Transcript Chapter 3, Husted & Melvin

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Chapter 3 -- Classical Model
• INTERNATIONAL
ECONOMICS,
ECO 486
• Display your name card
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Learning Objectives
• Understand five more assumptions
• Determine and understand comparative and
absolute advantage
• Find international trade equilibrium
• Explain gains from trade
• Derive range of wages that will permit trade
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Learning Objectives
• Understand five more assumptions
• Determine and understand comparative and
absolute advantage
• Find international trade equilibrium
• Explain gains from trade
• Derive range of wages that will permit trade
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Assumption #8
• Factors of production cannot move between
countries
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Assumption #9
• There are no barriers to trade in goods.
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Assumption #10
• Exports must pay for imports
• Assumptions 8-10 apply to both the
Classical and HO Models
• Assumptions 11 & 12 apply only to
Classical Model
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Assumption #11
• Labor is the only relevant factor of
production in terms of productivity analysis
or costs of production.
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Assumption #12
• Production exhibits constant returns to
scale, CRS, between labor and output.
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CRS Implies Linear PPF
• See Figure 3.1, page 68
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Autarky
• See Figure 3.2, page 69
• Given perfect competition,
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Autarky
• See Figure 3.2, page 69
• Given perfect competition,
– P = MC
– Autarky price of S equals slope of PPF
– Resource payments correspond to their
productivity
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Learning Objectives
• Understand five more assumptions
• Determine and understand comparative and
absolute advantage
• Find international trade equilibrium
• Explain gains from trade
• Derive range of wages that will permit trade
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Absolute Advantage
• Compare one good across countries.
• Country with lower labor input has an
absolute advantage in that good.
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Comparative Advantage
• Calculate opportunity costs.
• Compare one good across countries.
• Country with lower opportunity cost has a
comparative advantage in that good.
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Which Advantage?
• Absolute advantage is a special case.
• Comparative advantage is the general case.
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Learning Objectives
• Understand five more assumptions
• Determine and understand comparative and
absolute advantage
• Find international trade equilibrium
• Explain gains from trade
• Derive range of wages that will permit trade
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Terms of Trade
• Once trade begins, an international
equilibrium results
• Results in one world price for a good
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Terms of Trade
• Once trade begins, an international
equilibrium results
• Results in one world price for a good
– called the terms of trade
– between the two autarky prices
– determined by reciprocal demand
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International Trade Equilibrium
• See Figure 3.3, page 71
• Complete specialization in Comparative
Advantage good
• CIC & ToT tangent at consumption point
• Congruent trade triangles imply balanced
trade
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Learning Objectives
• Understand five more assumptions
• Determine and understand comparative and
absolute advantage
• Find international trade equilibrium
• Explain gains from trade
• Derive range of wages that will permit trade
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Gains From Trade
• Higher CIC shows a gain
• Measure gains from trade using GDP
• Sources of gain:
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Gains From Trade
• Higher CIC shows a gain
• Measure gains from trade using GDP
• Sources of gain:
– production (gains from specialization)
– consumption (ToT price lower than autarky)
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Learning Objectives
• Understand five more assumptions
• Determine and understand comparative and
absolute advantage
• Find international trade equilibrium
• Explain gains from trade
• Derive range of wages that will permit trade
Perfect Competition Review
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(Product & Resource Markets)
• PXC = MC for a good, X, in a country, C
• MC = w/MPPL (Labor, L, is only var. input)
• w=MRPL =(MR) MPPL=(P) MPPL=VMPL
Perfect Competition Review
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(Product & Resource Markets)
• PXC = MC for a good, X, in a country, C
• MC = w/MPPL (Labor, L, is only var. input)
• w=MRPL =(MR) MPPL=(P) MPPL=VMPL
• MRPL = Marginal Revenue Product
MR = Marginal Revenue;
MPPL = Marginal Physical Product of L
VMPL = Value Marginal Product of L
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Prices & Wages
• PXC = MC = w/MPPL
• MPPL is measured as units of X per hour
• hoursXC is stated as hours per unit of X
• PXC = wC (hoursXC)
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Exchange Rates
• State exchange rate, E, in US dollars per
UK pound
– say $2/£
• A good will be imported if its foreign pretrade price (x E) is less than the domestic
price
PSA < E x PSB
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Buy Low . . .
• Trade requires
PSA < E x PSB
PTA > E x PTB
 autarky prices
 A has comparative advantage in S
 B has comparative advantage in T
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Trade & Wages
• Substitute PXC = wC (hoursXC)
wA (hoursSA) < E x wB (hoursSB)
wA (hoursTA) > E x wB (hoursTB)
To solve
divide both sides by (E x wB)
divide both sides by (hoursXA)
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Trade & Wages (Cont.)
WA
hours SB

E  W B hours SA
WA
hoursTB

E  W B hoursTA
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Trade & Wages (Cont.)
• Trade will occur
if the wage ratio
does not exceed
the productivity
ratio
WA
hours SB

E  W B hours SA
WA
hoursTB

E  W B hoursTA
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Trade & Wages (Cont.)
• If one country is
technologically
advanced, it
must have a
higher wage
rate.
WA
hours SB

E  W B hours SA
WA
hoursTB

E  W B hoursTA
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Losing Comparative Advantage
• If the wage ratio exceeds the productivity
ratio, trade will not occur
• If a currency is overvalued (say $1/£
instead of $2/£), both goods may be cheaper
in one country
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Review Homework
TEXTILES, T (millions of yards per year)
Q#8: Degree of Specialization
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X = COMPLETE SPECIALIZATION,
P = PARTIAL SPECIALIZATION
10 X
Autarky Equilibrium
8
6
P
C = COMPLETE SPECIALIZATION,
C ALLOWS GREATER CONSUMPTION
G
D
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CIC2
CIC1
CIC0
2
PPF
0
2
4
6
8
10
SOYBEANS, S (millions of bushels per year)
TEXTILES, T (millions of yards per year)
Quantity of Soybeans Demanded
10
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PS/PT = 2.5 yd.T/bu.S
H
Autarky General Equilibrium
|slope PPF| = PS/PT = 2 yd.T/bu.S
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G
6
L
PS/PT = 1 yd.T/bu.S
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CIC2
CIC1
CIC0
2
PPF
0
1.8
2
4
4.7
6
8
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SOYBEANS, S (millions of bushels per year)