Chapter 14 Flashcards
What is the 2x2x1 model?
2 countries
2 goods produces
1 input, call it “labour”
What do we assume when observing the 2x2x1 model?
Competitive markets: no firms have market power
No technological changes
Constant returns to scale in production: Double the inputs and you double the outputs.
No transportation or trade costs
No money: All trade is barter.
What do we assume when labour is the sole input in the 2x2x1 model?
Labor is completely mobile between the two sectors of production.
Labor is homogeneous: no skilled/unskilled or hard working/shirking distinctions.
Labor is fully employed: Everyone that wants a job has one.
Labor is immobile between the two countries.
What is productivity?
It is the amount of output per unit of input
What is labour productivity?
It is the output per unit of labour inputs
Units of output / hours worked
What is absolute productivity advantage?
It is the higher output per hour worked than a competitor. It is the absolute advantage
Where will the trade prices settle?
Somewhere between the domestic costs of production in the two countries
What does the production possibilities curve show?
It shows the tradeoffs between the two goods in this simple model
Why is the PPC a straight line?
It is a straight line because there is a constant tradeoff between the two products
Production inside the PPC is inefficient
Production outside is impossible
Production along the curve is full employment
Though countries can produce anywhere on the PPC curve, what do they want to achieve?
They want to produce the output with the highest value
Greatest value is dependent on the trade price
What is the slope of the PPC?
It is the relative price of the good on the horizontal axis
What is a relative price?
It is the price of one good in terms of another
What is autarky?
It is the term given to countries that do not trade
What does the consumption possibilities curve represent?
It represents what a country can consume when it produces at a point on its PPC and trades
When are consumption possibilities maximized?
When we are on the CPC that is furthest from the origin
What does maximizing the value of output do?
It maximizes the gains from trade
What does absolute advantage mean?
It means that a country has greater labour productivity
What does comparative advantage mean?
It means a country has a lower opportunity cost
What does competitive advantage mean?
It means that they are selling at a lower cost
What does comparative advantage mean?
It means that they have a lower opportunity cost
When does comparative advantage equal competitive advantage?
When markets are perfectly competitive and the prices of all inputs and outputs reflect their relative scarcity
When does comparative advantage not equal to competitive advantage?
When the prices do not reflect the relative scarcity
When do prices not reflect scarcity?
In trade, this occurs mostly when governments supply protection or subsidies.
Protection drives up the price of imports
Subsidies drives down the private cost of production.
When can countries be internationally competitive in industries where they do not have a comparative advantage?
When they receive subsidies
What are the arguments that trade adjustment assistance justifies?
Trade makes the nation better off; the winners can compensate the losers and still gain.
Fairness.
Not doing so creates a backlash that endangers trade and the gains from trade.
