Chapter 5 Flashcards
Comparative advantage (Ricardian) model of intern’l trade
the analysis of intern’l trade under the assumption that opportunity costs are constant, which makes PPFs straight lines
Autarky
a situation in which a country does not trade with other countries
Sources of comparative advantage
- high skilled labor
- technology
- availability of natural resources
- amount of labor
- climate
Heckscher-Ohlin Model
A country that has an abundance supply of a factor of production will have a comparative advantage in goods whose production is intensive in that factor
World price
an assumption in which there are unlimited quantities of a 1. 1. good that can be purchased from abroad at a fixed price; 2. under this assumption, the world price is assumed to be lower than the price of the good in autarky (domestic price).
3. when a country opens to trade, it is assumed that the domestic price will fall toward the world price.
World quantity
- it is assumed that the domestic quantity for a good is lower than the world quantity
- the quantity of a good demanded by domestic consumers rises from the quantity in autarky to the quantity demanded after open up for trade (the total demand with being open to world trade)
- the quantity supplied by domestic producers falls from the quantity in autarky to quantity supplied domestically
- the difference between the domestic quantity demanded and the domestic quantity supplied, Qd-Qs, is filled by imports
Effects of imports on consumer/producer surplus
- Imports of a good lead to fall in their domestic price
- Consumer surplus rises
- Producer surplus falls
Effect of exports
- For exports, the world price is assumed to be higher than autarky or domestic price
- purchases of domestic goods from abroad drive the domestic price up until it is equal to the world price
- Quantity demanded by domestic consumers falls from Qa to Qd (final quantity demanded?)
- Quantity supplied by domestic producers rises from Qa to Qs.
- This difference between domestic production and domestic consumption, Qs-Qd, is exported
Effect of exports on consumer/producer surplus
- Consumer surplus falls
2. Producer surplus rises
Effects of international trade on income distribution (example)
- Economy opens up to auto part imports from Mexico; domestic auto parts industry declines, hires fewer accountants
- But accounting has employment opps in many industries so higher paying jobs might be found; job opportunities expand for accountants as a result of international trade
- Accountants are affected by auto part imports only to the extent that these imports change wages of accountants in the economy as a whole
- Wage rate of accountant is a factor price (the price employers have to pay for the services of a factor of production)
Factors of production and the Heckscher-Ohlin Model
If internat’l trade increases the demand for a factor of production, that factor’s price will rise; if intenat’l trade reduces the demand for a factor of production, that factor’s price will fall.
International trade and demand for factors
- H-O model says that a country tends to export goods that are intensive in its abundant factors and to import goods that are intensive in its scarce factors
- Int’l trade tends to increase demand for factors that are abundant in our country and decrease demand for factors that are scarce
H-O and Wages
- If int’l trade has the effects predicted by the H-O, its growth raises the wages of highly educated American workers and reduces wages of low-educated workers
- Trade reduces income inequality between countries as poor countries improve their standard of living by exporting to rich countries
Effects of a Tariff
- Raises both the price received by domestic producers and the price paid by domestic consumers
- When tariff is imposed, no longer profitable to import goods unless domestic price received by importer is greater than or equal to world price plus the tariff
- Domestic price rises to Pt (Pw + tariff)
- Domestic production rises to Qst, domestic consumption falls to Qdt, imports fall to Qdt-Qst
- Higher domestic price increases producer surplus, reduces consumer surplus
- Producers gain, consumers lose, and government gains
- Consumer losses are greater than sum of producer and government gains, leading to net reduction in total surplus equal to areas B+D
Deadweight loss
- Created by a tariff or quota
- Mutually beneficial trades are prevented from occurring
- For tariff: DL is equal to loss in total surplus
- Some mutually beneficial trades go unexploited, some consumers who are willing to pay more than world price, Pw, do not purchase the good, even though Pw is true cost of a unit of the good to the economy
- Economy’s resources wasted on inefficient production: some producers whose cost exceeds Pw produce the good, even though an additional unit of the good can be purchased abroad for Pw
