chapter 3 -- classical model
DESCRIPTION
Chapter 3 -- Classical Model. INTERNATIONAL ECONOMICS, ECO 486 Display your name card. Learning Objectives. Understand five more assumptions Determine and understand comparative and absolute advantage Find international trade equilibrium Explain gains from trade - PowerPoint PPT PresentationTRANSCRIPT
1Chapter 3 -- Classical Model
• INTERNATIONAL ECONOMICS,ECO 486
• Display your name card
2Learning 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
3Learning 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
4Assumption #8
• Factors of production cannot move between countries
5Assumption #9
• There are no barriers to trade in goods.
6Assumption #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
7Assumption #11
• Labor is the only relevant factor of production in terms of productivity analysis or costs of production.
8Assumption #12
• Production exhibits constant returns to scale, CRS, between labor and output.
9CRS Implies Linear PPF
• See Figure 3.1, page 68
10Autarky
• See Figure 3.2, page 69
• Given perfect competition,
11Autarky
• 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
12Learning 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
13Absolute Advantage
• Compare one good across countries.
• Country with lower labor input has an absolute advantage in that good.
14Comparative Advantage
• Calculate opportunity costs.
• Compare one good across countries.
• Country with lower opportunity cost has a comparative advantage in that good.
15Which Advantage?
• Absolute advantage is a special case.
• Comparative advantage is the general case.
16Learning 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
17Terms of Trade
• Once trade begins, an international equilibrium results
• Results in one world price for a good
18Terms 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
19International 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
20Learning 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
21Gains From Trade
• Higher CIC shows a gain
• Measure gains from trade using GDP
• Sources of gain:
22Gains 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)
23Learning 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
24Perfect Competition Review
(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
25Perfect Competition Review
(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 LVMPL = Value Marginal Product of L
26Prices & 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)
27Exchange Rates
• State exchange rate, E, in US dollars per UK pound
– say $2/£
• A good will be imported if its foreign pre-trade price (x E) is less than the domestic price
PSA < E x PSB
28Buy 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
29Trade & Wages
• Substitute PXC = wC (hoursXC)
wA (hoursSA) < E x wB (hoursSB)
wA (hoursTA) > E x wB (hoursTB)
To solvedivide both sides by (E x wB)
divide both sides by (hoursXA)
30Trade & Wages (Cont.)
hourshours
WEW
hourshours
WEW
TA
TB
B
A
SA
SB
B
A
31Trade & Wages (Cont.)
• Trade will occur if the wage ratio does not exceed the productivity ratio hours
hoursWEW
hourshours
WEW
TA
TB
B
A
SA
SB
B
A
33Trade & Wages (Cont.)
• If one country is technologically advanced, it must have a higher wage rate.
hourshours
WEW
hourshours
WEW
TA
TB
B
A
SA
SB
B
A
34Losing 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
35
Review Homework
36
0 2 4 6 8 10
2
4
6
8
10
SOYBEANS, S (millions of bushels per year)
C
Q#8: Degree of Specialization
X
CIC1
CIC2
CIC0
G
Autarky Equilibrium
TE
XT
ILE
S, T
(mill
ions
of y
ards
per
yea
r)
PPF
C = COMPLETE SPECIALIZATION,ALLOWS GREATER CONSUMPTION
X = COMPLETE SPECIALIZATION,P = PARTIAL SPECIALIZATION
P
D
37
0 2 4 6 8 10
2
4
6
8
10
SOYBEANS, S (millions of bushels per year)
L
Quantity of Soybeans Demanded
H
CIC1
CIC2
CIC0
G
Autarky General Equilibrium|slope PPF| = PS/PT = 2 yd.T/bu.S
TE
XT
ILE
S, T
(mill
ions
of y
ards
per
yea
r)
PPF
PS/PT = 1 yd.T/bu.S
PS/PT = 2.5 yd.T/bu.S
4.71.8