Gains from trade
Production
Consumption
Workers’ Gain
Worker’s wage in home country: W = Pc / MPL or W = W/PC (Terms of cheese)
MPL = PC/aLC
Home Country Wage: $12 an hour
Foreign Country Wage: $4 an hour
Home’s exports: Cheese
alc = 1
½ = PC / PW
Foreign exports: Wine
alc = 3
2 = PW / PC
Free trade is beneficial only if a country is more productive than foreign countries.
Opportunity cost drives the need for free trade, not necessarily the productivity. Some people don’t want to give up certain products for a different one.
Free trade with countries that pay low wages hurts high wage countries.
While trade may reduce wages for some workers, thereby affecting the distribution of income within a country, trade benefits consumers and other workers.
Consumers benefit because they can purchase goods more cheaply.
Producers/Workers benefit by earning a higher income in the industries that use resources more efficiently, allowing them to earn higher prices and wages relative to no-trade.
Free trade exploits less productive countries whose workers make low wages.
The Ricardian model predicts that countries completely specialize in production.
Do we see that in reality?
This rarely happens for three main reasons
More than one factor of production reduces the tendency of specialization (Chapters 4 - 5)
Protectionism (Chapters 9 - 12)
Trump’s Tariffs being imposed is an example of protectionism.
Transportation costs reduce or prevent trade, which may cause each country to produce the same good or service.
Non-traded goods and services (haircuts/auto repairs) exist due to high transport costs.
Countries tend to spend a large fraction of national income on non-traded goods and services.
This fact has implications for the gravity model and for models that consider how income transfers across countries affect trade.
Do countries export those goods in which their productivity is relatively high?
Positively sloped line, export the goods you are relatively more productive in.
Relative productivity matters most in trade
The main implications of the Ricardian Model are well supported by empirical evidence
Productivity
differences play an important role in international trade
Comparative Advantage
Trade inequality
Some unequal distribution, some heads might lose their job.
Assumptions
H-O model only uses two factors of production, labor and capital
You are combining both. You can’t do something with just capital, you need someone to work that.
Only two goods are being traded. (Food & Cloth)
Only two countries, Home and Foreign
Identical Taste
Both countries
Same technology across both countries.
Not for both goods. We are assuming the same technology is present in both countries. For example: To make cloth is the same in both countries but to make cloth in one country is different than making food in a different country.
“The way you combine labor and capital to produce food at home is the same as foreign.” (The ratio)
Different relative factor endowments/stock.
Factor endowment/stock: total available quantity of labor and capital you have.
Ricardian Model
Just uses one factor of production, labor
Only two goods are being traded. (Cheese & Wine)
Only two countries, Home and Foreign
Identical Taste
Both countries
Labor productivity is constant.
Labor productivity varies from country to country.
Technology is different across sectors and countries.
Technology: Combing your inputs to make an output. Whatever you’re doing for that, could be the process for making it.
Comparative Advantage: When you can produce a good for less of an opportunity cost than another country.
Factor intensities: Ratio of labor to capital for a specific good.
Assumption about these: They are not equal for both goods.
Labor intensities for food ≠ labor intensities for clothing.
Home is relatively abundant in labor. Relatively scarce in capital.
I am research Sweden for my presentation.
Need to explain on each answer why that is the answer.
No Class 03/13/2025 for Midterm
Read Chapter 5 + 6 of textbook
Ricardian Model
One Factor
Facor productivity differential
Hecksher-Ohlin Model
Two factors
Identical Technology
Relative Factor Endowment differential
Specific Factor Model
Three Factors
Restricted Factor Mobility
One factor mobile, two factors not mobile.
Standard trade model is a general model that includes Ricardian, specific factors, and Heckscher-Ohline models as special cases.
Two goods, Food (F) and cloth (C)
Each country’s PPF is a smooth curve.
PPF: Tells you the maximum amount you can produce with your current resources.
Slope gives you the opportunity cost of production.
Helps us understad the welfare effects of trade in a more generalized framework.
Helps us to analyze welfare effects of trade due to changes in this economy.
Example:
What happens to a country’s welfare if there is an expansion in its export sector?
What happens to a country’s welfare if there is an expansion in its import sector?
Two main reasons why international trade has strong effects on the distribution of income within a country:
Industries differ in the foctors intensities (H-O Model).
Resources cannot move immediately or costlessly from one industry to another.
Sources of trade:
Differences in production possibilty frontiers.
Differences in labor services, labor skills, physical capital, land, and technology between couuntries cause differences in production possibility frontiers.
Relative supply:
A country’s PPF determines its relative supply function in each country.
National relative supply functions dtermine a world relative supply function.
World Equilibium:
World relative supply function along with world relative demand determines the equilibirium under international trade.
How much cloth and food a country produces depends on the relative price of cloth to food Pc / PF and opportunity costs.
Remember, the producer is always trying to maximize profits.
Relative supply curve is the relationship between relative quanitity of goods supplied and relative prices of the good.
Need to find how production changes when the relative prices change.
What is terms of trade:
Price of exports divided by price of imports: PX / PM
X = Volume of Exports
M = Volume of imports
Increase in the terms of trade leads to welfare going up. They grow together and decrease together.
Helps us to analyze welfare effects of trade due changes in the economy.
Example:
What happens to a country’s welfare if there is an issue in its export sector?
What happens to country’s welfare if there is an increase in its import sector?
Outward shift on the PPF means growth in the country.
Government adopts various policies that affect the volume of trade, terms of trade between countries.
Examples:
Import tariffs
Import Quotas
Ad-Valorem Tariffs
Export subsidies
Voluntary Export Restraints
Such policies may have important effects on countries welfare and income.
A tariff is a tax levied when a good is imported.
A specific tariff is levied as a fixed charge for each unit of imported goods.
For example, $2 per barrel of oil.
Per unit tariff
If a T-Shirt costs $10 per shirt, for every T-Shirt you import you pay $3 to import it so the producer will up the cost to $13 a shirt.
An ad valorem tariff is levied as a fraction of the value of imported goods.
For example, 25% tariff on the value of imported trucks.
Think of the Chicken Tax type shit
Focus on one kind trade policy
Import tariffs (specific tariff): taxes levied on imports
Analyze the effect of these policies using
General equilibrium framework
Partial equilibrium framework
Both policies influence terms of trade and therefore national welfare.
Import tariffs and export subsidies drive a wedge between prices in world markets and prices in domestic markets.
Simultaneous shifts in RS and RD.
Continue with our previous assumptions:
2 countries: home and foreign
2 goods: cloth and food
Both countries are trading with one another
Home exports cloth and foreign exports food
Analyze the relative price and supply effects of a tariff imposed by one country on the other.
Need to make an additional assumption regarding size of the economy in the world market.
Large
Small
Home country imposes a tariff on food imports.
Create a wedge between domestic (internal) and world (external) prices of goods.
Internal price: price at which goods are traded within the country (nationally)
External price: price at which goods are traded internationally (world market) — terms of trade.
Suppose home country imposes a 20% tariff on the value of food imports.
The (internal) price of food relative to the price of cloth rises for domestic consumers.
Likewise, the (internal) price of cloth relative to the price of food falls for domestic consumers.
Supposed home country imposes a 20% tariff on the value of food imports,
Domestic producers will receive a lower relative price of cloth, and therefore will be more willing to switch to food production.
Relative supply of cloth will decrease in the world market (World relative supply of cloth shifts to the left.)
Domestic consumers will pay a lower relative price for cloth, and therefore will be more willing to switch to cloth consumption.
Relative demand for cloth will increase (World relative demand for cloth shifts to the right).
When the home country imposes an import tariff, the terms of trade increase and the welfare of the country may increase.
The magnitude of this effect depends on the size of the home country relative to the world economy.
If the country is a small part of the world economy, its tariff policies will not have much effect on world relative supply and demand, and thus on the terms of trade.
But for large country, a tariff may maximize national welfare at the expense of foreign countries.
Tariff imposes costs by distorting production and consumption incentives in Home country.
Over all effect on tariff on welfare depends on:
How terms of trade gain compares to efficiency losses.
Need to take a closer look to evaluate the welfare effects of tariffs — Partial Equilibrium Analysis — where we focus on one market (import competing goods) in the home country and analyze the gains and losses from tariffs.
Partial Equilibrium: Focus on a single market rather than all sectors in the economy.
Consider how a tariff affects a single market, say that of wheat.
Two countries: Home and foreign
One good: wheat
Both country consume and produce wheat.
We will consider specific tariff, t
Tariff creates a wedge between domestic price and foreign price
Pt = P* + t
Review Midterm Review