Ch. 6: The Standard Trade model Flashcards
Which 4 key relationships are the Standard trade model built upon?
(1) the relationship between the production possibility frontier and the relative supply curve.
(2) the relationship between relative prices and relative demand.
(3) the determination of world equilibrium by world relative supply and world relative demand.
(4) the effect of the terms of trade— the price of a country’s exports divided by the price of its imports—on a nation’s welfare.
What does the indifference curve show?
Makes a set of combinations of the two goods that leave the individual equally well off. There are 3 properties about Them:
(1) They are downward sloping: Less food is okay if they get more cloth.
(2) An individual prefers having more of both good: The more up to the right, the higher level of welfare.
(3) Each indifference curve gets flatter when moving to the right: The more C and less F, the more valuable F becomes compared to a unit of C, so more C is needed to compensate for F.
What is the income effect?
The rise in welfare.
• Tend to increase consumption of both goods.
What is the substitution effect?
The shift in consumption at any given level.
• Acts to make the economy consume less C and more F.
What is the terms of trade?
The price of the good a country exports divided by the price of the good it imports.
• A rise in the terms of trade increases a country’s welfare, while a decline in the terms of trade reduces its welfare.
Is economic growth in other countries good or bad for our nation? Second, is growth in a country more or less valuable when that nation is part of a closely integrated world economy?
- Economic growth in the rest of the world may be good for our economy since it means larger markets for our exports and lower prices for imports.
- Economic growth in the rest of the world may mean increased competition for exporting and domestic producers.
Which two sources can be the reason for economic growth in a country?
- Increases in a country´s resources
* Improvements in the efficiency
Why are growth biased?
- Technological progress in one sector will expand the PPF in the direction of that sector´s output. (Ricardian).
- An increase in the supply of a factor of production will produce a biased expansion of PPF toward the direction of the good in which the factor is specific or the good whose production is intensive in the factor whose supply increased.
What happens when home experiences growth biased toward cloth?
Output of cloth rises –> Output of food declines –> Output of cloth relative to food rises –> World RS shift to the right –> Shown in Fig. 6.8 Panel A. –>Decrease price of cloth –>Worsen TOT for home –>Improves TOT for foreign.
What is export-biased growth?
Export-biased growth tends to worsen a growing country’s terms of trade, to the benefit of the rest of the world.
What is import-biased growth?
import-biased growth tends to improve a growing country’s terms of trade at the rest of the world’s expense
Is growth in the rest of the world good or bad for our country? Does the fact that our country is part of a trading world economy increase or decrease the benefits of growth?
- It depends on the bias of the growth.
- Export-bias growth in the rest of the world is good for us, improving our TOT.
- Import-bias growth abroad worsen our TOT.
- Export-bias growth in home worsen TOT
- Import-bias growth in home improves TOT
What is immiserating growth?
Export-biased growth by poor nations would worsen their terms of trade so much that they would be worse off than if they had not grown at all.
• Strongly export-biased growth must be combined with very steep RS and RD curves, so that the change in the terms of trade is large enough to offset the direct favorable effects of an increase in a country’s productive capacity.
• It is more theoretical than actually likely to happen.
What is the effect of a tariff?
To make imported goods more expensive inside a country than outside.
What is the effect of an export subsidy?
An export subsidy gives producers an incentive to export. It will therefore be more profitable to sell abroad than at home.
