Dornbusch-Fischer-Samuelson Model

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Dornbusch-Fischer-Samuelson Model

BIBLIOGRAPHY

The Dornbusch-Fischer-Samuelson (DFS) model of international trade was introduced into the economics literature by three Massachusetts Institute of Technology (MIT) professors in 1977. The model extends the widely accepted theory of comparative advantage of classical economist David Ricardo (17721823) to a conceptually infinite number of commodities, and the model integrates money and payments into what essentially had been a barter model. From DFS, greater understanding can be gleaned of the determinants of international trade patterns.

The model assumes the traditional classical framework of two trading countries and of labor being the sole factor of production. Suppose the countries are A and B. Country A exports any good where the wage rate for A s workers (WA) multiplied by the labor time needed to produce a unit of the good (LA) is less than the wage rate for B s workers (WB) multiplied by the labor time needed to produce a unit of that good in B (LB); that is, A exports any good where WA · LA < WB · LB. Country A imports goods where WA · LA > WB · LB. Expressed alternatively, country A will export goods where (WA/WB) < (LB/LA) and import goods for which (WA/WB) > (LB/LA), and, in DFS, a continuum of goods is specified in descending order of (LB/LA). (It is assumed for simplicity in this discussion that there are no transport costs and that the exchange rate is fixed at one unit of A s currency = one unit of B s currency.) Thus, if the wage ratio (WA/WB) is given, an examination of labor times can determine which goods in the continuum will be exported from A to B and which from B to A.

But what determines the wage ratio? As noted above, (WA/WB) would, when compared with the (LB/LA) ratios, determine the trade pattern; however, the trade pattern itself would also determine (WA/WB). For example, if the trade pattern is such that most of the different goods are exported from A to B and few goods are exported from B to A, then, in essence, there is strong demand for A s goods (and therefore for A s labor) and a trade surplus for country A. This demand for A s labor will bid up WA relative to WB. As WA rises, some goods previously exported from A to B [because (WA/WB) < (LB/LA) for those goods] will no longer be exported but will be imported by A because (WA/WB) has increased.

With this interaction of the trade pattern and wage rates, an equilibrium trading pattern is established. Equilibrium occurs with balanced trade (exports = imports for each country) and, for the borderline good in the continuum between the goods exported by A and those exported by B, (WA/WB) = (LB/LA). All goods where (WA/WB) < (LB/LA)the goods with higher (LB/LA) ratioswill be A s exports. All goods for which (WA/WB) > (LB/LA)the goods with the lower (LB/LA) ratioswill be B s exports. The original DFS article then introduced transportation costs, nontraded goods, and exchange rate and other considerations, but the major contribution was this simultaneous determination of relative wage rates and the trading pattern.

From this equilibrium position, the impact of changes in various economic elements can be analyzed. For example, suppose that all consumers turn their tastes relatively away from A s goods and toward B s goods. The new demand for B s goods will increase the wage rate in B relative to the wage rate in A, a change that will cause some of B s export goods to become A s export goods. At the new equilibrium, balanced trade will be restored, country B will be exporting fewer different goods than originally, and B s wages will have risen relative to A s.

Consider next the perhaps surprising consequences of a uniform productivity increase in all of country A s industries. With this productivity increase, LA (labor time needed for one unit of output) falls in each of A s industries, and there will be a greater number of different goods exported from A to B than previously [because (LB/LA) will now be greater than (WA/WB) for some goods for which (LB/LA) was formerly less than (WA/WB)]. However, with more demand for A s goods, (WA/WB) will rise and some of the new exports from A will revert back to being imports from B. In the model, though, the end result is that, on net, the number of different goods exported from A has increased and (WA/WB) has risen. Real income has increased in A, as its wages have gone up while the cost of producing its goods has gone down. Importantly, though, real income in country B also has risen. Even though B s wage has declined relative to A s wage, B s absolute income has risen because the productivity increase has made B s imports from A less expensive. Hence, a significant lesson from DFS is that productivity improvements under competition get transmitted across country bordersthere is no absolute gain by one country and corresponding absolute loss for the other country.

The original DFS model has formed the basis for a number of extensions. Rudiger Dornbusch, Stanley Fischer, and Paul Samuelson themselves (1980) later incorporated a second factor (capital) into the model in a Heckscher-Ohlin framework and produced further conclusions. (Heckscher-Ohlin [or alternatively, Heckscher-Ohlin-Samuelson ] refers to a standard trade model based on relative factor endowments of countries and relative factor intensities in the production of commodities.) The DFS model also has been extended, among much other research, in its Ricardian formulation to more than two countries in growth and customs union contexts (Wilson 1980; Appleyard at al. 1989) and into a multicountry framework, combined with monopolistic competition and econometric work, in its Heckscher-Ohlin formulation (Romalis 2004). A considerable amount of empirical work over the years has supported the relationship between labor productivity/costs and trade patterns predicted by the classical economists and DFS, a comprehensive example being Wendy Carlyn, Andrew Glyn, and John Van Reenen (2001). Criticisms of the model can be directed toward the realism of its assumptions of perfect competition and of smooth adjustment to technological change and other disturbances.

SEE ALSO Absolute and Comparative Advantage; Heckscher-Ohlin-Samuelson Model; Rybczynski Theorem; Stolper-Samuelson Theorem; Trade

BIBLIOGRAPHY

Appleyard, Dennis R., Patrick J. Conway, and Alfred J. Field Jr. 1989. The Effects of Customs Unions on the Pattern and Terms of Trade in a Ricardian Model with a Continuum of Goods. Journal of International Economics 27 (1/2): 147164.

Carlyn, Wendy, Andrew Glyn, and John Van Reenen. 2001. Export Market Performance of OECD Countries: An Empirical Examination of the Role of Cost Competitiveness. Economic Journal 111 (468): 128162.

Dornbusch, Rudiger, Stanley Fischer, and Paul A. Samuelson. 1977. Comparative Advantage, Trade, and Payments in a Ricardian Model with a Continuum of Goods. American Economic Review 67 (5): 823839.

Dornbusch, Rudiger, Stanley Fischer, and Paul A. Samuelson. 1980. Heckscher-Ohlin Trade Theory with a Continuum of Goods. Quarterly Journal of Economics 95 (2): 203224.

Romalis, John. 2004. Factor Proportions and the Structure of Commodity Trade. American Economic Review 94 (1): 6797.

Wilson, Charles A. 1980. On the General Structure of Ricardian Models with a Continuum of Goods: Applications to Growth, Tariff Theory, and Technical Change. Econometrica 48 (7): 16751702.

Dennis R. Appleyard

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