the relative price changes,
Home’s export and import change.
The offer curve traces points.
– At (PC/PF)1, Home trade between
production point Q1 and consumption
point D1. Home’s trade is TC
1 of cloth
export and TF
1 of food import,
corresponding Point T1 on Offer curve.
– At (PC/PF)2, Home trade between
production point Q2 and consumption
point D2. Home’s trade is TC
2 of cloth
export and TF
2 of food import,
corresponding Point T2 on Offer curve.
TC
2
TF
2
TF
2
TC
2
TF
1
TF
1
TC
1
TC
1

7. Deriving Offer Curve - Foreign
• Foreign exports Food and
imports Cloth.
– The horizontal axis measures
an amount of cloth Foreign
imports.
– The vertical axis measures an
amount of food Foreign
exports.
• The offer curve of Foreign
can be derived in the same
way.
T

8. Deriving Offer Curve (cont.)
• A country’s offer curve bulges
toward the axis measuring its
exporting goods.
– Home’s offer curve (C) bulges toward
the horizontal axis measuring export
and import of cloth.
– Foreign’s coffer curve (F) bulges toward
the vertical axis measuring export and
import of food.
Home’s
Offer
curve
Foreign’s
Offer
curve

9. Equilibrium on Offer Curve Diagram
• The international equilibrium is one that
both countries face the same relative price
and one’s export is equal to another’s
import.
QC - DC = DC* - QC* & QF* - DF* = DF – QF
• It is an intersection of two offer curves.
– At E, Home’s export of cloth is equal to Foreign’s
import of cloth (OX).
– Home’s import of food is equal to Foreign’s
export of food (OY).
– The relative price is a slope of line OE or OY/OX.

10. Equilibrium on Offer Curve Diagram
• A crossing points of two offer curves is an equilibrium.
– At any other relative price, the desired quantities of exports and imports of
the two nations would not be equal.
– Then, they would pressure on the relative price to move toward its
equilibrium.
– When a relative price of cloth is higher than the equilibrium relative price,
Home wants to export more cloth, but Foreign wants to import less cloth. A
surplus of cloth in the world market pushes a relative price of cloth down
toward the equilibrium relative price.

11. Economic Growth
• Economic growth occurs when
– nations’ resources increase
– its technology advances.
• When the economic growth occurs
– the nation is able to produce more goods.
– the production possibility frontier expands outward.

12. Types of Economic Growth
• Economic growth may be balanced or biased.
• Balanced growth: the nation’s PPF shifts out evenly in all direction.
– All factors increase at the same rate.
– Technological progress affects productivity of all industries equally.
• Biased growth: the nation’s PPF shifts out in one sector more than
others.

13. Reasons for Biased Economic Growth
• Growth is usually biased.
– Factors increase differently. (e.g. capital increases faster than labor)
– Technological progress occurs differently across industries and affects
productivity of industries differently. (e.g. productivity increased more in
manufacturing industries than service industries)
– Rapid growth has occurred in U.S. computer industries but relatively little
growth has occurred in U.S. textile industries.

14. Balanced Growth
• Economic growth: An expansion of
country’s production possibilities
frontier from PPF to PPF*
• Given the same relative price (PB), a
country will produce two goods in the
same ratio before and after growth.
– At B, QC/QF = 130/20 = 6.5
– At B*, QC/QF = 260/40 = 6.5
• The slope of the old and new PPFs will
be the same at any point where they are
cut by a ray from the origin.
– PB = PB*
PPF
PPF*
B*

15. Biased Growth
• Given the same relative price (PB), a
country will produce different ratio of
two goods before and after growth.
– At B, QC/QF = 130/20 = 6.5
– At C, QC/QF = 270/10 = 27
• Along the ray the slope of PPF
changes.
– PB > PB*
B*
PB*
PPF*
PPF

16. Two Types of Biased Growth
• Growth is biased when it shifts
production possibilities out more
toward one good than toward
another.
(a) Growth is biased toward cloth
(b) Growth is biased toward food
• When only the labor resource
increases, the output of both goods
increases, but the output of labor-
intensive goods increases more than
the output of capital-intensive goods.

17. Economic Growth and Relative Supply
• Balanced growth will not change relative supply
because two products will be produced at same
proportion at the same relative price before and
after an economic growth.
• Biased growth causes relative supply to change.
– When the economic growth is biased toward cloth
industry, the relative supply curve of cloth will shift
rightward because at the same relative price of cloth it
will increase its production of cloth and decrease its
production of food (QC/QF ↑).

18. Economic Growth and Terms of Trade
• Biased growth and the resulting change
in relative supply causes a change in the
terms of trade.
– Biased growth in the cloth industry (in either
the home or foreign country) will lower the
price of cloth relative to the price of food and
lower the terms of trade for cloth exporters.
– Biased growth in the food industry (in either
the home or foreign country) will raise the
price of cloth relative to the price of food and
raise the terms of trade for cloth exporters.

19. Welfare Effect of Economic Growth
• Since Home is a cloth-exporter and Foreign is a food-exporter, a cloth-biased
growth lowers the terms of trade of Home and raises the terms of trade of
Foreign, and makes Home worse-off and Foreign better-off.
• This can happen when either Home or Foreign has a cloth-biased growth.
• If labor-abundant country like Home experiences population growth and resulting
an increase in labor resource, its terms of trade worsens by producing more labor
intensive goods and depressing its relative price in the world market.
• Since the relative price of cloth (labor-intensive good) decreases, the real income
on labor also decreases.

20. Export-Biased and Import Biased Growth
• Export-biased growth: growth that expands a country’s production
possibilities dis-proportionately in that country’s export sector.
– Biased growth in the cloth industry in Home is export-biased growth for
Home.
• Import-biased growth: growth that expands a country’s production
possibilities dis-proportionately in that country’s import sector.
– Biased growth in food production in Home is import-biased growth for Home.

21. Economic Effects of Biased Growth
• Export-biased growth expands a country’s production possibilities dis-
proportionately in that country’s export sector.
– Decreases the price of exporting goods
– Reduces a country’s terms of trade
– Reduce its welfare and Increase the welfare of foreign countries.
• Import-biased growth expands a country’s production possibilities dis-
proportionately in that country’s import sector.
– Decreases the price of importing goods
– Increases a country’s terms of trade
– Increase its welfare and Decrease the welfare of foreign countries.

22. Immiserizing Growth
• Immiserizing growth: Export-biased growth by poor nations would
worsen their terms of trade so much that they would be worse off
than if they had not grown at all.
– It does not mean that the country is producing and exporting at the price less
that its opportunity cost. It is still exporting at its opportunity cost – its
production is still on its PPF and tangent to the relative price line.
– Instead, its export generates less revenue due to substantial fall in price, so
that it can import less goods from other countries than before.

23. Causes for Immiserizing Growth
• Immiserizing growth is more likely to occur when
– growth tends to increase substantially the nation’s exports at constant terms of
trade
– the nation is so large that the attempt to exports substantially will cause a
deterioration in its terms of trade
– the income elasticity of the other nation’s demand for the nation’s export is very low
– the nation is so heavily dependent on trade
• Immiserizing growth is more likely to occur in developing countries than in
developed countries.
– Developing countries tend to depend on exports of natural resources. When their
productivity of production of the resources increases, they may flood the resources
in the world market and its price may plunge.

24. Immiserizing Growth - Diagram
• Before an economic growth (PPF)
– Home faces PC/PF of relative price of cloth
– Export cloth and import food
– Consumes at C
• Home grows only toward production of cloth
from PPF to PPF* (Export-biased growth).
• After an economic growth (PPF*)
– Home’s cloth production increases greatly
– Relative price of cloth falls to PC/PF* (Flatter
isovalue line)
– Consume at C*
– Home is worse-off because C* is below C
• It is still better to trade than autarky.
PPF PPF*
PC/PF
PC/PF
PC/PF
*

25. Implication of Biased Growth of the Rest of
the World to the U.S. Economy
• Export-biased growth in the rest of the world is good for the U.S.
– Those goods that the U.S. imports will become relatively cheap as the rest of the world
produce greater quantity.
• Import-biased growth in the rest of the world is bad for the U.S.
– If the rest of the world increases the production of goods that the U.S. produces and exports,
their pieces become relatively cheap and the U.S. needs to produce and export more to pay
for imports.

26. Economic Growth of China and Effects on
the U.S. Economy
• The data indicates that changes in
the U.S. terms of trade have been
small with no clear trend over the
last few decades.
• The terms of trade for China have
deteriorated over the past decade,
suggesting their recent growth may
have been export-biased.
• However, Chinese technological
progress may make the U.S. worse
off by eliminating trade between
two countries.

27. Investment and Economic Growth
• Economics growth occurs when a country invests on capital today.
• An economy can consume or invest today – produce consumption goods or
capital goods by allocating fixed resource.
– Consumption goods: Goods consumed now and give satisfaction to
consumers.
– Capital goods: Goods used to produce other goods and do not give any
satisfaction to consumers.
– Any investment today leads to greater production of consumption goods in
future.
• Trade-off between current consumption and future consumption.
– Economic growth is not free.
– Current consumption is an opportunity cost of greater future consumption.

28. International Borrowing and Lending
• Open economy has the third choice – without scarifying current consumption, it
can still invest on capital today through borrowing goods (resources) from other
country.
– By borrowing now, the country promises to pay back in future by its output.
• Intertemporal trade: a country exchanges goods today in return for some goods
in the future.
– Borrowing and lending can be considered as trading goods in different time.
– Borrowing and lending are flows of IOUs. There must be flows of goods in
opposite direction – Borrowers are importers of current goods.

29. Intertemporal Production Possibility Frontier
Model
• The standard trade model can be modified to
analyze international borrowing and lending.
– Two goods are current and future
consumption (same good at different
times), rather than different goods at the
same time.
• A special kind of production possibility frontier,
an intertemporal production possibility
frontier, depicts different possible
combinations of current output and future
output.
Current Goods
Future Goods

30. Shapes of Intertemporal Production
Possibility Frontier
• Countries usually have different opportunities to
invest to become able to produce more in the
future.
• If a country has better opportunities to invest now
to generate more output in the future, its
production possibilities will be biased towards
future output.
– Home can produce more now, but does not
have many investment opportunity for future
production.
– Foreign cannot produce much now, but has
many opportunities for future production. Current Goods
Future Goods
Home’s IPPF
Foreign’s IPPF

31. Shapes of Intertemporal Production
Possibility Frontier
• A country will choose the optimal
combination of production and consumption
today and future.
– At A, a country chooses to produce and
consume QC now and QF in future.
• The slope of PPF indicates an opportunity cost
of current consumption measured by forgone
future consumption.
– Slope = ΔQF / ΔQC
Future Goods
A
Current GoodsQC
QF

32. Optimal Intertemporal Production and Consumption
Choice without International Lending and Borrowing
• Without international borrowing and lending, a country
chooses a point for current and future productions, which
are current and future consumptions as well.
• Given its preference between current and future
consumption depicted in intertemporal indifference
curves, a country chooses a point tangent to the highest
indifference curve.
– At A, a country chooses to produce and consume QC now
and QF in future.
• Even if a country has many investment opportunities, it
may not undertake all opportunities since it has to
consume some today.
– No complete specialization toward Future Goods. More
future goods production, higher the opportunity cost of such
investment.
Future Goods
A
Current GoodsQC
QF

33. Optimal Intertemporal Production and Consumption
Choice with International Lending and Borrowing
• However, with international borrowing and lending, current consumption is not
necessary be equal to current production.
• If a country can borrow or lend at real interest rate of r, the quantity of
repayment in the future will be (1+r) times the quantity borrowed today.
• This means that 1 unit of future consumption is worth 1/(1+r) unit of current
consumption.
• The total value of production over the two periods in today’s value is
V = QC + QF/(1+r)

34. Intertemporal Isovalue Line
• Along the intertemporal iso-value line, total
value of production over the two periods is
same.
• Points along the intertemporal isovalue line
is possible through international borrowing
and lending
• Slope of intertemporal isovalue line = -(1+r).
• A country chooses a point where an
opportunity cost of current consumption is
equal to its value – a tangent point along the
PPF.
Future
Goods
Current
Goods

35. Intertemporal PPF, Intertemporal Indifference Curves, and
Optimal Intertemporal Production and Consumption
• Home and Foreign are different in the
intertemporal production possibilities and their
preference between current and future
consumption.
• Home has production possibilities biased
towards current output, while Foreign has
production possibilities biased towards future
output.
• Home prefers future consumption more than
current, while Foreign prefers current
consumption more than future.
Current Goods
Future Goods
Home’s IPPF
Foreign’s IPPF
Home’s IIC
Foreign’s IIC
AF
AH
QC
F
QF
F
QC
H
QF
H

36. Optimal Intertemporal Consumption Pattern
and Real Interest Rates
• Without international borrowing and lending,
Home chooses a point at low real interest rate.
– Intertemporal isovalue line is flatter.
– An opportunity cost of current consumption is low.
• Foreign chooses a point at high real interest rate.
– Intertemporal isovalue line is steeper.
– An opportunity cost of current consumption is high.
• Home has a comparative advantage in current
production, while Foreign has a comparative
advantage in future production.
– Foreign can borrow from Home at lower interest rate,
while Home can lend to Foreign at higher interest rate.
Current Goods
Future Goods
Home’s IPPF
Foreign’s IPPF
Home’s IIC
Foreign’s IIC
AF
AH

37. Optimal Intertemporal Production with
International Lending and Borrowing
• At lower interest rate, Foreign
chooses Point Q* for
production, less current
production and more future
production than Point A*.
• At higher interest rate, Home
chooses Point Q for production,
more current production and
less future production than
Point A.
• Consumption choices with
international lending and
borrowing reflect each
country’s preferences.
Home Foreign
Current
Goods
Current
Goods
Future
Goods
Future Goods

38. Optimal Intertemporal Consumption with
International Lending and Borrowing
• By borrowing from Home, Foreign
chooses Point D* for consumption,
more current consumption and less
future consumption than Point A*.
• By lending to Foreign, Home
chooses Point D for consumption,
less current consumption and more
future consumption than Point A.
• Consumption choices with
international lending and borrowing
reflect each country’s preferences.
• Both countries gain from
international lending and borrowing
since both countries reach higher
intertemporal indifference curve
with international lending and
borrowing.
Home Foreign
Current
Goods
Current
Goods
Future
Goods
Future Goods

39. International Lending and Borrowing as
Intertemporal Trade
Intertemporal Trade:
• When Foreign borrows from Home,
Foreign uses the borrowed funds to
purchase current goods from Home.
– Foreign imports DC*-QC* of current
goods from Home.
– Home produces more today and
exports excess to Foreign today.
• When Home receives payment back
from Foreign in future, Home will use
the fund to purchase future goods
from Foreign.
– Home will import DF-QF of future goods
from Foreign.
– Foreign produces more in future and
will export excess to Home in future.
Home Foreign
Current
Goods
Current
Goods
Future
Goods
Future Goods

40. Determining Equilibrium Real Interest Rate
with Borrowing and Lending
• When international borrowing and lending are
allowed, the relative price of current
consumption (and the world real interest rate) is
determined by the intersection of world relative
demand and world relative supply.
• Relative supply and demand of current goods
measure
– Relative price of current goods (PC/PF) is the
slope of intertemporal isovalue line: (1+r).
– Relative quantity of current goods is QC/QF.
Relative price of Current
Goods
Current Goods
Future Goods

41. Relative Supply and Relative Demand in
International Borrowing and Lending Market
• Relative Supply
– Given real interest rate, Foreign has more investment
opportunities
– Foreign can produce relatively more future goods
than Home (QC/QF is lower in Foreign)
– Foreign’s relative supply curve lies left of Home’s
relative supply curve.
• Relative Demand is assumed to be equal between
Home and Foreign.
• Relative supply curve is upward-sloping: Higher the
price of current goods, more production of current
goods (higher QC/QF).
• Relative Demand curve is downward-sloping: Higher
the price of current goods, less consumption of
current goods (lower QC/QF).
Relative price of Current
Goods
Current Goods
Future Goods

42. Equilibrium Real Interest Rate with
Borrowing and Lending
• The world relative supply curve with
international borrowing and lending (RSWORLD) is
between two relative supply curves without
international borrowing and lending (RDFOREIGN
and RSHOME).
• The world real interest rate is determined by the
intersection of world relative demand and world
relative supply.
– Equilibrium world real interest rate is
between real interest rates of two countries.
Relative price of Current
Goods
Current Goods
Future Goods

43. Intertemporal Comparative Advantage
Countries which borrow in international market:
• Have a comparative advantage in future production because of low relative price of
future goods.
• Have a high real interest rate in absence of international borrowing and lending.
– The high interest rate corresponds to a high return on investment.
• Have more investment opportunities available relative to current productive capacity.
• More likely to experience high economic growth (Greater production in future).
• Import current goods: They have trade deficits in current goods.

44. Disclaimer
Please do not copy, modify, or distribute
this presentation
without author’s consent.
This presentation was created and owned
by
Dr. Ryoichi Sakano
North Carolina A&T State University
Disclaimer
Please do not copy, modify, or distribute
this presentation
without author’s consent.
This presentation was created and owned
by
Dr. Ryoichi Sakano
North Carolina A&T State University