Nunn International Business Model

The theoretical model developed by Nunn (2005) illustrates how contract enforcement environment affects countries’ comparative advantage. As pointed out by him, the model is not general but instead focused on one example of how contract enforcement differences among nations affect pattern of the trade. The model adopted by Nunn (2005) is an extended version of Dornbusch, et al. (1977). The extended model is using differences in countries’ contract enforcement as another source of Ricardian productivity differences rather than labor.
The Model
The model assumes that there is a continuum of final goods indexed by zϵ[0,1]. Different from original model where labor is the only factor of production, the underlying assumption is that production

It is assumed that each principal have sufficient knowledge for customized input production. An agent is hired by the principal to produce an input. This is specific to the final good producer. Before production starts, the principal and agent bargain over how to split expected surplus of the relationship. The agent’s share of surplus is denoted by s and therefore the principal’s share is denoted by (1-s). Level of customization that the agent chooses is defined as q≥0. The surplus that is obtained from input production with some level of customization is given by f(q). By assumption, 〖f(q)〗^'>0 and 〖f(q)〗^''≤0 which means that production of inputs is an increasing function of the level of customization with a decreasing rate. For simplicity, the production and customization of inputs are assumed to take place at zero

So that changes in p^s⁄p^(s^' ) shifts countries’ cost curves vertically relative to each other. This mechanism arranges z ̃ and the range of goods produced by each country.
When there are many countries, say three, in equilibrium each country specializes its production in different intervals of the goods. Differences between judicial quality among countries arise differences in the slope of the cost curves since α(z) is the same for all countries. The cost curve of the countries get steeper if the country have low judicial quality. Because each countries’ judicial quality differ from the other countries and thus slopes of cost curves too, specialization patterns of countries differ from each other.
Figure 3 demonstrates an equilibrium with three countries. The country with lowest quality of contract enforcement environment will specialize in the part of the lowest z goods, [0,z ̃_1 ]. The country with highest quality of contract enforcement environment will specialize in the part of the highest z goods, [z ̃_2,1]. And the country with an intermediate level of judicial quality will specialize in the middle range of z goods, [z ̃_1,z ̃_2