CH. 3: STANDARD THEORY OF INTERNATIONAL TRADE
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  • PPF with increasing cost.

    • -2 goods: Y (vertical axis) and X (horizontal axis) and 2 nations.
    -Increasing cost implies that increasing production of one good, more and more of the other good must be given up (Concave PPF).
    -This implies MRT (Marginal Rate of Transformation), or the absolute value of the slope of the PPF, is increasing.
    MRT of X for Y = the amount of Y that must be given up to produce one more X.

    -Why are PPFs different between countries and why is cost (opportunity) increasing?
    -PPFs are different because of different factor endowments (some nations have more L,K,land and natural resources) and different technology.
    -Cost is increasing because factors are not homogeneous and are not used in the same intensity (K/L ratio differs).
     

  • Indifference curves.

    • -An indifference curve (IC) shows different bundles of two goods that give the same utility/satisfaction/happiness (tells us about preferences).
    -Convex IC (diminishing marginal utility).
    -IC cannot intersect.
    -More is better than less.

    -Marginal Rate of Substitution (MRS) is the slope (absolute value) of the IC.
        MRS indicates the amount of Y that can be given up in order to gain one more unit of X and be on the same IC.

  • Equilibrium without trade

    • -Without trade the equilibrium is where MRT=MRS.  =>IC and PPF tangent. (fig. 3.3, p.68)
    - The slope of the tangent is -(Px/Py):  In nation 1 = 1/4 ; nation 2 = 4/1.
        Price of X (relative to price of Y) is less in nation 1 => Nation 1 has comparative advantage in X.
                                                                                     => Nation 2 has comparative advantage in Y.
    -This implies nation 1 (2)  will export good X (Y) and import good Y (X).

    -Case study 3.1, p.69: Composition of exports and imports: US, EU and Japan.

  • Equilibrium with trade

    • With trade Px/Py will be between 1/4 and 4.
    Since Px/Py will be higher than 1/4, nation 1 will increase production of good X.
    and nation 2 will increase production of good Y (since Px/Py will be lower than 4 (which means Py/Px is higher with trade => nation 2 will increase production of good Y).

    -What will the new Px/Py be?  somewhere between 1/4 and 4, where exports of Y (X) is equal to imports of Y (X), i.e. zero net exports (fig.3.4, p. 71).  Trial and error reveals Px/Py =1.
    -Nation 1 produces at point B but consumes at point E.  Note that point E is on a higher IC than pt. A (no trade point).
     => this implies trade has increased welfare for nation 1 (and nation 2).

    Note that each nation does NOT completely specialize in each good (because of increasing cost).
     

    -Gains from trade can be decomposed into 2 parts:
    1) exchange         => no change in production (compared to no trade point) but move to a higher IC (pt. A to T, fig.3.5, p.72)
    2) specialization => change in production (pt. T to E).

    -Case study 3.3 (p.76) shows percentage change in employment in the U.S. between 1970 and 1980.
     Is the table consistent with what we would predict in terms of pattern of trade?
     Are the industries where employment has fallen more or less labor intensive than the industries where employment has increased?

    -Case study 3.4 (p. 77):  Why have manufacturing jobs declined in the U.S.?  How much of the decline can be 'blamed' on trade?

    -Trade based on differences in tastes.
    -Even though nations have the exact same PPF, as long as their preferences are different (IC's tangent to PPF at two different points) there are gains from trade.  Again, world prices will be such that each nation has NX=0.

    -What if PPFs and ICs are the same in each nation, do they gain from trade?