Chapter 42: The Trade Theory Diagram
Peter Lloyd In international trade theory, a figure combining a concave transformation curve and a quasi-concave social indifference map has been widely used to show gains from trade and other welfare propositions for trading economies. Ronald Findlay described it as ‘the sacred diagram of the international trade economist’ (Baldwin, 1982, p. 142). The model has one country producing, consuming and trading two goods. The country is assumed to be small in the particular sense of smallness used in the theory of international trade, that is, a price taker. Under these conditions, the country gains from trade. Extensions of the figure have been used to illustrate a variety of issues in the normative theory of trade policy. These figures are still used in almost every undergraduate text and many graduate texts on international trade. 1. THE DIAGRAM Figure 42.1 presents the basic diagram. In it the production possibilities of the country are represented by a transformation curve PP9. This curve is drawn as strictly concave. It is assumed that a social indifference map representing the preferences of the community between all alternative combinations of aggregate consumption of the two goods exists. Furthermore this map is always drawn as if it is well-behaved, and in particular, the social or community indifference curves do not intersect and all curves are strictly concave from above. Thus, it is assumed that the map has all of the basic properties of a well-behaved indifference map representing the preferences of a single individual between bundles of the...
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