THE ISSUES

This chapter examines two groups of issues. The first part of the chapter uses trade theory to show what happens when factors of production can move freely from one country to another. It concentrates on three issues:

• How factor movements affect the total outputs of the countries involved and the composition of each country's output.

• How they affect the incomes of the factors of production.

• How they affect trade flows, the terms of trade, and economic welfare.

The second part of the chapter deals with some major issues raised by the theory of factor movements but not treated fully by it:

• Why firms engage in multinational production, putting plants in many countries rather than one country.

• How multinational production affects the individual economies involved and trade flows between them.

The chapter ends with a brief excursion into the theory of taxation. When a firm or individual resides in one country but earns income in another, what principles should govern the taxation of that income?

PERSPECTIVES AND OBJECTIVES

Most of our work thus far has focused on the nation state as the basic unit of analysis and has measured the effects of trade on the welfare of the typical consumer. When examining capital formation, for example, we compared the sizes of two changes affecting the welfare of the typical consumer in the growing country—the change in real income measured at initial prices and the change in the terms of trade induced by the change in the output mix.