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EC336 - TRADE > H-O > Flashcards

H-O Flashcards

1
Q

What class of Trade theory is HO? Why do countries trade?

A

Neoclassical model - countries trade because they’re different from one another.

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2
Q

How are countries different in HO

A

Different resource endowments

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3
Q

Another name for HO model

A

Factor proportions theory

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4
Q

Model dimensions

A

2-2-2
2 countries
2 goods
2 FOPs

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5
Q

What do we assume about the use of resources

A

FULL EMPLOYMENT - no unemployment or unused land

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6
Q

Assumption about market structure

A

Perfect Competition in goods and factor markets

Since it’s a neoclassical model

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7
Q

What do we assume about factor mobility?

A

Mobile across industries

Immobile across countries

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8
Q

When we have more than one FOP, what does this mean for PPF.

A

PFF no longer a straight line - KINKED

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9
Q

Give 2 resource constraints

A

aTF QF + aTC QC = T

aLF QF + aLC QC = L

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10
Q

Relative intensity assumptions

A

Cloth = labour intensive
Food = land intensive
aLC/aTC > aLF/aTF

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11
Q

What does the intensity assumption mean for opportunity costs?

A

aLC/aLF > aTC/aTF
opportunity cost of cloth in terms of food higher for labour constraint.
Hence labour constraint is steeper.

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12
Q

In words, why is the opportunity cost of cloth in terms of food higher for labour than land constraint

A

Cloth is labour intensive, so to produce one more unit of cloth, more food has to be given up to free up the necessary labour.

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13
Q

Intensity assumption in terms of total resources by industry

A

LC/TC > LF/TF

- the cloth industry uses a higher labour to land input ratio

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14
Q

Why do we get a kinked PPF?

A

Because we have 2 constraints. The kinked PPF is where both constraints are satisfied simultaneously.

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15
Q

what are the 2 slopes of the kinked PPF??

A

Slope of PPF = opportunity cost of cloth in terms of food
Pre-kink: slope = aTC/aTF
post: slope = aLC/aLF

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16
Q

How does opportunity cost of cloth change with mix of production?

A

The more cloth we have compared to food, the higher the opportunity cost if cloth in terms of food of producing an extra unit of cloth.

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17
Q

How do we get a curved PPF?

A

Allow for input substitutability
- can substitute less land for more workers or visa versa
Hence as not constant across outputs.

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18
Q

How many different opportunity costs along curved PPF

A

Infinite

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19
Q

What do isoquants show

A

Combinations of input that produce the same level of output

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20
Q

L shaped isoquant means

A

NO substitution of inputs - can only use them in a fixed ratio.

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21
Q

Curved isoquant means

A

Continuous substitution of inputs (not at a constant rate as then it would be a straight line)

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22
Q

Other than the PPF, what else do we need to determine optimum production?

A

PPF = what an economy CAN produce

Adding prices = tell us what an economy WILL produce

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23
Q

What’s an isovalue line?

A

Shows a constant value of production

V bar = PcQc + PfQf

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24
Q

Give isovalue line equation with Qf as subject and hence what is slope f isovalue

A 
Qf = V bar / Pf - Pc/Pf Qf
Slope = relative price of cloth in terms of food.
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25
Q

Optimality condition for production

A

Isovalue line tangent to PPF
Slope of isovalue line = slope of PPF
Relative price of cloth = opportunity cost of cloth

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26
Q

Why does finding optimum production not automatically give up input combinations?

A

Because of input substitutability, this output can be produced with different combinations of inputs. We need input prices to determine inout usage.

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27
Q

Explain CC and FF demand functions graphically

A

X axis = T/L
Y axis = w/r
Therefore CC & FF slope upwards

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28
Q

What do our relative intensity assumptions men for CC and FF? (2)

A

CC is to the left of FF: T/L is higher for food at any given w/r
CC is steeper

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29
Q

FOC under perfect competition

A

P=MC

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30
Q

Stolper Samuelson theorem & explain

A

The higher the relative price of labour, the higher the relative price of the good that uses labour intensively.
Hence higher w/r —> higher Pc/Pf
Backwards interp: the higher the relative price of a good, the higher the relative return to the FOP used intensively in that good production.

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31
Q

CC and FF: higher w/r leads to higher T/L by basic demand relationship. Explain the backwards interpretation using perfect competition FOC.

A

Higher T/L means MPL rises relative to MPT due to diminishing marginal products.
Under perfect competition: w/p = MPL & r/p = MPT
hence w/r = MPL/MPT
So a rise in T/L —> higher MPL/MPT —> higher w/r.

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32
Q

How does a rise in w/r affect T/L differently in the 2 industries

A

Higher w/r increases T/L in both industries
But the increase in greater in food than cloth
And it’s always true that T/L is higher in food than cloth.

33
Q

How do we interpret a rise in T/L??

A

We always assume full employment - so the rise CANNOT be a rise in ABSOLUTE values - it is instead a rise in the RATIO.

34
Q

Outline the method to find CC and FF mathematically.

A 
Production function must be given. 
Profit = PQ - wL - rT
Differentiate wrt L and T to get 2 FOCs (w/p=MPL, r/p=MPT)
Divide to get w/r = f(T/L)
- Do this separately for each industry.
35
Q

By intensity assumption, how do then powers on L in the production function differ between cloth and food?

A

alpha L > alpha T

Where alpha = power on L in the cobb Douglas production function

36
Q

Outline method to estimate SS

A

Combine MPL & MPT expressions to eliminate T/L for each industry.
Remember wages are equal across industries.
Do Pc/Pf to find relative price.

37
Q

What diagram do we use to determine absolute allocation of factors across industries?

A

BOX PLOT

38
Q

The size of the box reveals…

A

The exogenous supplies of land and labour

39
Q

How do we find the equation of the rays for the box plot for each industry?

A 
We want T= f(L)
Use Lc = aLc x Qc & Tc=aTC x Qc
aLC/aTC = Lc/Tc
Tc = Lc x aTC/aLC
Do the same for food.
40
Q

Where is optimal allocation across industries? How do we find it matehticslly?

A

Where the. 2 rays intersect.
Use 2 rays equations
Also 2 resource constraints: Lc + Lf = L & Tc + Tf = T

41
Q

How do the slopes of the cloth and food rays differ and why?

A 
By intensity assumption:
aLC/aTC > aLF/aTF
Therefore for our slopes: aTC/aLC < aTF/aLF
hence the CLOTH Ray is FLATTER
the FOOD Ray is STEEPER
42
Q

What happens if the rays do not intersect inside the box plot?

A

An economy specialises in the production of one good only.

43
Q

How come inout allocations determines output of the 2 goods?

A

Because Lf Tf Lc Tc are inputs into the 2 resource constraints which form the PPF.
So the inout allocations determine Qc and Qf

44
Q

How does a change in factor endowments affect the box plot?

A

Change in the size of the box

No change in the slope of the rays assuming output prices constant.

45
Q

Rybczynski theorem

A

Holding output prices constant, an increase in the supply of one FOP will increase the supply of the good that uses this factor intensively, and decrease the supply of the good that does not.

46
Q

Other than using a box plot, how else can be illustrate the Rybczynski theorem?

A

Shift out of PPF - increase in supply of ONE FOP —> PPF shifts our for BOTH goods (economy CAN produce more of both, but it’s not optimal to do so).
BIASED SHIFT in direction of the good that uses the increased supply FOP intensively.

47
Q

How can we interpret the Rybczynski theorem in terms of trade between 2 countries?

A

A country that is relatively well endowed in labour will produce more cloth and less food compared to the other country.

48
Q

What aspect of our model does trade impact?

A

PC/PF - Trade = source of Change-in output prices

49
Q

3 assumptions that both countries have the same

A

Tastes / preferences
Relative demands
Technology

50
Q

HO focuses on differences in countries in terms of

A

RELATIVE FOP ABUNDANCE
L/T vs L/T
A comparison of a comparison = comparative advantage

51
Q

According to HO, a country has a comparative advantage in which good?

A

A country has a comparative advantage in producing the good which uses its relatively abundant FOP intensively.

52
Q

How do the home and foreign PPF differ?

A

Home PPF shifted out more in direction of cloth assuming home is relatively labour abundant and cloth is relative labour intensive.

Foreign PPF shifted out more in direction of food.

53
Q

Explain RS RD diagram for Autarky home and foreign

A

Assume same RD
RS of cloth higher for home by Rybczynski theorem (produce more of goods intensive in FOP you have a higher relative supply in)
Therefore lower Pc/Pf for home in Autarky
And lower w/r ratio for home in Autarky by SS

54
Q

Explain RS RD diagram trade equilibrium

A

Convergence of relative prices, in between 2 pre trade domestic prices.
Home: trade +VE demand shock for cloth so Pc/Pf rises
Foreign: trade +VE demand shock for good so Pc/Pf falls

55
Q

HO theorem

A

An economy exports good that are intensive in the FOP its relatively well endowed in, and imports goods that are intensive in the FOP its relatively scarce in.

I.e. export the good you have a comparative advantage in.

56
Q

BC in an open economy & explain

A

PcDc + PfDf = PcQc + PfQf
Value of consumption = values of production - assume no international borrowing / lending.
Autarky: Dc=Qc & Df=Qf
(Df - Qf) = (Pc/Pf)(Qc - Dc)

57
Q

Explain optimal production as consumption in Autarky

A

Optimum where PPF, BC & IC tangent
production must equal consumption point
Therefore, consumption must lie ON PPF.

58
Q

Explain optimal consumption and production afte Trade.

A

Can consume @ any point on BC - does NOT have to be on PPF since can import and export therefore consumption NOT necessarily equal to production (but always feasible to be)
- BC now steeper for home since Pc/Pf rises —-> new optimum production

59
Q

Therefore, how does trade impact welfare?

A

Can consume more of both goods after trade —> higher IC —> higher welfare AS A WHOLE.
- But by SS, there are winners and losers

60
Q

HO prediction of income inequality effects of trade

A

Owners of abundant factors gain, owners of scarce factors lose with trade.

61
Q

HO prediction on factor prices

A

HO predicts factor price EQUALISATION

Not only w/r = w/r, but the absolute values equalise: w=w, r=r

62
Q

Did Ricardian predict factor price equalisation? Why/why not?

A

NO - different technologies —> different factor prices
Wages higher in country with absolute advantage in both goods (lower labour unit requirements for both goods means higher productivity.)

63
Q

Explain why wages equalise between countries, in terms of pre trade wage levels then how they change.

A

Home: relative abundance in labour means w< w* pre trade
Trade —> +VE demand shock for cloth in home
—> indirect +VE demand shock for labour in home —> w rises

64
Q

But how do wages and rental rates equalise across countries when we assume FOP are immobile across countries?

A

EMBODIMENT:

  • home cloth exports embody mainly labour, foreign food exports embody mainly land - as if countries indirectly trading FOPs —> arbitrage.
65
Q

4 reasons why we don’t see factor price equalisation in the data

A
  1. 2 trading countries may not produce the same goods
  2. DIFFERENT TECHNOLOGY
  3. Trade barriers and trade costs prevent full arbitrage
  4. Imperfect mobility across industries: specific factors stuck
66
Q

What does the change in income inequality due to trade depend on?

A

Existing incomes

If pre trade, income abundant fop > income scarce fop, trade increases income inequality. If Wls pre trade.

67
Q

Does the empirical evidence support trade as a cause of income inequality?

A

NO - countries like Mexico and China exported goods intensive in unskilled labour over last 25 years, yet income inequality has risen.
- Mechanism via changes in goods prices: little evidence of prices of goods intensive in skilled labour rising relative to goods intensive in unskilled in developing economies.

68
Q

Why is there little evidence of trade as a real cause of income inequality?

A

Trade tends to be a small fraction of big economies like US.

domestic factors are more important - SKILL BIASED TECHNOLOGICAL CHANGE

69
Q

Explain the political asymmetry in trade politics

A

Losers = tend to be concentrated among a few
Winners = tend to be dispersed among many
Therefore, losers are more organised politically.

70
Q

Example of trade gains & political asymmetry

A

Each American pays $8 per year to restrict sugar imports.
Total cost = $2bn
Total gain = $1bn
- but gains concentrated among a few sugar producers who are hard to beat politically.

71
Q

What paradox rebuffs the HO theorem?

A

Leontief Paradox
Using data on rich countries, found US exports less K intensive than its imports, despite the US being the most K abundant country.

72
Q

What type of trade lends more support to HO theorem?

A

North-South Trade i.e. when looking at trade between rich and poor countries.

73
Q

What did Daniel Trefler find in 1995 and how does he explain this?

A

MISSING TRADE - actual traded volumes < predicted by HO
Countries should produce and export until factor price equalisation - we do NOT see this.
Due to: different technology —> different MPL and quality of goods

74
Q

FACTOR PRICE EQUALISATION IS CONDITIONAL ON WHAT ASSUMPTION?

A

ASSUMPTION OF SAME TECHNOLOGY

- Ricardian model shows that we do NOT get factor price equalisation when technology differs across countries.

75
Q

How is abundance defined in > 2-2-2 model?

A

Abundance = FOP share > share of GDP for a country.

76
Q

How does HO respond to myth 1 that free trade is only beneficial if a country is strong enough to withstand foreign competition?

A

Argues that trade is based on comparative, not absolute advantage.
L/T vs L/T not the absolute amounts.

77
Q

How does HO respond to myth 2 the pauper labour argument ?

A

It is somewhat true - owners of abundant factors gain, owners of scarce factors lose.
(But evidence suggests domestic factors more important determinants of income inequality)

78
Q

How does HO respond to the exploitation argument

A

False - HO predicts that in poor countries, where abundant in low skilled, wages low skilled should rise relative to wages high skilled, so income inequality should actually fall.
(But again little empirical evidence)

EC336 - TRADE (9 decks)

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