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Chapter 4

ECO230Y1 Chapter Notes - Chapter 4: Budget Constraint

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Junchul Kim

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Chapter 4:
Ricardian model assumes labour to be the only factor of production; how ever in the real
world, trade also reflects diff in countries resources; e.g. Canada exports forest products
to US not b/c its lumberjacks are more productive relative to their US counterparts but
b/c sparsely populated Canada has more forested land per capita than the US.
Heckscher-Ohlin Theory/ Factor-Proportions Theory: int’l trade is largely driven by diff
in countries resources; emphasizes the interplay b/w the proportions in which diff factors
of production are available in diff countries and the proportions in which they are used in
producing diff goods.
When there are 2 factors of production, there maybe some room for choice in the use of
inputs; the PPF is no longer a straight line; thus the opportunity cost of producing an
extra unit of good X in terms of good Y is NOT constant—it is low when the economy
produces little good X and a lot of good Y, but high when the economy produces a lot of
good X and little good Y.
(when the factors of production cannot be substituted for one another, the PPF has a kink)
Isovalue Line: a line along which the value of output is constant
-the economy produces at the pt that maximizes the value of production given the
prices it faces; i.e. the pt on the highest possible Isovalue line; at this pt, the
opportunity cost of X in terms of Y= relative price of X i.e. Px/Py
Increase in the economy’s supply of land will, holding prices constant, lead to a fall in the
output of the labour-intensive good.
Biased expansion of production possibilities: occurs when the PPF s hifts out much more
in one direction than in the other— the key to understand how diff in resources give rise
to int’l trade, i.e. 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.
* Countries tend to export goods whose production is intensive in factors with which
they are abundantly endowed.
(abundance: defined in terms of a ratio NOT in absolute quantities, thus relative terms)
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