Answers_to_Asst_6

Answers_to_Asst_6 - Answer Key - Assignment 6 - ECON...

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1 Richard E. Baldwin (1992), “Measurable Dynamic Gains from Trade,” Journal of Political Economy 100(11), pp. 162-174. Answer Key - Assignment 6 - ECON 422/822 - Fall 2008 1. Richard Baldwin incorporated the welfare gains from international trade as described by the general equilibrium model of trade (the PPF/Indifference curve diagram) into the Solow model in a straightforward manner. Recall that the exploitation of comparative advantage or increasing returns to scale permits an economy to transform a given set of productive resources into a greater value of final output. These gains from trade are, therefore, equivalent to a one-time increase in the economy’s production function. Trade is a form of one-time technological progress. Figure 1 shows that the shift in the production function results in an immediate increase in real output from Y* to Y’, as the stock of capital K*, combined with the fixed labor force, becomes capable of producing (and trading for) a greater value of output. There are additional changes, however. First of all, the increase in output implies that people also have the capacity to save more: If they continue to save a constant proportion of income, then the saving function shifts up proportionately to the production function, as shown in Figure 1, and the steady state stock of capital grows from K* to K**, and, as a result, output rises gradually to Y**. The Solow model thus shows that a one-time rise in the production function caused by international trade leads to transitional growth as the economy adjusts to a new steady state equilibrium. The international economist Richard Baldwin applied actual data to the Solow model and estimated that the eventual welfare gains from trade liberalization. He found, for example, that total growth would be 30 percent greater than the static trade effect for France and 129 percent greater than the static trade gains for Germany. Germany’s larger gain was due to its higher saving rate. 1 The Solow growth model shows that: ! The static general equilibrium gains from international trade raises per capita income because specialization and trade enable the economy to transform its given productive resources into a greater value of final output. ! The trade-induced rise in the production function leads to transitional growth as the economy adjusts to a new steady state equilibrium, thereby raising the gains from trade above those suggested by the previous two chapter’s static models of trade. ! The Solow model enhances the likely gains from international trade, but it also makes it very clear that, if international trade only provides for a one-time gain in efficiency, then it cannot be the source of long-run permanent economic growth. The evidence that shows that international trade and economic growth have been closely related over long periods of time, perhaps for over 200 years. This evidence suggests that there must be some relationship between international trade and technological progress, the source of permanent long-run economic growth.
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2. Prebisch began by pointing out that in a world with free trade, developing economies’ comparative
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This note was uploaded on 11/29/2009 for the course ECON 423 taught by Professor Vandenberg,h during the Spring '08 term at UNL.

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Answers_to_Asst_6 - Answer Key - Assignment 6 - ECON...

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