week2 - trade models- Ricardian, specific factors model,

What is comparative advantage?

the ability to produce a good at a lower opportunity cost than another producer

Ricardian Model

- supply side and role of labour productivity - differences in technology between trading partners that account for trade- even if one country is more efficient than all the others in the production of all goods, it is still not in its interest to be in autarky, rather can gain by specialising in production and engaging in trade with other countries--> assumes perfect mobility

ricardian model: one factor economy model step up


what is the slope of a production possibility frontier

opportunity cost

ricardian model: explain relative supply and relative demand curves


what does ricardian model show

country specialised in the production of goof that have relatively lower unit labour requirements

whats the consequences of the ricardian model

that both the foreign and home countries can consumer anywhere up to the blue line which is outside countries production frontiers

how can you show the gains from trade

1. indirect method of production - can make wine by making cheese 2. consumption possibilities - can consume different mixes

why is it not true that free trade is beneficial only if your country is strong enough to stand up for foreign competition (ricardian model_)


why is it not true that foreign competition is unfair and hurts other countries when it is based on low wages (ricardian model_)

only thing that matters is relative wage in own country of different products

why is it not true that trade exploits a country and makes it worse off if its workers receive much lower wages than workers in other nations

if didn't trade then good would be more expensive so would be even worse in terms of purchasing power

set up for comparative advantage with many goods


whats the implication of the comparative advantage model with many goods

start with demand for goods produced with each countries 1. w/w* goes up 2. relative demand for home Labour goes down because it is relatively more expensive3. good produced in home country more expensive relatively4. world demand down

provide three reasons why specialisation (ricardian model) is not extreme in real international economies

1. existence of more than one factor of production reduces the tendency towards specialisation 2. countries sometimes protect industries from foreign competition 3. it is costly to transport foods - in some cases cost of transportation is enough to lead countries into self sufficiency in certain sectors e.g. high weight to value ratio like cement - non traded goods- little international trade with goods that have high weight to value ratio

what are misleading predictions of the ricardian model

- No role for difference in resources among countries as a cause of trade e.g. we have no diamonds so they're always gonna be better at producing- predicts extreme degree of specialisation - not real- assumes away/forgets distribution problems- neglects possible role of econ of scale as a cause of trade

give an example that can be explained by the ricardian model

china as an exporter

whats an issue with the ricardian model that the specific factor model fixes

ricardian model assumes only one factor (labour) so suggests that when a country becomes better off through trade, all the individuals within that country gain as well - specific factors model has additional factors of production and uses this in part to show how international trade can make individuals both better and worse off

what are the assumptions of the specific factors model without trade

- one country (no trade initial) - two goods (cloth and food)- three factors of production: Lc,Lf, K (capital used only for cloth), T (land used only for food) - production function of each goodQc=Qc(K,Lc)Qf=Qf(T,Lf)Lc+Lf=L

explain law of diminishing marginal returns in terms of cloth for specific factors model


draw and explain the the four quadrant diagram that highlights the allocation between food and cloth for the specific factors model (including MPL)

- it combines 1) both production functions, 2) the allocation of labour 3) the overall economy production possibilities frontier in top left and bottom right are production functions which are nonlinear due to the diminishing returns that aristocrat's from the fixed factors - draw the allocation of labour first and map it out to the production functions to form the overall economy ppf - the slope of the individual production functions is MPLf,c and represents the additional output from one unit of labour - one additional unit of cloth would take 1/MPLc hrs of labour and require one less in food i.e. -MPLf - slope of the PFF will be -MPLf,MPLc... to find to where economy actually produces at need to introduce prices and the wage rate in the two sectors

explain the diagram showing wages in specific factor model

- firms will demand labour up to the point where the cost of that labour is equal to the revenue they earn on that unit general: MPL * P =w - diminishing return (MPL gets smaller) the demand for labour curve is downwards sloping in equilibrium :-(PcMPLc) = PfMPLfrearrange:-Pc/Pf = -MPLf/MPLcratio of prices = slope of PPF

specific factor model: show the interaction between the ppf and prices

in equilibrium (can see clearly from wages diagram) :-(PcMPLc) = PfMPLfrearrange:-Pc/Pf = -MPLf/MPLcratio of prices = slope of PPF

specific factor model: explain how the wages graph changes when the price of both goods change in the same proportion

nothing - real wage remains the same so no movement

specific factor model: explain what happens if the price of only cloth increases

- demand for labour cloth shifts with an increase in prices (P'c) but wages rises is less than proportional- labour shifts out of food and into cloth Lc'1>Lc1 and Lf'1 <Lf1- slope of relative prices = slope of PPF- -Pc/Pf has gotten steeper so production moves to Qf' and Qc'

specific factor model: when the price of cloth increases and more labour is demanded and more cloth is made, how does the distribution of income change

labour - ambiguous - real wages in terms of cloth have fallen as prices rose by more than the nominal wage rose. real wages in terms of food have risen - the affect on distribution of income depend on the relative importance of each in budgetscapital - positive- used in cloth - real wage they pay workers falls as prices risen proportionally more so profits riselandowners - negative- used in food- real wage has risen while the relative price of food has fallen

explain the specific factors model with an open economy i.e. international trade


what two factors explain world trade

1. labour productivity - ricardian model 2. differences in countries resources (heckscher ohlin model)

set up the Heckscher ohlin model

2x2x2 model2 countries: Home (labour abundant) and foregin (capital abundant)2 goods: cloth and food2 factors of production: labour and capital production functions:Qc=Qc(Kc,Lc)Qf=Qf(Kf,Lf)capital/ labour used to produce a yard of cloth/calorie of food: aKc,Akf,Alc,Alf (not capital As tho)assumes both countries make both goods - if have extreme labour would just make cloth- only works if countries have relatively similar endowments assumed technologies are the same assumes price of good same in two countries but natural barriers.g. transport costs and barriers to trade assume that mix of inputs can change i.e certain quantity of a good can be produced with lots of capital or lots of labour - it depends on relative prices of the inputs assume that these factors of production are mobile across sectorsassume a competitive market: price of each good = Marginal cost of production i.e. P=Mc (breaking of these assumptions mean that complete factor-price equalisation is not observed)

whats the main difference between the heckscher ohlin model and the specific factor model

HO assumes factors of production are mobile across sectors whereas specific factor model only assumes labour is mobile

heckscher ohlin model: explain capital and labour constraints (assume no factor substitution

resource use cannot exceed the total supply of the resource akcQc + akfQf =< KalcQc +alfQf =<Ldraw them on a graph Note which products are capital or labour intensive (akf/alf)

heckscher ohlin model: Labour and capital constraints are binding- explain what this means and the consequences

the PPF is bounded by BOTH the constraintsso if produce only food, can produce at most 1,000 units of food because it takes 3 units of capital to produce 1 unit of food then have spare resources the kink is the only point where all resources be employed The opportunity cost of cloth in terms of food is not constant e..g the app cost of cloth in terms of food rises as the economy produces more cloth - generally, an economy will tend to be relatively effective at producing goods that are intensive in the factors with which the country is relatively well endowed in

heckscher ohlin model: if you assume that you can substitute labour for capital and vice versa what affect does this have on the PPF and what determines the position on the PPF


heckscher ohlin model: whats an isovalue line

V= PcQc + PfQf value = value of production in cloth + value of production in food- along an isovalue line, value is constant- slope of isovalue lines = ratio of prices

heckscher ohlin model: how do firms decide on what mix of inputs to use

to do with relative factor prices : w/r- graph the relationship between factor prices (w/r) and the labour to capital mix (K/L) of food (FF) and cloth (CC) production - downwards sloping - when wages are relatively low, firms choose more workers and less capital - in our example, akf/alf> aka/alc so can see that food is more capital intensive and cloth is labor intensive which means that for any given w/r production of cloth uses more labour

heckscher ohlin model: what does the price of a good depend on and draw the relationship between the ratio of factor prices and ratio of goods prices

we've assumed a competitive market i.e. MC=p so price of a good depends on cost of that good to produce w.g. wage rises then price of the good using a lot of labour will rise and it wouldn't have much affect is only use little amounts of labour positive relationship between ratio of factor prices (w/r) and the ratio of goods prices (Pc/Pf)

heckscher ohlin model: draw the price of factors and goods graph with the input mix and interpret it

when Pc/Pf increases, both the production of food and cloth uses less L/KMPl rises when L/K falls because diminishing marginal returns. w=MPl so w/r will rise from both w increase and r falling as MPk is falling

explain what happens in the heckscher olin model once there's open trade

- home is relatively labour abundant and foreign is relatively capital abundant - cloth is labour intensive good, homes production possibility frontier relative to foreigns is shifted out more in the direction of cloth than food so tend to produce a higher ratio of cloth to food- trade leads to convergence of relative prices - countries differ in their factor abundances, so for any price ratio of cloth to food, home will produce a higher ratio of cloth to food than foreign will ( home will have larger relative supply of cloth- assume same relative demand - if no international trade then home at 1 and foreign at 3 but when there is price convergence at 2. so the relative price of cloth rises in home ad declines in foreign - the country exports the good who's relative price increases so home export cloth and foreign will export food (relative price of cloth declines in foreign which means relative price of food rises)- home becomes an exporter of cloth because it is labour abundant and becuase production of cloth is labour intensive

what is the outcome of the Hecksher Ohlin model

the country that is abundant in a factor exports the food whose production is intensive in that factor

who gains in the huckster ohlin model

long term: owners of a country abundant factors fain from trade but owners of a countries scare factor lose A raise in the price of cloth raises the purchasing power of labour in terms of both goods while lowering the purchasing power of capital in terms of both foods - home where relative price of cloth rises - people who get income form labour gain from this trade but then incomes from capital are worse off- foreign the opposite happens

what difference between conclusion on income distribution in specific factors model vs HO model

specific factors - factors of production that are "stuck" in an important competing industry lose from the opening of trade - this only temporary thoHO- factors of production that are used intensively by the import competing industry are hurt by the opening of trade

whats the leontief paradox

in context of empirical evidence on HO modeltrade in goods as a substitute for free in factors - Us is high on capital to labour ratio but not an exporter of capital intensive goods

whats an example that can be explained by Ho model

pattern of trade between developed and developing countries