Transcript Model Building

Model Building
In this chapter we are going to lean some
tools for analyzing the following questions:
Model Building
In this chapter we are going to lean some
tools for analyzing the following questions:
• What goods will a country import?
Model Building
In this chapter we are going to lean some
tools for analyzing the following questions:
• What goods will a country import?
• What goods will a country exports?
Model Building
In this chapter we are going to lean some
tools for analyzing the following questions:
• What goods will a country import?
• What goods will a country exports?
• What will be the trade volume? how much
trade ?
Model Building
In this chapter we are going to lean some
tools for analyzing the following questions:
• What goods will a country import?
• What goods will a country exports?
• What will be the trade volume? how much trade ?
• What will be the price at which they trade?
Model Building
In this chapter we are going to lean some
tools for analyzing the following questions:
•
•
•
•
What goods will a country import?
What goods will a country exports?
What will be the trade volume? how much trade ?
What will be the price at which they trade?
• What is the effect of trade on the price of
factors of production?
Model Building
In the process of model building, one
should make sure to avoid the normative
aspects of the question under analysis.
Model Building
In the process of model building, one
should make sure to avoid the normative
aspects of the question under analysis. That
is, try to avoid making any "ought to be"
statements which are in the realm of
normative rather that positive economics.
In Positive economics we always try to stay
with the positive aspect of the analysis, i.e.,
we need to explain what is.
Model Building:
ASSUMPTIONS: SUPPLY SIDE
1-- all economic agents are rational
Model Building:
ASSUMPTIONS: SUPPLY SIDE
1-- all economic agents are rational
- firms are profit maximizers
Model Building:
ASSUMPTIONS: SUPPLY SIDE
1-- all economic agents are rational
- firms are profit maximizers
- consumers are utility maximizers
Model Building:
ASSUMPTIONS: SUPPLY SIDE
2-- there are
 2 countries; A (America) and B (Britain)
Model Building:
ASSUMPTIONS: SUPPLY SIDE
2-- there are
 2 countries; A (America) and B (Britain)
 2 goods S (Soybeans) and T (Textiles)
Model Building:
ASSUMPTIONS: SUPPLY SIDE
2-- there are
 2 countries; A (America) and B (Britain)
 2 goods S (Soybeans) and T (Textiles)
 both goods are consumed all the time in both countries
Model Building:
ASSUMPTIONS: SUPPLY SIDE
2-- there are
 2 countries; A (America) and B (Britain)
 2 goods S (Soybeans) and T (Textiles)
 both goods are consumed all the time in both countries
 both goods are identical in both countries
Model Building:
ASSUMPTIONS: SUPPLY SIDE
3-- there is no money illusion.
Model Building:
ASSUMPTIONS: SUPPLY SIDE
4-- In each country
 factor endowment is fixed
Model Building:
ASSUMPTIONS: SUPPLY SIDE
4-- In each country
 factor endowment is fixed
 technology is constant
Model Building:
ASSUMPTIONS: SUPPLY SIDE
5-- Perfect competition in
 product market and
Model Building:
ASSUMPTIONS: SUPPLY SIDE
5-- Perfect competition in
 product market and
 input market
Model Building:
ASSUMPTIONS: SUPPLY SIDE
6-- Factors of production are mobile within
each country and industry.
Model Building:
ASSUMPTIONS: DEMAND SIDE
Each Indifference curve shows
• trade off between two commodities
Model Building:
ASSUMPTIONS: DEMAND SIDE
Each Indifference curve shows
• trade off between two commodities
• level of satisfactions (total utility)
Model Building:
ASSUMPTIONS: DEMAND SIDE
Each Indifference curve shows
• trade off between two commodities
• level of satisfactions (total utility)
• only ordinal and not cardinal preferences.
Model Building:
ASSUMPTIONS: DEMAND SIDE
Indifference curves analysis is based on the
following assumptions:
i-- Commodity units are divisible to a very
small size,
Model Building:
ASSUMPTIONS: DEMAND SIDE
Indifference curves analysis is based on the
following assumptions:
i-- Commodity units are divisible to a very
small size,
ii-- consumers tastes are well defined,
Model Building:
ASSUMPTIONS: DEMAND SIDE
Indifference curves analysis is based on the
following assumptions:
i-- Commodity units are divisible to a very
small size,
ii-- consumers tastes are well defined,
iii-- MU >0
Model Building:
ASSUMPTIONS: DEMAND SIDE
Indifference curves analysis is based on the
following assumptions:
i-- Commodity units are divisible to a very
small size,
ii-- consumers tastes are well defined,
iii-- MU >0
iv-- no nuisance commodity
Model Building:
ASSUMPTIONS: DEMAND SIDE
Characteristics of ICs
i-- ICs are non-intersecting.
Model Building:
ASSUMPTIONS: DEMAND SIDE
Characteristics of ICs
i-- ICs are non-intersecting.
ii-- ICs are continuous
Model Building:
ASSUMPTIONS: DEMAND SIDE
Characteristics of ICs
i-- ICs are non-intersecting.
ii-- ICs are continuous
iii-- ICs are everywhere dense and go
through every point in the XY map.
Model Building:
ASSUMPTIONS: DEMAND SIDE
Characteristics of ICs
i-- ICs are non-intersecting.
ii-- ICs are continuous
iii-- ICs are everywhere dense and go
through every point in the XY map.
iv-- ICs have a negative slope
Model Building:
ASSUMPTIONS: DEMAND SIDE
Characteristics of ICs
i-- ICs are non-intersecting.
ii-- ICs are continuous
iii-- ICs are everywhere dense and go
through every point in the XY map.
iv-- ICs have a negative slope
v-- ICs are Convex to the origin.
Model Building:
Budget Constraint
Indifference Curves show the desire of the
individual and the community. In other
words, their willingness.
Model Building:
Budget Constraint
Indifference Curves show the desire of the individual and
But
there is another requirement, ability to
purchase a commodity. (a demand curve
shows the ability and willingness )
the community. In other words, their willingness.
Model Building:
Budget Constraint
Indifference Curves show the desire of the individual and the community. In
other words, their willingness. But there is another requirement, ability to
purchase a commodity. (a demand curve shows the ability and willingness )
Ps S + Pt T  I
Model Building:
Budget Constraint
Ps S + Pt T  I
Since I/ Ps is the total amount of S that one
could buy with an income level I
Model Building:
Budget Constraint
Ps S + Pt T  I
Since I/ Ps is the total amount of S that one could buy with an
income level I and I/ Pt is the total amount of T
that one could buy with a given amount of I,
then the ratio of the I/ Pt to I/ Ps represents:
• slope of the price line (the budget line ).
- (I/Pt)/(I/Ps) = - (Ps/Pt)
Budget Constraint
Example
Model Building:
ASSUMPTIONS: DEMAND SIDE
7-- A consistent community's preferences
can be presented.
This is a tricky business. It is impossible
(Arrow's Impossibility Theorem) to
generate a set of ordering that is internally
consistent for individuals as well as for the
community as a whole.
Model Building:
ASSUMPTIONS: DEMAND SIDE
7-- A consistent community's preferences
can be presented.
Order of
individuals
Preferences
Janice
Parisa
Zach
1
apples oranges bananas
2
oranges bananas
apples
3
bananas apples
oranges
Model Building:
ASSUMPTIONS: DEMAND SIDE
7-- A consistent community's preferences
can be presented.
Order of
individuals
Preferences
Janice
Parisa
Zach
1
apples oranges bananas
2
oranges bananas
apples
3
bananas apples
oranges
Model Building:
ASSUMPTIONS: DEMAND SIDE
If the group were to rank these fruits, we
would have:
• apples are preferred to oranges by Janice
and Zach
Model Building:
ASSUMPTIONS: DEMAND SIDE
If the group were to rank these fruits, we
would have:
•
apples are preferred to oranges by Janice and Zach
• Oranges are preferred to Bananas by Janice
and Parisa.
Model Building:
ASSUMPTIONS: DEMAND SIDE
If the group were to rank these fruits, we
would have:
•
•
apples are preferred to oranges by Janice and Zach
Oranges are preferred to Bananas by Janice and Parisa.
• But yet, even though apples are preferred to
oranges and oranges are preferred to
bananas, apples are not preferred to bananas
by the group.
Model Building:
ASSUMPTIONS: DEMAND SIDE
There are three possibilities to have a
consistent preference ordering:
1-- Robinson Crusoe economy
Model Building:
ASSUMPTIONS: DEMAND SIDE
There are three possibilities to have a
consistent preference ordering:
1-- Robinson Crusoe economy
2-- A dictatorial economy where one person
decides for all,
Model Building:
ASSUMPTIONS: DEMAND SIDE
There are three possibilities to have a
consistent preference ordering:
1-- Robinson Crusoe economy
2-- A dictatorial economy where one person decides for all,
3-- all individuals have a same preference
ordering.
Model Building:
ASSUMPTIONS: DEMAND SIDE
There are three possibilities to have a
consistent preference ordering:
1-- Robinson Crusoe economy
2-- A dictatorial economy where one person decides for all,
3-- all individuals have a same preference ordering.
We assume all individuals have a same
preference ordering.
Model Building:
General Equilibrium Solution
of the Model: Autarky Solution
Given the assumptions of:
i-- Consumer and producers' rationality
Model Building:
General Equilibrium Solution
of the Model: Autarky Solution
Given the assumptions of:
i-- Consumer and producers' rationality
ii-- Perfect competition in
-- factor market
-- product market
Model Building:
General Equilibrium Solution
of the Model: Autarky Solution
Given the assumptions of:
i-- Consumer and producers' rationality
ii-- Perfect competition in
-- factor market
-- product market
iii-- Fixed
-- technology
-- endowment
Model Building:
General Equilibrium Solution
of the Model: Autarky Solution
Given the assumptions of:
i-- Consumer and producers' rationality
ii-- Perfect competition in
-- factor market
-- product market
iii-- Fixed
-- technology
-- endowment
iv-- Increasing cost PPC
Model Building:
General Equilibrium Solution
of the Model: Autarky Solution
The economy will find an optimal solution
on the PPC.
Model Building:
General Equilibrium Solution
of the Model: Autarky Solution
The economy will find an optimal solution
on the PPC. This optimal point will be the
tangency point of the budget line,
indifference curve, and the Production
Possibility Curve, say point A.
Model Building:
General Equilibrium Solution
of the Model: Autarky Solution
S
T
Model Building:
General Equilibrium Solution
of the Model: Autarky Solution
S
PPC
T
Model Building:
General Equilibrium Solution
of the Model: Autarky Solution
S
Price line/budget
constraint
T
Model Building:
General Equilibrium Solution
of the Model: Autarky Solution
S
Indifference Curve
A
T
Model Building:
General Equilibrium Solution
of the Model: Autarky Solution
S
S1
Indifference Curve
A
T
Model Building:
General Equilibrium Solution
of the Model: Autarky Solution
S
S1
A
T
T1
Model Building:
General Equilibrium Solution
of the Model: Autarky Solution
At this point, A, where all three components
of the system converge, the Marginal Rate
of Substitution between S and T, and slopes
of the budget line and the PPC Curve are
equal
MRSst = slope of the budget line = (-Ps/Pt)
Model Building:
Adjustment to the equilibrium point
Let's assume that the economy produces at a
point like B.
T
T2
B
T1
A
IC1
IC0

S2
S1
S
Model Building:
Adjustment to the equilibrium point
Let's assume that the economy produces at a
point like B.
T
T2
B
T1
A
IC1
IC0

S2
S1
S

Model Building:
Adjustment to the equilibrium point
There will be a surplus of S and a shortage
of T at the prevailing relative prices (Py/Px).
Model Building:
Adjustment to the equilibrium point
There will be a surplus of S and a shortage of T at the prevailing relative prices
(Py/Px).
• Surplus of S leads to a decrease in the
production of S and employment of factors
of production in that industry.
Model Building:
Adjustment to the equilibrium point
There will be a surplus of S and a shortage of T at the prevailing relative prices
(Py/Px).
•
Surplus of S leads to a decrease in the production of S and employment of
factors of production in that industry.
• Shortage of T leads to an increase in
production of T and therefore those
resources that are released from industry S
are absorbed in the T industry.
Model Building:
Adjustment to the equilibrium point
There will be a surplus of S and a shortage of T at the prevailing relative prices
(Py/Px).
•
•
Surplus of S leads to a decrease in the production of S and employment of
factors of production in that industry.
Shortage of T leads to an increase in production of T and therefore those
resources that are released from industry S are absorbed in the T industry.
As a result the output mix will be changed
from B to A.
Model Building:
National Demand and Supply
Using the information provided in the PPC
and ICs, we can derive the national demand
and supply.
Model Building:
National Supply
Using the information provided in the PPC and ICs, we can derive the national
We know the slope of the PPC
gives the technical rate of transformation of
one commodity into another.
demand and supply.
Model Building:
National Supply
Using the information provided in the PPC and ICs, we can derive the national
demand and supply. We know the slope of the PPC gives the technical rate of
So if we draw a
tangent (representing the relative price of S
in terms of T) to the PPC at every point we
can derive the national supply for the two
commodities.
transformation of one commodity into another.
Model Building:
National Supply
Using the information provided in the PPC and ICs, we can derive the national
demand and supply. We know the slope of the PPC gives the technical rate of
transformation of one commodity into another. So if we draw a tangent
(representing the relative price of S in terms of T) to the PPC at every point we
We can see
how many units of S is produced at every
relative price.
can derive the national supply for the two commodities.
T
A

S
Pt

A’
S1
S
T
A


S
Pt

A’
S1
S
T
A
B


S
Pt
B’


A’
S1
S2
S
T
A
B


S
Pt
NS
B’


A’
S1
S2
S
Model Building:
National Demand
We also know that the slope of the IC gives
the Marginal Rate of Substitution between
Textiles and Soybeans (MRSst). That is, the
rate at which a consumer is willing to
exchange one commodity for another.
Model Building:
National Demand
We also know that the slope of the IC gives the Marginal Rate of Substitution
between Textiles and Soybeans (MRSst). That is, the rate at which a consumer
So, if we draw
a tangent (relative price line) the relevant IC
curve we can find the amount of the
commodity (S) that will be demanded at
that relative price.
is willing to exchange one commodity for another.
T

A
S
Ps/Pt
A’

S
S1
T

A
B

S
Ps/Pt
A’

B’

S
S1
S2
T

A
B

S
Ps/Pt
A’

B’

ND
S1
S2
S
Model Building:
General equilibrium
If we put both the national demand and the
supply we can find the equilibrium price
and the quantity of all commodities
Model Building:
General equilibrium: Autarky
NS
Ps/Pt
E
ND
S
Model Building:
International Comparison
Ps/Pt
NS
NS
E


A
C
D
E’
B
ND
ND
S
S
Great Britain
United States