Modeling of choice through the trade costs algorithm.

Dogaru, Vasile

1. INTRODUCTION

The constant task which we want to solve is to identify the context in which can be used the formulas of comparative advantages' measurement, identified by research of the defined hypotheses in typical cases of exchange. We rewriting the formulas from the deducted algorithm of the simple barter case (Dogaru, 2006) for a more exact approximation of the comparative advantages of the two economic entities, through taking in consideration the different clauses which involves external costs, excluded in the initial prices considered in this basic scheme. Observing in more details the buying-selling processes it appears obvious that each external goods exchange requires various tariff and non-tariff efforts from which the transportation ones which presently have a relatively increased role (Harrigan, 2003). Other international costs--regarding various tariff and non-tariff measures or, in general, all the trade costs--gives us a full picture of these efforts, sometimes called external costs.

2. RESEARCH COURSE

Modeling choice of goods, if the existence of several options exchange, can be done using comparative advantage scheme by removing successive the variants less effective. The most effective may be chosen in the last two remaining options.

The inclusion of various costs, which adds to the initial prices considers the necessity of formalization in the Evariste Galois meaning (Georgescu-Roegen, 1971), in order to be able to observe the change of the comparative advantage, according to Manoilescu (1937) generalized scheme. The identification of comparative advantage related to new efforts can be made using as instrument the new algorithm. Each from the initial prices of the two products will be changed with the unitary level of these costs (1).

[p.sub.e] + [c.sub.E ex] = [p.sub.me] ; [p.sub.i] + [c.sub.E im] = [p.sub.mi] (1)

where: [p.sub.e], [p.sub.i]--internal initial prices from the E and I country; [p.sub.me], [p.sub.mi]--internal changed prices from the E and I country; [c.sub.E ex], [c.sub.E im]--the external unitary costs of the E and I exporting entities, of the two products exchanged, Pr 1 and Pr 2.

Through the importation from I country to E country of Pr 2 product, the new price [p.sub.me2] will neutralize the origin in our analytical scheme. Therefore the symbol refers to a product spatial found in E country although this is manufactured within I country. Initial price of Pr 1 product from E country, exported in I country, will be changed at new price, [p.sub.mi1], the exportation costs are included. The same suppositions are made also for the case regarding the change of the internal products' prices. In this analysis is alleged lack of internal costs.

The relative total advantage's formula, used in the new terms, will be (2).

Avmrt = [P.sub.me2]/[P.sub.me1] : [P.sub.mi2]/[P.sub.mi1] (2)

where:

[p.sub.me 1/2], [p.sub.mi1/2]--the modified internal prices from E and I country of Pr1 and Pr2 products.

In the formula (2) the trade costs are proportionally distributed (see the difference versus (7)).

Correspondently, the relative modified advantage's formula for E economic entity will be:

[A.sub.vmrE] = [P.sub.me2]/[P.sub.me1] : [P.sub.2]/[P.sub.1] (3)

where: [P.sub.1] and [P.sub.2] are international prices.

If these costs are proportionally distributed the relative advantage remains the same and the absolute one would increase, according to (1.5) formula (Dogaru, 2006), because the initial prices are increased with the trade costs. The resolution is not viable because in fact the comparative advantage--measured as gains from trade--will decrease. Therefore, the reference point is not well established.

The orienting point is necessary to become (temporary) a case in which each entity trades on its local national markets the two products obtained either through production or through buying. In order to get as closer possible to the real exchange terms we will suppose that the entities E and I can be simultaneously wholesale merchants, so that [p.sub.e1], [p.sub.e2], [p.sub.i1] and [p.sub.i2] will be accepted by the buyer in the en-detail net--or manufacturers, for the merchandises for the intermediate consumption (Dogaru, 2006).

The hypothesis from the previous case with all the proportionally modified prices is suspended but the respect guarantee of the hedonic price hypothesis must be fulfill. The necessary condition of the exchange goods is, according to interest principle, as each of the forward (modified) correspondent prices to the imported goods, to be smaller or at least equal to those existent on the internal market.

[P.sub.me2(I)] [less than or equal to] [P.sub.e2(E)] ; [P.sub.mi1(E)] [less than or equal to] [P.sub.i1(I)] (4)

The new prices are calculated in quality equivalent, as in forward the products are supposed, having this reference point, to be identical in the basis of the hedonic price's hypothesis (Eatwell, 1987). The letters between the brackets, E and I, from the above mentioned inequalities indicates us the country product origin and the small letters the country where they are sold. In the monetary competitive economy the prices of products are compared through the exchange rate.

In order to identify the comparative advantage the trade costs are going to be distributed in forward only for the imported products' prices. If the two economic entities distribute the costs over the imported products' prices--Pr2 for E entity and Pr1 for I entity--although the trade costs are made also for the exported price, but yet only in favor of the other product's importation, the relative comparative advantage changes towards the initial formula. In consequence we suppose the prices' change, [p.sub.me2] for E country and [p.sub.mi1] for I country. The relative advantage's formula, correspondently modified for E economic entity will be:

[A.sub.vmrE] = [P.sub.me2]/[P.sub.e1] : [P.sub.2]/[P.sub.1] (5)

Note: In order for a real exchange to be identified the respect of the condition, [p.sub.me2] to be smaller or equal with [p.sub.e2], is necessary.

In the case of the simultaneous (4) and (5) conditions' fulfillment, economic entity E's relative advantage changes only in the limit of the initial relative comparative advantage, calculated without the trade costs. If (4) condition is not respected for maintaining or increase the absolute value advantage in country E, it is necessary that the influence in [A.sub.vmrE], because of [p.sub.me2] internal price's increase, to be bigger than the influence of the absolute advantage's decrease through the probable decrease of the quantity for sale from Pr2 product. The twist point is case in which [p.sub.me2]=[p.sub.e2]. The analyzed case is similar as mechanism with the one of the profit's total maximization once with the simultaneous increase of the sold quantity and of the unitary profit's decrease across the quantity related to of minimum cost (the neoclassic curve of the total profit's maximization).

In forward we will observe the case of the trade cost algorithm in which only the exported prices will be affected. It has been indirectly deducted from the previous case that for Pr1 sample product, maintained for selling on E country's internal market, the inclusion of these costs in pe1 price of this internally sold product is not justified. The judgment is similar for [p.sub.i2] price of Pr2 product from I country. The trade costs will add in this new case, changing correspondently the analytical border of the exchange process, only for the exported sample products. In conclusion [c.sub.Eex2] and [c.sub.Eim1] costs' size will be considered zero or included in [c.sub.Eex1] and [c.sub.Eim2]. In the new terms the formula of the changed total relative advantage, [A.sub.vmrt], will be (6):

Avmrt = : [P.sub.e2]/[P.sub.me1] : [P.sub.mi2]/[P.sub.i1] (6)

The case is different than the previous ones, of the proportional distribution of the costs over all prices or only over the imported ones. In this case it can be noticed the total relative advantage of the two economic entities reduces in comparison with the initial situation. The reversal of the trade costs between [p.sub.me1] and [p.sub.mi2] will not influence [A.sub.vmrt] size according to a property from mathematics. The comparison of initial internal prices of the exported products, [p.sub.e1(E)] si [p.sub.i2(I)], with the changed prices, [p.sub.me1(E)] si [p.sub.mi2(I)], according to (4) condition, is not necessary in order to decide the opportunity of the internal exchange, separate on each of the two internal markets, as in the previous case.

Avmrt = [P.sub.me2]/[P.sub.me1] : [P.sub.mi2]/[P.sub.mi1] (7)

Now another case requires be finished and which through generalizing includes the three previous cases and also other possible situations: the simultaneous change of all prices with condition (4) fulfillment.

In these terms a smaller comparative advantage is going to be achieved. In normal conditions the absolute comparative advantage, who in fact every economic entity is interested, cannot be bigger, because the condition (4) must be respected. The increase of the absolute advantage size is possible due to the quantities increase of imported (exported) products sold and if the value of comparative advantage increase can overcome prices decrease (smaller than the initial ones).

The identification of this analytical case with the change only of the exported product's price, [p.sub.me1] and [p.sub.mi2], by each entity has as a purpose to make the comparison in simplified terms possible. Therefore, in case of such distribution of the trade costs, it has been quite easily remarked that each part's comparative advantage is smaller than the standard situation, the initial one, without the trade costs.

Economic entities calculate the initially comparative advantage and by taking into account the trade costs. Assume the following two exchange cases (table 1). In the new case, it is a reduction in the relative advantage compared to 1.35 at 1.155. Adequately the total profit, which is the monetary shape of comparative advantage, is decreased related to the reducing the quantities of goods traded.

3. FINDINGS

The scientists can use these formulas to measure the efforts of economic entities, according to analytical economy's principle. The trade costs algorithm, included in the Manoilescu generalized scheme, fills an analytical gap, of comparative advantages' measurement. The new algorithm is operable and could be used by the enterprisers for various cases occurring during negotiations.

The calculus with this algorithm will be finish in a quickly way. If the trade costs' size equals the initial comparative advantage's size, allegedly without these trade costs, the exchange cannot be made anymore, but for the case of an unequal exchange, in which at least one of the two partners will not achieve comparative advantage. The results obtained by algorithm of trade costs it is necessary to be developed further to identify other cases, which can provide a faster measuring of comparative advantage.

4. REFERENCES

Dogaru, V. (2006). Manoilescu generalized scheme regarding the international goods exchange--a general presentation, Economic Issues, nr. 226-227, National Institute for Economic Research, Romanian Academy, ISBN 973-788547-3, 978-973-7885-47-0, Bucharest.

Eatwell, J. & others, editors. (1987). The New Palgrave. A Dictionary of Economics, tome I-IV, The Macmillan Press Limited, ISBN 0-333-372352, London.

Georgescu-Roegen, N. (1971). The Entropy Law and the Economic Process, Harvard University Press, SBN 674-25780-4, London.

Harrigan, James, Evans & Carolyn L. (2003). Distance, Time, and Specialization, National Bureau of Economic Research, Cambridge, MA 02138, 2003, Working Paper 9729.

Manoilescu, M. (1937). The National Productive Forces and the External Trade, Scientific and Encyclopedic Publishing House, 1986, Bucharest.

Tab. 1 Calculation of comparative advantage with the trade
costs algorithm

 [p.sub.e] [p.sub.i] [p.sub.me] [p.sub.mi]

Cloth 90 100 90 110
Wine 80 120 85 120