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

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greenraccoon19

30 Apr 2016

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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: Terms of trade effect: if the terms of trade fall, i. e. price of export falls relatively (px/py decreases) 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: technological progress, expansion of resources (increase in capital and/or labour) Shifts in rd can be due to: income transfer due to war reparations, foreign aid, international loans.

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Fill in the blanks. In case you get stuck, Iâve provided a list of all the missing words in alphabetical order at the end of the question. According to David Ricardoâs model, the pattern of trade between nations is determined by the distribution of ______________________ advantage. Unlike the ______________________ advantages described by Smith, Ricardoâs explanation allows for trade between partners in which one nation has superior ______________________ in the manufacture of all goods. Thatâs because Ricardoâs principle rests on the economic concept of ______________________ (defined as the amount of good Y that must be sacrificed when the nation produces a unit of good X) which can never be concentrated in just one nation. The model is usually specified with barter-style trade, meaning that we use ______________________ rather than ______________________ prices for the tradable goods. The price of each good on international markets must be higher than ______________________ in the exporting countries and lower than ______________________ in the importing countries. Although all parties can benefit from trade, there is no reason to think that they benefit equally. The ______________________ are derived from the difference between the opportunity costs of production in each nation and then distributed between participating nations according to the market price. As the price of a nationâs ______________________ good rises, it receives a larger share of the gains from trade, and we say that its ______________________ are appreciating. However, nations that ______________________ this good will receive a smaller share of the benefits from trade.

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Comparative

Export

Gains from trade

Import

Max WTP

Min WTA

Money

Opportunity cost

Productivity

Relative

Terms of trade

tansnake161

Q2. (35 points) The following table shows the output of textile and auto one unit of labor can produce in the U.K. and the U.S.:

	Textiles	Autos
United Kingdom	16	4
United States	6	3

A)Which country has an absolute advantage in textiles and which country has an absolute advantage in autos?

B)What is the autarky price ratio of autos relative to textiles in each country?

C)Which country has a comparative advantage in textiles and which country has a comparative advantage in autos?

D)Which product should each country export?

E)Suppose the United States has 300 units of labor available. Construct the production-possibilities frontier (PPF) and identify the optimal autarky equilibrium (using an indifference curve) for the United States.

F)Suppose the international price is set at 1 auto:3 units of textile and the U.S. decides to completely specialize at producing the product in which it has a comparative advantage. How would the above graph change? Use the graph to show the gains from trade and the export and import quantities. For each unit of export good, how much does the U.S. gain (measured in terms of the other good)?

G)Discussion: At what level of international price ratio will all the benefits from trade accrue to the United States?

Your answer:

raspberrymole776

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

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