chapter2_2008 - L Karp International Trade March 6 2008 2 A...

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LKarp International Trade March 6, 2008 2 A general model The previous set of notes discussed one of the principal models of international trade, the Ricar- dian model. The next two sets discuss two alternatives, the specific factor (or Ricardo-Viner) model and the Heckscher-Ohlin-Samuelson (HOS) model. This set of notes shows you how to use a few simple constructions to analyze a variety of trade problems, in a somewhat general setting. For the general equilibrium setting we maintain the assumption of two commodities; when discussing trade, we use a model of two countries. The main difference between the model here and in the previous and subsequent sections is that here we leave the technology in the background. We simply assume that the technology is convex, i.e. the PPF is concave. Since we do not put any additional structure on the economy, we will not be able to say anything about factor returns. Therefore, in discussing welfare we need to posit a social welfare function. I begin by describing how to do comparative statics for a single open economy: “open” means that the country trades. In particular, we want to know how a change in the relative price at which the country is able to trade changes consumption and production, thus changing imports and exports. We use this information to construct import demand curves (equivalently, export supply curves). These curves are analogous to standard demand and supply curves, except that with they are “general equilibrium” relations, in that they allow income to change as the relative price changes. These curves are used to determine the equilibrium world price. We will discuss the meaning of “stability” and the role of stability in comparative statics. As an example of comparative statics – and because of its intrinsic interest – we then consider the Transfer Problem, which considers the effect on trade and welfare of a gift from one country to another. Next, we review a very important idea in economics (not just in trade theory): The theory of the second best. This lecture series will discuss a number of examples of this theory – including an example of incomplete markets and risk, and immiserizing growth. In relation to this theory, we discuss the Principle of Targeting. 18
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2.1 Open economy model and comparative statics I will repeatedly use a simple construction that relates an exogenous world price to levels of production, consumption and trade. For the time being I assume that the country does not im- pose any taxes or subsidies or tariffs. Therefore, the world relative price equals the relative price faced by consumers and the relative price faced by producers. The introduction of taxes or tariffs breaks this equality among the relative prices. Even though I do not distinguish be- tween the relative world price and the relative price faced by consumers and producers (because those relative prices are all the same, in the absence of taxes, subsidies and trade restrictions), it is important to keep in mind that an agent’s behavior depends on the prices he faces. For
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chapter2_2008 - L Karp International Trade March 6 2008 2 A...

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