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Endowment shock and its welfare effects in open market economies.

Article Excerpt
I. Introduction

World production is dramatically changing, shifting from the United States to China. This phenomenon occurs over the spectrum of all goods and services and includes not only furniture, textile, kitchenware, car tires, and the like but also precision machine tools, networking gears, electronic circuit boards, heavy electric appliances, petrochemicals, and microchips. The present paper analyzes the potential effects of this global trend utilizing a simple model with two countries, two goods, and two representative agents.

The foundations for free trade theory were established by giants such as Smith (1776), Ricardo (1817), and Mill (1844). For a defense of free trade, see for example, Friedman (2000), Douglas (2003), Bhagwati (2004), and Wolf (2004). For a balanced approach see Sen (2000), and Stiglitz (2003). Johnson and Stafford (1993), Gomory and Baumol (2000) and Samuelson (1972, 2004) provide examples where free trade leads to one party losing from trade. The current paper revisits the issue by applying a simple model of income in kinds.

This paper investigates the effects of various increases in endowments or technological improvements by one country on its own welfare and the welfare of its trading partners. The paper derives the equilibrium bundles of consumption and explores what happens, for instance, to U.S. citizens if Chinese technology continues to advance in various directions. It is shown that if China acquires more endowments that favor the production of the good in which it has had a comparative advantage (or if China improved its technology in a good in which it has had a comparative advantage), the people of the U.S. and China would benefit from this improvement but the terms of trade would change in favor of the United States. The utility of people in both countries also rises. (1)

However, the interesting case is technological improvement, or the positive endowment shock, occurring in an industry in which the U.S. previously dominated the U.S.--Chinese trade market. If the U.S. continues to export that good, even after the technological improvement in China, it will lose out as the Chinese terms of trade have changed favorably. Furthermore, technological improvement in...

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