Free Trade Flashcards
Condition for a small country to export X under FT?
World relative price of X > Domestic opportunity cost of X
(Px/Py)^w > (Px/Py)^aut = y/x
National BC under FT = Consumption possibilities given that…
Value of aggregate consumption = National income.
Trades are balanced.
BC under FT goes through the country’s production bundle.
|Slope| = (Px/Py)^world
Algebraic proof for free trade
Px X^d + Py Y^d = Px xL
Value of imports = Py Y^d = Px(xL-X^d)
Therefore BC = Y^d = Px/Py (xL-X^d)
Goes through (xL, 0)
What change to the workers reflects a gain from trade?
What about is algebraic terms?
Trade liberalisation => Worker’s purchasing power (real income) has risen in terms of good Y. (If specialising in X)
Real wage in terms of exported goods is unchanged.
Real wage in terms of imported goods rises.
Autarky :
W/Px = x
After trade
W/x = Px
W/y > Py
Does the difference in price of exporting good domestically relative to world price matter?
Yes. The greater the difference in relative price the greater the gains from trade.
TOT = price of exports / price of imports
TOT = quantity of imports that one unit of imports buys
TOT increase = TOT improvement = Welfare gain.
Adam Smith argued the reason to engage in international trade is to obtain imports.
For 2 countries to trade, where must the world price be?
For 2 countries to trade, the (Px/Py)FT World must be must between both countries.
As a result both countries have CA in a specific good relative to reach other and the FT world price.
For 2 large countries, what is the graphical explanation
Each country will specialise in the good with CA.
To lines with |slope| = FT world drawn from each intercept from the country with CA.
Tangent IC on new BC shows new consumption
Difference from intercept to consumption = Imports and Exports.
How is the (Px/Py)FT world determined?
By global supply of demand
Equation for balanced trade?
Px Xt = Py Yt
Equation for country A’s exports
(Hint : Use Cobb-Douglas preferences (a))
A’s exports = Xa L - a Xa L
Xa L = A’s production = National income
a Xa L = A’s consumption of X
Meaning of large a?
What does a small La mean?
Strong global demand for A’s export good X.
Smaller La = lower supply of X relative to Y in world market.
As a result small countries gain more from FT.
Why does a country specialise in producing its CA good / what are the benefits of FT?
It increases world real income
Pareto gain for workers over Autarky and world welfare gain.
Increases economic efficiency
Access to a larger market (can sell to international markets)
Higher real incomes.
- Specialisation and trade reduce costs and prices.
- Increases purchasing power of consumers and boots real income
Increase competition.
- Drives innovation, quality and lower prices.
Technology and knowledge sharing
Trade stimulates economic growth
- Investment
- Entrepreneurship
- Long term trade gains
What are the downsides from FT?
Loss of domestic industries. Job losses in certain sectors.
Uneven distribution of gains within or between countries. Potentially increasing inequality.
Dependence of foreign markets.
- Heavy reliance on foreign markets for essential goods can create vulnerabilities.
Environmental concerns
- Increased production and transportation of goods can lead to degradation such as higher carbon emissions
Wage suppression
- Workers in industries exposed to foreign competition could experience downward pressure on wages or loss of jobs
Greater economic integration can erode local cultures (labour laws, environmental regulations)
Adjustment costs (firms may struggle in the short run)
Formula for average cost between industries using Wage and Labour production?
ACusa = (Wusa/LPusa)
A country will export in an industry if its relative productivity at the industry exceeds its relative productivity at the national level.
Concerns in trade of rich and poor countries
Rich countries overlook the fact that low wages reflect low productivity
Poor countries overlook the fact that high productivity leads to high wages
What did David Smith say about productivity?
Productivity is the ultimate driver of economic growth and any improvement helps competitiveness and the public finances. It is intimately connected to pay.
