Lec10-Intl_Trade_Princ_Comparative_Adv

Lec10-Intl_Trade_Princ_Comparative_Adv - Lecture Note 10:...

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Unformatted text preview: Lecture Note 10: International Trade and the Principle of Comparative Advantage David Autor 14.03, Microeconomic Theory and Public Policy, Fall 2005 1 1 International Trade and the Principle of Comparative Advantage Given the General Equilibrium production model we sketched earlier, it is a simple matter to add free trade to this picture. In this exercise, we want to answer the following questions: 1. Are the gains from trade necessarily positive in aggregate? Or does the answer depend upon which country we are trading with? 2. What are the underlying economic factors that give rise to gains from trade (e.g., tastes, technologies, factors, wealth/poverty)? 3. Why is it only di f erences in the price ratio across countries that matter for trade, rather than di f erences in the absolute level of prices? 4. If the gains from trade are positive for all parties, why is trade so often violently opposed? 1.1 Trade in the General Equilibrium Diagram As noted previously, we can think of the General Equilibrium problem as a utility maxi- mization subject to three constraints: 1. No actor is worse o f in the market equilibrium than in the initial allocation. How do we know this is satis f ed? A person could always refuse to trade and consume her original endowment instead. 2. In equilibrium, no party can be made better o f without making another party worse o f (otherwise there are un-exhausted gains from trade). 3. No more goods can be demanded/consumed than the economy is endowed with. That is, sum of the consumption of both parties cannot exceed the total endowment. 3a [No goods are left unconsumed that is, there is no excess supply. This is not truly a constraint, simply a property of the equilibrium.] Now, we want to analyze how opening to international trade a f ects utility in the previ- ously closed economy. 2 A critical thing to notice here is that opening to International trade relaxes the 3 rd con- straint. Countries that are trading can potentially swap part (or all) of their endowments with their trading partners. In equilibrium, a country may consume a di f erent bundle from what it is originally endowed with (e.g., it could trade some co f ee for sushi and hence consume more sushi than it could possibly produce). Moreover, if the country opening to trade is small relative to the rest of the world, it e f ectively faces no upper limit on the supply of goods it could potentially purchase at world prices. That doesnt mean it can buy anything it wants it has to be able to a f ord the goods it desires by trading other goods. But its budget set is now not constrained by its own physical endowments. Lets formalize this insight (see f gure) Shelter S A S C T S P T U A U T Food- (p S /p F ) T- (p S /p F ) A F P T F A F C T Consumption in Free Trade Production in Free Trade Autarky Production = Consumption The initial situation of the country Home under autarky (no trade) is depicted by the Production Possibility Frontier (...
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This note was uploaded on 04/11/2008 for the course ECON 14.03 taught by Professor Autor during the Spring '08 term at MIT.

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Lec10-Intl_Trade_Princ_Comparative_Adv - Lecture Note 10:...

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