Transcript INTERNATIONAL TRADE

INTERNATIONAL
TRADE
LECTURE 6:
Gains from Trade in Neoclassical Theory
Contents

To illustrate the equilibrium point under autarky

To introduce the international trade and to see
its influence to autarky economy

To research the minimum conditions for trade

To explain some important assumptions in the
analysis
Introduction

The effects of restrictions on international trade
 Example:
U.S. to non-NAFTA countries in 1999
 Conclusion: sizable welfare losses in general can
occur because of interferences with free trade
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This chapter focus on participating the trade to
avoid welfare cost
 An
updating of the Ricardian analysis
 Loose some assumptions
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Increasing opportunity cost
Factors more than labor
Explicit demand considerations
Autarky Equilibrium
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Autarky: total absence of participation in
international trade
Basic assumptions
 Consumers
seek to maximize satisfaction
 Suppliers of factor services and firms seek to
maximize their return from productive activity
 There is mobility of factors within the country but not
internationally (same factor return)
 There are no transportation costs or policy barriers to
trade (simple)
 Perfect competition exists (simple)
Autarky Equilibrium
In autarky,
production takes
place on the PPF,
and the equilibrium
is at point E
Px/Py=MRT=MCx/MCy
Px/MCx = Py/MCy
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Point A situation and B
Autarky Equilibrium
Bring consumers
into the picture and
autarky equilibrium
is at point E
Px/Py=MRS=MUx/MUy
Px/MUx = Py/MUy
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Autarky Equilibrium
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Conclusion
 In
autarky equilibrium, the following condition
should be satisfied
MRT = MCx/MCy = Px/Py = MUx/MUy = MRS
 In autarky equilibrium, production of each
good in a country must equal the consumption
of that good (OX1 Vs OY1)
 What happened when export or import exist?
Contents
 To
illustrate the equilibrium point
under autarky
MCx/MCy = Px/Py = MUx/MUy
production equal consumption

To introduce the international trade and to see its influence to autarky
economy

To research the minimum conditions for trade

To explain some important assumptions in the analysis
Introduction of International Trade

The trade triangle
 The
opening of a country to international trade means
exposing the country to a new set of relative prices
 Result: the producers and consumers will adjust to
them by reallocating their production and
consumption patterns and thus lead to gains from
trade
 The ultimate source of gain from international trade is
the difference in relative prices in autarky between
countries
Introduction of International Trade
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Prices in autarky is
(Px/Py)1
International prices is
(Px/Py)2
What does the
difference mean?
The change of
equilibrium point for
producer
The change of
equilibrium point for
consumer
Note: C’ is beyond the
PPF
Introduction of International Trade
 Trade
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triangle FC’E’
The base of this right
triangle FE’ represents the
exports of the country
The height or vertical side
of the triangle FC’
represents the imports of
the country
The hypotenuse C’E’
represents the trading line,
and its slope indicates the
world price ratio or terms of
trade
Introduction of International Trade

The consumption and Production Gains
from trade
 The
total gains from trade will be divided into
two parts: the consumption gain and the
production gain, or we say, the gains from
exchange and the gains from specialization
Introduction of International Trade
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Initial equilibrium point E
Consumption gain: When
faced with trade price ratio,
even without changes in
production, E C
Production gain: with the new
relative prices, there is an
incentive to producers CC’
The total gains from trade is
composed by CI1CI1’ and
CI1’CI2
Introduction of International Trade
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Trade in the partner country
 Assume
a two-country world
 Analysis for the partner is analogous to that
employed for the home country while trade
pattern is reversed
Introduction of International Trade
 For
partner, the international relative prices is less
than autarky prices
 Export? Import? Trade triangle?
Introduction of International Trade
 Note:
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The partner country also gains from trade
The two trade triangle must be the same
Again, the ultimate source of gain from
international trade is the difference in relative
prices in autarky between countries
Concept Check P95
Contents

To illustrate the equilibrium point under autarky

To introduce the international trade and
to see its influence to autarky economy
 Both
country gain and the source of gain
from international trade is the difference in
relative prices in autarky between
countries

To research the minimum conditions for trade

To explain some important assumptions in the analysis
Minimum Conditions for Trade
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Introduction
 Relative
price differences will present
potential gains from trade
 Two principal sources of relative price
variation between two countries
Differences in supply conditions
 Differences in demand conditions
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Minimum Conditions for Trade
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Trade between countries with identical
PPFs
 In
the Classical Ricardian analysis, there is no
incentive for trade because the pretrade price
ratios in the two countries would be the same
 In Neoclassical theory, two countries with
identical production conditions can benefit
from trade because of different demand
conditions in the two countries and the
presence of increasing opportunity costs
Minimum Conditions for Trade
 Two
countries have
different autarky ratio
 Country I good at
produce X and Country II
good at produce Y
 The equilibrium point will
stand between E and e
 Both countries will attain
higher indifference
curves
 Note: with constant
opportunity cost PPF,
relative prices in the two
countries would not differ
Minimum Conditions for Trade
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Trade between countries with identical
demand conditions
 Production
conditions may differ because
different technologies are employed with the
same relative amounts of the two factors
 Assume: country I is more efficient in
producing good X and country II is more
efficient in producing good Y
Minimum Conditions for Trade
 Identical
community
indifference map
and different PPF
exist and thus
different domestic
price ratio
 The equilibrium
point will stand
between E and e
 Both countries will
attain higher
indifference curves
Minimum Conditions for Trade
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Conclusion
 Relative
prices in autarky reflect underlying supply
and demand conditions which include the relative
amounts and quality of available resources, the
characteristics of the production technologies
employed, and the nature of demand in a country
 The underlying basis for trade can change as
technology changes, as factors grow within countries,
as factors move between countries, and as individual
country demand patterns change in response to
economic development and the increased exposure
to different products and cultures.
Some Important Assumptions
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Costless factor mobility
 Factors
of production can shift readily and
without cost along the PPF as relative prices
change and trade opportunities present
themselves
 This is impossible in the ‘real world’ and the
factors will not slide easily along the PPF but
moves inside it—equipment, labor, etc.
 Thus, some type of government assistance is
required
Some Important Assumptions
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Full employment of factors of production
 All
of a country’s factors of production are fully
employed
 It means that the country is operating on the PPF
 The real world does not always reach full
employment
 This assumption is to separate conceptually the
problem of efficiency and welfare from that of idle
capacity
Some Important Assumptions
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The indifference curve map can show welfare
changes
 We
know that when income distribution changed, the
community indifference curves may intersect
 Assumptions used here is to construct
nonintersecting community indifference curves
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Individuals within the economy have reasonably similar
tastes
The opening of the economy to trade does not radically alter
the distribution of income
 Much
moreCompensation principle: potential gains
from trade exist in the sense that, within the country,
the people who gain from trade can compensate the
losers and still be better off
 Thus, trade would still be preferred to autarky
Concept check on P101
Summary

To illustrate the equilibrium point under autarky

To introduce the international trade and to see
its influence to autarky economy

To research the minimum conditions for trade

To explain some important assumptions in the
analysis