2 management - School of International Business and ...

Günter S. Heiduk
well as a »perfect«(Cobb-Douglas type) production function and excludes time and space (Fig-
ure 11). Empirical observations of two countries regarding their productivity, factor endowment,
goods prices, consumer preferences, volume, direction and structure of trade are squeezed into
two »point economies«with a potential of an overlapping common (international) sector (Figure
12). The applied methodology allows determining the trade by differences between the countries.
The aforementioned restrictions of the model allow differentiating the countries by three variables
only: productivity, factor endowment, consumer preferences. In order to determine trade by one
different feature only, the remaining two have to be equalized. After setting these differences in a
situation of autarky, the next step is introduction of free trade as an exogenous shock that leads
to adaptation processes. Relative price differences on goods markets cause quantitative reac-
tions of producers and consumers in both countries. The result is trade which equalizes the price
differences between the countries. The final (world) equilibrium shows the welfare effect of trade
by the increased level of consumption in both countries (Box 1).
Figure 11 | Basic Concept of the Theory of International Trade
Source: Own
Then the general theorem of international trade reads as follows: Each country exports the
good at the lower relative price. The country possesses a comparative price advantage in the
production of this good. The specialization in each country is resulting in a one-way trade or in-
ter-industry trade. Under the prevailing assumptions the comparative advantages are maximized
(Annex, Figure 1a).
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