2 factors 2 sectors Flashcards
What are the standard assumptions?
Perfectly competitive goods and factor markets, constant returns to scale (CRS), (free trade)
Factors fully mobile within country across industries (long-run view)
What is the intuition in finding the competitive equilibrium?
The slope of the PPF is the opportunity cost of increasing y2 in terms of the required reduction of y1. This is equal to the marginal rate of transformation (MRT) which itself is the ratio of marginal productivities of labor and capital in the respective sectors.
Same is true in a closed economy
What happens when a country opens up to trade?
the relative price of good 1 increases from p to p’
⇒ Equilibrium production changes from point A to A’
⇒ Export some of good 1 (and import 2) to obtain higher utility
define unit costs with a CRS
With CRS, unit costs equal marginal costs and average costs
what does price-taking behavior imply?
Price-taking behavior implies that price equals marginal cost
explain the change in the unit costs when w changes
page 15-16
Factor Price Equalization Theorem
If two countries produce both goods using the same technologies and both goods are freely traded, factor prices are equal across countries.
explain how factor prices change when output prices change
Stolper-Samuelson page 17
Stolper-Samuelson Theorem
An increase in the relative price of a good will increase the real return to the factor used intensively in that good, and reduce the real return to the other factor.
Rybcynski Theorem
An increase in one factor endowment will increase the output of the industry that uses this factor intensively, and decrease the output of the other industry.
explain the cone of diversification and the consequence of a change in the endowments
page 18-19
