Sense and Surprise in Competitive Trade Theory (2010 WEAI Presidential Address)

Economic models are often judged by the reality of their assumptions or their success at predicting realistic outcomes. In this chapter, I suggest a different criterion for judging models in international trade theory in competitive settings: (i) Does the model conform to common sense in leading to results that even suggest the model is not necessary, and yet (ii) can the same model be used as a tool to reveal in simple terms why certain outcomes that may appear surprising (often labeled a paradox in trade theory) nonetheless are correct. Many trade theory paradoxes appear as the result of income effects in simple general equilibrium models. Here attention centers instead on two of the familiar production models: The Specific-Factors model and the Heckscher–Ohlin model, either separately or when combined. It is shown that very basic properties of production underlie many of the surprising results in competitive trade theory.