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Section 8 - Section 8 International Trade and Open-Economy...

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Section 8 International Trade and Open-Economy Macroeconomics
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One of the first things we learned is that individuals are better off if they specialize and trade How? Increased production Why? Take advantage of comparative advantage The same holds for countries Reasons for comparative advantage (1) Differences in climate (2) Differences in factor endowments (3) Differences in technology
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Domestic Autos P Q P Q Foreign Autos S D P D Q D D S P F Q F → Foreign autos are cheaper than domestic autos Q: What will happen if domestic consumers are able to import foreign autos?
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A: Domestic consumers will start to substitute the cheaper foreign autos for the more expensive domestic autos This will drive down the price of domestic autos until it is equal to the price of foreign autos Why? Because domestic consumers will continue to buy Foreign autos as long as the price of foreign autos is less than the price of domestic autos
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We call this the “Law of One Price” → With free trade, the price of a good must be equal across different countries selling the good Why? If it is not, then individuals have the incentive to buy the good in the cheaper country and export it to the more expensive country We call this “Purchasing Power Parity” when referring to the values of currency across countries
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Domestic Autos P Q P Q Foreign Autos S D P D Q Dom D S P F Q F → So with free trade, the domestic price gets driven down to the foreign price Q: How many autos are imported? Q Total → At P F domestic firms want to supply Q Dom domestic consumer want to purchase Q Total ?
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Domestic Autos P Q P Q Foreign Autos S D P D Q Dom D S P F Q F At P F there is an excess demand of Q Total - Q Dom Q: With free trade, how is the excess demand met? Q Total A: With imports So the number of autos imported is Q Total - Q Dom Imports
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S D Q P P D Q D Consumer Surplus Producer Surplus Domestic Autos Consumer Surplus Gain to domestic consumers from purchasing Q D units at price P D
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