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Lecture 9

ECO230Y1 Lecture Notes - Lecture 9: Utility, Comparative Advantage, Diminishing Returns

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Masoud Anjomshoa

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The Standard Model of Trade
Standard Model of Trade
Standard model of trade is Hecksher-Ohlin model,
which is good to analyze the impacts of moving from
autarky to free trade.
-But the standard model is used to analyze the
impacts of economic growth, trade policies,
transfer of income on trading equilibrium.
-Terms of Trade (TOT): Price of country’s
export divided by price of country’s import:
Welfare Effects of Terms of Trade:
Terms of Trade Effect: If the terms of trade fall, i.e. price of export falls relatively
(Px/Py decreases)
Sources of Gains from Trade:
-Gains from exchange (consumption gains):
Benefit from changing in relative prices
(cheaper import) (A to Cb)
-Gains from specialization (production
gains): Benefit from changing in production
combination from A to Pt (or from Cb to Ct)
How are the changes in Terms of Trade
-Shifts in relative supply (RS) and relative
demand (RD) curves
-Shifts in RS can be due to economic growth:
oTechnological progress
oExpansion of resources (increase in
capital and/or labour)
-Shifts in RD can be due to:
oIncome transfer due to war reparations, foreign aid, international
-Both RD and RS shifts can be due to import tariffs or export subsidies
Relative Demand Curve  If Px/Py increases  X > Y relatively  Y is substituted for
oX/Y decreases  RD is downward sloping
Relative Supply Curve:  CRTS technology + diminishing returns to factors = PPF is
Economic Growth and Trade
Export-Biased Growth and Trade:
-Suppose Home country exports X, which is labour intensive.
-If Home export sector (X) expands disproportionately due to
expanding labour force (abundant factor), or increase in productivity of X
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