Standard Trade Model Flashcards
What model is the standard trade model?
A generalised neoclassical model of trade, where Ricardian and HO models are special cases of it.
How does comparative advantage arise?
Through “productive differences” between countries - doesn’t specify exactly what.
Production optimality condition
Opportunity cost of cloth = relative prices of cloth
I.e. slope of PPF = slope of isovalue line
2 conditions for a concave and smooth PPF.
- > 2 inputs = concave
2. Input substitutability = smooth
Relative supply is determined by
PPF - productive differences —> different PPF —> determines RS
Optimum consumption
Max utility s.t BC (value of consumption = value of production)
Slope of IC = slope of BC
MRS of cloth for food = relative price of cloth
What do we assume about ICs? What does this imply?
Assume IC is for a representative consumer
- Means effects of a change in income distribution on demand are negligible
- assume labour and land workers react to price changes in the same way.
What is MRScf
MRScf = MRS of cloth for food = MUc/MUf
- how much food the consumer is willing to give up for an additional unit of cloth, keeping utility constant.
When must consumption lie for an open economy on the graph?
It must lie along the BC
but it does NOT have to lie on PPF since can import and export.
What two lines on the allocation graph are the same?
Isovalue line = BC
Both have relative price of cloth as the slope.
Production response to higher Pc/Pf due to trade
Higher Pc/Pf = steeper isovalue line
Tangent to PPF more south east now
Qc rises, Qf falls
Consumption side response to rising Pc/Pf du to trade (2 effects)
IE: assume both goods normal. Higher Pc/Pf = higher export income = can consume more imports too. Dc and Df rise.
SE: Pc relative more expensive so Dc falls and Df rises.
How do we know whether IE or SE stringer?
If PC/PF rises:
IE > SE if Qc rises overall
SE>IE if Qc falls overall
How do we determine the SE?
Draw a hypothetical BL with the NEW slope and tangent to OLD IC.
- movement along IC = SE
How does IE affect ICS?
IE = shift of IC = change in welfare
Why does utility only consider consumption of the 2 goods?
Because we assume full employment, so when prediction changes we do NOT need to consider labour-leisure effects.
TOT =
TOT = Px/Pm
What is biased growth?
Growth often occurs in one sector more than another.
2 ways to illustrate biased growth
- Shift out PPF disproportionately in one direction
2. Shift of RS - if growth unbiased, relative supply would be unchanged.
Does it matter where the growth takes place?
NO - what matters is what direction the growth is biased in, not where is takes place.
impacts of export biased growth
Export biased growth —> higher RS of export good = worse TOT = lower welfare
(Effects opposite for foreign)
impacts of import biased growth
Import biased growth = lower RS of export good = improved TOT = higher welfare
Does the empirical evidence support the TOT predictions from growth in China in high tech goods?
High tech goods = import biased growth for China = TOT rises
Export biased growth for west = TOT worsens
- But the data shows the opposite!
What’s immiserisimg growth?
Growth in poorer countries could be self defeating if its export biased. TOT worsens.
How do we show immiserise growth graphically?
PPF shifts our disproportionate towards export good.
Isovalue line flatter as Pc/Pf rises.
Show isovalue lines crossing, so that new consumption point to south west of old —> lower IC.
Under what conditions does immiserise growth happen?
Need RD V INELASTIC - so that shift in RS has large effect on TOT.
International income transfers are a … side phenomenon
DEMAND SIDE - transfer purchasing power, which can shift RD.
2 economists in the transfer debate problem and their views.
Debate about burden of Germany war reparations.
Keynes: nominal sums < true burden as TOT worsened.
Ohlin: no TOT worsening
When does n income transfer NOT shift RD?
If the 2 countries have the SAME MARGINAL PROPENSITY TO SPEND ON THE GOODS.
Why did Keynes believe that RD did shift after German war reparations?
He argued Germany had a higher MPS on its export good, so transfer of money to allies —> RD of export good falls = TOT worsens for Germany.
Under what condition would TOT effects soften the blow to the donor of an income transfer?
If the donor has a higher MPS on it’d import good, transferring money —> higher RD for its export good —> TOT improves.
What’s the paradoxical possibility with development aid?
That recipients if aid could be made worse off.
If the recipients of aid have a higher MPS on their import good relative to the donor, RD for their export good falls = TOT worsens.
Empirical evidence on whether MPS tends to be higher for own exports or imports.
US spends 85% national income on domestic goods, 15% on imports.
So MPS tends to be higher on own exports.
Meaning donating money —> worse TOT.
Import tariff =
Tax levied on imports
Export subsidy =
Payments given to domestic exporters
2 types of prices trade policies creates wedge between
Domestic / internal prices
Vs
World / external prices.
TOT depends on what type of price! Why?
WORLD/ external prices determine TOT - since exports and imports are traded on world markets.
Production response to impor twriff
Import tariff = internal Pc/Pf falls
Flatter isovalue line = optimum production lower Qc higher Qf
RS of cloth falls
Consumption response to import tariff
Internal Pc/Pf falls
SE: Dc rises, Df falls
RD for cloth shifts up
Why no IE in consumption response to trade policies?
Trade policies affect INTERNAL prices, not external, so export or import income unaffected.
Overall effect of import tariff for economy
Lower RS, higher RD = higher WORLD Pc/Pf = TOT improves!
Summarise effects on internal and external prices of import tariff
Internal Pc/Pf falls due to import tariff raising food prices
External Pc/Pf rises due to RS falling and RD rising in response
Why might a tariff not be great for welfare despite TOT improvement?
Because it creates distortions in the domestic market - TOT isn’t the only thing that matters for welfare. Or could lead to retaliation.
The ability of a country’s trad policies to affect world RS & RD depend on…
Relative size of home vs foreign economies or industries
- if home a large part of world economy, its domestic production and consumption responses are able to influence world RD and RS
How does an export subsidy affect internal price?
Internal Pc/Pf rises
Domestic production response to export subsidy
Internal Pc/Pf rises = steeper isovalue line = tangent @ higher Qc, lower Qf = RS of cloth shifts right
Domestic consumption response to export subsidy
Internal Pc/Pf rises
SE: Dc falls, Df rises = RD shifts down.
Overall effect of export subsidy on TOT
RS rises, RD falls —> external Pc/Pf falls = TOT worsens for the country that imposed the export subsidy.
Summarise internal and external price effects of export subsidy
Internal Pc/Pf rises due to export subsidy
External Pc/Pf falls as RS rises and RD falls in response.
2 negative effects of export subsidy
- Worse TOT
2. Monetary cost + distortions —> DWL
In a 2 country 2 good model, trade can be seen as a … … …
ZERO SUM GAME
e.g home imposing an import tariff improves their own TOT, meaning foreign TOT worsens.
Give an example of why trade is not necessarily a zero sum game when we have >2 countries >2 goods.
If US imposed import tariff on clothing —> US TOT improves
But if UK also imports clothing, then it benefits from the higher TOT too without having any of the distortions from the tariff.
Explain the impacts on TOT. Export subsidies by foreign counties om goods that the UK…
1) exports = worse TOT
2) imports = improved TOT
Explain the impacts on TOT. Import tariffs by foreign countries on goods that the UK…
1) exports = worse TOT
2) imports = improved TOT
How does export subsidy impact income distribution domestically?
Domestic exporter gain
Resources shift away from import competing sector
How does import tariff impact income distribution domestically?
Domestic import competing sector gains: consumers substitute away from now more expensive imports to domestic products.
Resources shift away from export sector.
