Chapter 1-5 Flashcards
Case of No Comparative Advantage
Even if one nation has an absolute disadvantage with respect to the other
nation in the production of both commodities, there is still a basis for mutually beneficial
trade, unless the absolute disadvantage (that one nation has with respect to the other nation)
is in the same proportion for the two commodities.
Assumptions of Law of CA
(1) only two nations and two commodities, (2) free trade, (3) perfect mobility of labor
within each nation but immobility between the two nations, (4) constant costs of production,
(5) no transportation costs, (6) no technical change, and (7) the labor theory of value. Although
assumptions one through six can easily be relaxed
Opportunity Cost Theory aka?
Law of Comparative Cost
PPF
PPF is the curve that shows the alternative combinations of two commodities that a nation can produce by fully utilizing the resources available with the best tech available.
Constant Opportunity Costs
Constant opportunity costs arise when (1) resources or factors of production are either
perfect substitutes for each other or used in fixed proportion in the production of both commodities
and (2) all units of the same factor are homogeneous or of exactly the same quality.
The slope of PPF is also called?
Marginal Rate of Transformation
Increasing OC
Increasing opportunity costs mean that the nation must give up more and more of one
commodity to release just enough resources to produce each additional unit of another
commodity.
The Marginal Rate of Transformation
The marginal rate of transformation (MRT) of X for Y refers to the amount of Y that a
nation must give up to produce each additional unit of X. Thus, MRT is another name for
the opportunity cost of X (the commodity measured along the horizontal axis) and is given
by the (absolute) slope of the production frontier at the point of production.
Community IC
A community indifference curve shows the various combinations of two commodities
that yield equal satisfaction to the community or nation.
The Marginal Rate of Substitution
The marginal rate of substitution (MRS) of X for Y in consumption refers to the amount of
Y that a nation could give up for one extra unit of X and still remain on the same indifference
curve. This is given by the (absolute) slope of the community indifference curve at the point
of consumption and declines as the nation moves down the curve.
Difficulty with CIC
However, a particular set, or map, of community indifference curves refers to a particular
income distribution within the nation. A different income distribution would result in
a completely new set of indifference curves, which might intersect previous indifference
curves.
This is precisely what may happen as a nation opens trade or expands its level of trade.
Autarky
Absence of Trade
nation has a lot of X so flatter IC
nation has a lot of X so flatter IC
Equilibrium-Relative Commodity Prices
and Comparative Advantage
The equilibrium-relative commodity price in isolation is given by the slope of the tangent
common to the nation’s production frontier and indifference curve at the autarky point
of production and consumption.
Equilibrium-Relative Commodity Prices
The equilibrium-relative commodity price with trade is the common relative price in both
nations at which trade is balanced.
Difference between Constant and Increasing OC
There is one basic difference between our trade model under increasing costs and the
constant opportunity costs case. Under constant costs, both nations specialize completely
in production of the commodity of their comparative advantage (i.e., produce only that
commodity).
Small Country Case
There, only the small nation specialized completely in
production of the commodity of its comparative advantage. The large nation continued to
produce both commodities even with trade (see Figure 2.3) because the small nation could
not satisfy all of the demand for imports of the large nation. In the increasing costs case,
however, we find incomplete specialization even in the small nation.
Production Function
A production function gives the maximum quantities of a commodity that a firm can produce
with various amounts of factor inputs.
Isoquants
An isoquant is a curve that shows the various combinations of two factors, say, capital
(K) and labor (L), that a firm can use to produce a specific level of output. Higher isoquants
refer to larger outputs and lower ones to smaller outputs.
MRTS
Isoquants are negatively sloped because a firm using less K must use more L to remain
on the same isoquant. The (absolute) slope of the isoquant is called the marginal rate of
technical substitution of labor for capital in production (MRTS)
Isocost
An isocost is a line that shows the various combinations of K and L that a firm can hire
for a given expenditure, or total outlay (TO), at given factor prices.
Expansion Path
The straight line from the origin connecting equilibrium points A1 and A2 is called
the expansion path and shows the constant K/L = 1/4 in producing 1X and 2X.
Factor Intensity
Note that it is not the absolute amount of capital and labor used in the production of
commodities X and Y that is important in measuring the capital and labor intensity of the two
commodities, but the amount of capital per unit of labor (i.e., K/L). For example, suppose
that 3K and 12L (instead of 1K and 4L) are required to produce 1X, while to produce 1Y
requires 2K and 2L (as indicated earlier). Even though to produce 1X requires 3K, while
to produce 1Y requires only 2K, commodity Y would still be the K-intensive commodity
because K/L is higher for Y than for X.
Factor Abundance
There are two ways to define factor abundance. One way is in terms of physical units (i.e.,
in terms of the overall amount of capital and labor available to each nation). Another way
to define factor abundance is in terms of relative factor prices (i.e., in terms of the rental
price of capital and the price of labor time in each nation).
According to the definition in terms of physical units, Nation 2 is capital abundant if
the ratio of the total amount of capital to the total amount of labor (TK/TL) available in
Nation 2 is greater than that in Nation 1
r/w
According to the definition in terms of factor prices, Nation 2 is capital abundant if the
ratio of the rental price of capital to the price of labor time (PK /PL) is lower in Nation 2
than in Nation 1 (i.e., if PK /PL in Nation 2 is smaller than PK /PL in Nation 1). Since the
rental price of capital is usually taken to be the interest rate (r) while the price of labor
time is the wage rate (w), PK /PL
= r/w.
Demand for a FoP is a?
Derived demand
The two theorems of H-O Theory are?
the so-called H–O theorem (which deals with and predicts the pattern of trade)
and the factor–price equalization theorem (which deals with the effect of international trade
on factor prices).
H-O Theorem
Heckscher–
Ohlin theorem as follows: A nation will export the commodity whose production requires the
intensive use of the nation’s relatively abundant and cheap factor and import the commodity
whose production requires the intensive use of the nation’s relatively scarce and expensive
factor. In short, the relatively labor-rich nation exports the relatively labor-intensive
commodity and imports the relatively capital-intensive commodity.
the factor–price equalization
(H–O–S) theorem
the factor–price equalization
(H–O–S) theorem as follows: International trade will bring about equalization in the
relative and absolute returns to homogeneous factors across nations. As such, international
trade is a substitute for the international mobility of factors.
H-O Model assumes?
Equal tastes and income distribution (same diagram for both curves)
Terms of Trade
The terms of trade of a nation are defined as the ratio of the price of its export commodity
to the price of its import commodity
