ECON 2100 Lecture Notes - Lecture 9: Factor Endowment, Economic Surplus, Market Power

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Published on 30 Sep 2016
Chapter 9- Application- International Trade
- Why do countries trade with each other?
Ricardo Model: A theory that explains the existence of a country’s comparative advantage by its
Heckscher-Ohlin theorem: A theory that explains the existence of a country’s comparative
advantage by its factor endowments.
New trade theory: Monopolistic Competition Model (people love variety) * cannot explained by
People and nations rely on specialization and trade in a way to address scarcity.
An Economic Consensus: Even though economists may not all agree, many favor free trade.
Recap: A country has a comparative advantage in the production of a good if it produces the
good at a lower opportunity cost than the other country.
- The World Price and Comparative Advantage
Comparative Advantage can be seen from prices, ceteris paribus.
Compare the domestic price of a good without trade and the world price of the good.
The world price refers to the price that prevails in the world market for that good.
Pw= The world price, price that prevails in world markets
Pd= domestic price of good without trade
Pd<Pw- means that country has comparative in that good and exports it
Pd>Pw- domestic price is more expensive; therefore the country does not have comparative
advantage and imports the good.
- The Small Economy Assumption
A small economy is a price taker in world markets; has no effect on Pw.
When a small economy partakes in free trade, it is more relevant at Pw.
Pd<Pw= export, consumer surplus falls, producer surplus rises, and total surplus rises.
Pd>Pw= import, consumer surplus rises, producer surplus falls, total surplus rises.
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