Econ_433_s10_lec2

Econ_433_s10_lec2 - Advanced International Trade Lecture 2...

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Advanced International Trade Lecture 2 Prof. Tybout January 14, 2010
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2 Lecture outline Trade theory basics Consumer behavior The Ricardian model Terms of trade Relevant reading: Feenstra and Taylor, chapter 2. First homework assignment to be post next Tuesday
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3 Consumer behavior Assume that all consumers have identical tastes, and that these tastes can be characterized by some utility function : U = U ( X , Y ) (Cobb-Douglas example) Further assume: diminishing marginal utility with respect to each good, and – an increase in consumption of one good does not decrease the marginal utility from the other. Then this utility function will imply indifference curves that are convex toward the origin. 0 , 0 , 0 , 0 , 0 2 2 2 2 2 > > < > X Y U Y U Y U X U X U
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4 Y U 0 X U 1
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5 Consumer Behavior Questions What must be the level of satisfaction associated with U 0 versus U 1 ? For a given individual, can the indifference curves for two levels of utility cross one another?
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6 Consumer behavior Consider a consumer with income I , so that this individual’s budget constraint (in a world with 2 goods and no saving or borrowing) is: or Y P X P I Y X + = X P P P I Y Y X Y =
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7 X Y I / P y Slope = - P x / P y U 0 U 1 Consumers maximize utility by choosing the combination of X and Y that is affordable (on the budget line) and on the indifference curve furthest from the origin. That is, they go to the tangency point A. Consumer behavior A Y cons X cons
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8 Consumer behavior At this utility maximizing combination of goods : – The budget is exhausted, and – the slope of the budget line matches the slope of the indifference curve (hereafter the marginal rate of substitution , or MRS ) : MRS P P Y X =
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Consumer behavior Assume identical homothetic tastes – All individuals are characterized by the same utility function. – Proportions in which goods are consumed depend
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Econ_433_s10_lec2 - Advanced International Trade Lecture 2...

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