Transcript No Slide Title

Comparative advantage: A basic example
Assumptions
• Two countries (Portugal and the UK)
• Two industries (wine and drape)
• One factor of production (labor), hence one type of agent in each country (workers)
• Constant returns to scale
• No transportation costs
• No government intervention
• Perfect competition
Wine
Drape
Endowments
(here, labor
forces)
Portugal
8
4
5
UK
1
2
20
Productivities
1
Portugal’s production-possibility frontier and the autarky
(before-trade) equilibrium
Wine
40
Consumer preferences
(demand side)
Consumption point without
international trade
Production possibility frontier
(supply side)
20
Drape
The UK’s production-possibility frontier
and the autarky equilibrium
Wine
Production possibility frontier
(supply side)
20
Consumption point without
international trade
Indifference curve
(demand curve))
Drape
40
The world’s production-possibility frontier
and trading equilibrium
Wine
40
World production possibility
frontier
world price ratio
(demand-determined)
Consumer preferences
(common to all countries)
Consumption point with
international trade
Drape
40
The gains from exchange
Production
Consumption
Wine
Drape
Wine
Drape
Portugal
40
0
20
20
UK
0
40
20
20
Total
40
40
40
40
5
The gains from exchange revisited
Wine
Indifference curves
Production
Possibility
Frontier
world price
ratio
Drape
6
The gains from specialization
Wine
Production
point
Indifference curves
world price
ratio
Production
Possibility
Frontier
Drape
7
The Rybszinski theorem
steel
production possibility frontier
after an increase in the capital endowment
initial production possibility
frontier
production possibility frontier
after an increase in the labor endowment
drape
8
The Heckscher-Ohlin theorem
(world & domestic)
indifference curves
home steel exports
steel
world price ratio
(drape is cheaper)
“trade
triangle”
domestic
PPF
drape
home drape imports
domestic price ratio (before trade)
9
The gains from trade (i): initial equilibrium
P
P
S*
S
P*a
Pa
D*
D
Quantities
Country H (relatively efficient)
Country F (relatively inefficient)
10
Equilibrium price
Method 1: Equate segments ab and cd
P
P*
Country H
a
b
Country F
P* a
Pw
Pa
c
d
11
Equilibrium price
Method 2
a) Construct excess supply (ES) and excess demand (ED) curves
ab = cd
a
b
Home ES
c
d
Pa
Export supply
Pa*
ab = cd
a
b
c
d
Foreign ED*
Import demand
12
Equilibrium price, method 2
b) Match the home ES and foreign ED curves on single « world » market
S*
Pa*
ES
P*a
S
Pw
Pa
D*
ED*
D
Quantities
E=M*
Country H
(exporter)
« World » market
Country F
(importer)
13
Gains from goods trade
Importer country
consumers’ gain, producers’
loss = neutral
P
A
B
K
C
G
pa
F
H
J
p*
I
World price
D
ED
(a) Importer country’s domestic market
(b) same thing seen on world market
14
Gains from goods trade
Exporter country
producers’ gain, consumers’
loss = neutral
A
ES
F
E
D
C
p* G
H
World price
B
pa I
EF
(a) Exporter country’s domestic market
(b) same thing seen on world market
15
Who gains from trade
Size and « similarity »
More « different » exporter gains more from trade
Net increase in
importer country’s
welfare = CS gain –
PS loss
ES
ES
ED
ED
SIMILARITY
ES
Larger exporter gains less from trade
ED
ES
Net increase in
exporter country’s
welfare = PS gain –
CS loss
SIZE
ES
ED
ED
16
Gains from factors trade
Starting point: autarky
Value of marginal
product of capital
r
Economy’s capital
stock
Very similar to trade in
G&S:
 Identical causes:
differences in prices
(factor rewards)
Return to
other factors
ra
 Identical consequences:
some gains, other loose,
and there is a net potential
gain.
Return to
capital
K
K
+
= GDP (equal to GNP in autarky)
17
Gains from factors trade
Capital flow from Home to Foreign
Two countries, H relatively well endowed with capital.
Initially, rH < rF, so capital has an incentive to migrate from H to F
VF = p*F*K
A
VH = pFK
I
rF
E
rW
B
rH
D
G
C
In equilibrium, the
marginal products
of capital are
equalized.
Gains from capital
movements: EBC for
H, EIB for F.
Home capital stock (before outflow)
Foreign capital stock (before inflow)
Extension of foreign capital stock (because of inflow)
18
Gains from factors trade
GNP vs. GDP, efficiency gain
VH=pFK
GNP
Home country’s GDP
VF=p*F*K
GNP*
Efficiency gain from capital flow
Foreign country’s GDP
19
Openness and size
Trade share in GDP
140
120
IRL
NLD
Larger
countries trade
less (not so
obvious)
trade share (% of GDP)
100
CHE
SWE
NOR
80
ISL
DNK
FIN AUT
60
DEU
GBR
PRT
40
Not very open
given their size
(should trade
more)
ESP
FRA
ITA
GRC
20
0
1.00E+09
TUR
1.00E+10
1.00E+11
1.00E+12
1.00E+13
PPP GDP
GDP at purchasing power parity
20
Transportation costs
“Fob”: free-on-board; “cif”:
cum insurance and freight.
Transport cost per unit: 
Pcif = Pfob +  = Pa + 
Condition for trade to take
place:
EScif
P*a
Pa +   Pa*
If condition violated, good is
said to be non-traded
ESfob
Pwcif

Pwfob
ED*
Pa
Less trade
21