Introduction2

Research Question2

Literature Review3

Trade Model3

Comparison of the US and Chinese Trade Data4

Features of Trade Models5

Foreign Policy of China and USA7

Different Agreements in the Foreing Relations between China and USA10

Future Pattern of USA and China Relationship13

Several Economic Factors for China and USA15

Critique of the topic18

Recommendation for the topic20

Conclusion21

Works Cited22

Effect of Foreign Trade

Introduction

China's exports significantly increased from 2000 to 2006. The total export value increased from $2.5 billion to $9.7 billion. At the same time, the total number of export shipments increased from 5.2 million to 16.2 million. In addition, the total number of exporting firms increased from 62,000 to 171,000. For the large increase of China's exports over just seven years along both intensive and extensive margins, we expect that the heterogeneous firm model of trade, which has an extensive margin, can help us understand these changes. The heterogeneous firm model of Chaney (2008) provides a new perspective on the relationship between the elasticity of substitution of consumer's preference across different goods and the impact of trade costs on trade value. However, the theoretical implications of the model have not been substantially tested in empirical studies, although other aspects of heterogeneous firm models have been well examined by datasets across many periods and countries. Therefore, all the issues and aspects related to the effect of foreign trade will be discussed in detail.

Research Question

The research question for the topic is:

What effect does trade between U.S. and China have on U.S. foreign policy with China?

Literature Review

Trade Model

The heterogeneous firm trade model of the researcher known as Melitz in 2003 brings the extensive margin adjustment of trade flows to the field's attention. In his model, firms are heterogeneous with respect to their productivity. Only firms with high productivity are able to cover the fixed cost of exports and become exporters. Therefore, when the trade costs decrease, not only incumbents but also new entrants would contribute to the overall increase of trade value. Building upon the works of Melitz in 2003, the researcher known as Chaney in 2008 points out that we are not supposed to, as in many traditional gravity equation analyses, interpret the trade cost elasticity of trade flows directly as the elasticity of substitution of consumers' preference. In his model, the extensive margin refers to the trade flow adjustment of the new entrants. The intensive margin refers to trade value adjustment of the incumbents. This is because for the intensive margin, similar to the homogeneous firm model of Krugman (1980), the consumer's elasticity of substitution across goods magnifies the impact of trade barriers on trade flows. For the incumbent exporters, the only wedge between selling in the domestic market and exporting is the variable trade cost. When the elasticity of substitution is high, a small decrease in variable cost would translate into a relatively large increase of trade value, and vice versa. Since the incumbents do not pay the fixed cost of export any longer, the fixed cost does not affect the intensive margin of trade (Bates, 73).

For the extensive margin, the elasticity ...