The Classical Framework Flashcards
Main Characteristics
- 2 goods, M and A
- 3 factors of production
- Labour to produce M and A (mobile between sectors)
- Land T, used to produce A
- Capital K, used to produce M
- Perfect competition (Price takers)
- Technology with decreasing returns to scale (marginal productivity of labour is decreasing for every extra unit of labour)
Why opening for trade?
- Frims that specialize in the good that become relatively more expensive:
- Income goes up, consumers can demand more of both goods
- Consumers can demand different quantities from the produced ones (gains from exchange)
Who wins and who loses from trade?
Winner: Specific factor of the good that becomes relatively more expensive
Loser: Specifi factor of the good that becomes relatively cheaper
- Uncertain: Mobile factor
What is the production function for manufactures?
For agriculture?
- Qm = Qm(K, Lm)
- Qa=Qa(T, La)
What is the opportunity cost in this model?
If Lm goes up by one, La needs to decrease by one (because Lm+La=L)
The opportunity costs for manufacturing in terms of agricultural goos = MgPrLa/MgPrLm
What is the Production Possibility Frontier? (PPF)
The PPF tells us how much we can produce of each good.
If Quantities of M goes up, quantities of A goes down (Because we need more L to produce Q, and therefore we need to take L from A. A cannot produce as much as before because of the missing L, but the marginal Productivity LabourA goes up).
What happens if we open up to trade and the prices of M goes up? (due to higher prices at the international market)
- Prices of M goes up, which mean we can sell to a higher price at the international market.
- Therefore, we want to produce more Qm. To increase this, labour goes up and the marginal productivity of Lm goes down.
This mean that our wages goes down relative to the price. Wages are the same across sectors!
