Comparative Advantage Increasing Cost Model

Transcription

1 G 652 Lectures 3, 4, and 5 omparative dvantage Increasing ost Model I. Review of the Ricardian Model ssumptions. Key assumptions. constant costs (Ms don t change as output levels change along F) 2. consumer tastes and preferences ignored. Other ssumptions. 2 nations and 2 commodities but only input 2. free trade 3. perfect mobility of the input resource within each nation but immobility between nations 4. no transportation costs 5. no technical change. onsequences of Key ssumptions. complete specialization of both nations in the product in which they have a comparative advantage 2. only the potential range of relative prices can be determined not specific TOT 3. production levels can be determined but not the level of trade or consumption of either of the two commodities

2 II. TWO-STOR MODL WITH INRSING OSTS. The roduction ossibilities Frontier (F) onstant osts Increasing osts given results in the same all along the same F. onstant Slope= / The slope of the F increases from left to right. To obtain a given amount of ( ), larger and larger amounts of ( ) must be given up. y x / =opportunity cost of producing an additional unit of in terms of how much must be given up. y y MRT increases along the F from left to right M x /M y at > M x /M y at y x / =MRT=M x /M y O > O y x x x

3 ountries Have Different Fs Nation Nation Differences in shapes arise from:. Different 2. se of different ssume: () Two factors: Labor (L) and apital (K) (2) is capital-intensive good; is labor-intensive good (3) Nation is relatively capital abundant; Nation is relatively labor abundant Thus: will tend to produce relatively more than will tend to produce relatively more than

4 . Introduce onsumers: ommunity Indifference urves (I) Definition: I shows the various combinations of the national consumption of two commodities that yield the same level of national utility (welfare, satisfaction).. The I is analogous to individual indifference curves in principle but the I exists only under some highly restrictive assumptions for individuals indifference curves: () declining Marginal Rate of Substitution (MRS) (2) the underlying function is ordinal (defined up to a strictly increasing monotonic transformation) (3) each individual s consumption is non-negative (4) no restrictions on the prices or the distribution of income among consumers (5) all consumers have homothetic preferences (i.e. income elasticity=) 2. roperties of community indifference curves: () Negatively sloping K (2) Slope is MRS=d/d (3) The MRS (slope) declines from left to right along the indifference curve. (Why?) (4) Declining MRS implies that the curve is convex to the origin (5) ach country has a family of community H indifference curves

5 3. What is the slope of a ommunity Indifference urve? H The slope is the change in divided by the change in at any given point on the I.

6 . Introduce onsumers: ommunity Indifference urves (I) Definition: I shows the various combinations of the national consumption of two commodities that yield the same level of national utility (welfare, satisfaction).. The I is analogous to individual indifference curves in principle but the I exists only under some highly restrictive assumptions for individuals indifference curves: () declining Marginal Rate of Substitution (MRS) (2) the underlying function is ordinal (defined up to a strictly increasing monotonic transformation) (3) each individual s consumption is non-negative (4) no restrictions on the prices or the distribution of income among consumers (5) all consumers have homothetic preferences (i.e. income elasticity=) 2. roperties of community indifference curves: () Negatively sloping K (2) Slope is MRS=d/d (3) The MRS (slope) declines from left to right along the indifference curve. (Why?) = (4) Diminishing MRS implies that the curve is convex to the origin (5) ach country has a family of community H indifference curves

7 . quilibrium in utarky roduction Side of the conomy NI/ y. Given price x and y : National I (NI) = x + y 2. Slope of NI = x / y 3. MRT = M x /M y 4. Optimal production point since M x /M y = x / y 5. t : M x /M y < x / y The opportunity cost of producing an extra unit of is less than the value of that unit. NI can increase by producing more and less. 6. t : M x /M y > x / y The relative value of the last unit of produced in terms of the given up is less than the opportunity cost of in terms of the given up. So less production of and more of will increase NI. NI/ x

8 . quilibrium in utarky (cont d) onsumption Side of the conomy. Nat. income = Value of cons. 2. NI = x + y 3. is point of optimum consumption MRS = M x /M y = x / y 4. t : M x /M y > x / y The relative utility (satisfaction) from consuming an extra unit of is greater than the relative cost of that unit of. Total utility (welfare) can increase by consuming more and less. 5. t : M x /M y < x / y The relative utility (satisfaction) from consuming an extra unit of is less than the relative cost of that unit of. Total utility (welfare) can increase by consuming less and more.

9 . quilibrium in utarky (cont d) Homothetic references NI 2 y NI y s income increases (with fixed ) the quantities consumed change proportionally (i.e., tangencies of curves to budget line lie along a linear expansion path from the origin). 2 Note that: 2 = 2 (, ) ( 2, 2 ) 2 NI 2 which means that and are increasing in proportion to each other as income grows. NI NI 2 2 NI x NI 2 x NI What if we start at another point on (like (, ))?

10 . quilibrium in utarky (cont d) Interaction of roduction and onsumption In the conomy F t oint : x y < e e x y D D > S x y x y

11 . quilibrium in utarky (cont d) Interaction of roduction and onsumption In the conomy F F t oint : x y > e e x y D D > S x y p x y F

12 . quilibrium in utarky (cont d) Interaction of roduction and onsumption In the conomy F D t oint : x y = e e x y quilibrium: M M x y = x = M y M x y

13 D F Nation (Labor bundant) Nation (apital bundant) III. TH SIS FOR ND GINS FROM TRD Now what if we have two countries? : The state of no trade. ach country is self-sufficient and does not trade with other countries. If these two countries are allowed to trade, the terms of trade (TOT) or price at which they will trade will be somewhere between the utarky TOT, that is, between and.

14 III. TH SIS FOR ND GINS FROM TRD What if we allow the two countries to trade? Nation (Labor bundant) Nation (apital bundant) D I < I < S I D F S - If S > D and/or S < D then / will D - If S < D and/or S > D then / will - When S = D and S = D then / will be the equilibrium

15 III. TH SIS FOR ND GINS FROM TRD exports to and Imports from ( Nation (Labor bundant) Nation (apital bundant) ). D S D F S D Q: What is the SIS for trade? :

16 III. TH SIS FOR ND GINS FROM TRD exports to and Imports from ( Nation (Labor bundant) Nation (apital bundant) ). D S D F S D Q: What are the GINS from trade? :

17 IV. DOMOSITION OF TH GINS FROM TRD Move from to T ( to ): Gains from T 2 Move from T to ( to 2 ): Gains from