Trade - Trade ECON 0424 Professor Leticia Arroyo Abad Fall...

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Trade ECON 0424 Professor Leticia Arroyo Abad Fall 2009 September 29, 2009
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2 Topics Why do countries trade? What explains trade patterns?
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3 Reasons for trade Proximity Resources Variety
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4 Absolute vs comparative advantage Absolute advantage: best technology for producing a good Comparative advantage: opportunity cost of producing a good in terms of other goods is lower in that country than it is in other countries.
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5 Based on technological differences across countries. differences in the productivity of labor. Original example: • Two countries: England and Portugal • Two goods: cloth and wine • Absolute advantage: Portugal • Comparative advantage: Ø Portugal --> wine Ø England --> cloth Ricardian model
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6 On Valentine’s Day the U.S. demand for roses is about 10 million roses. Growing roses in the U.S. in the winter is difficult. Heated greenhouses should be used. The costs for energy, capital, and labor are substantial. Resources for the production of roses could be used to produce other goods, say computers. The Concept of Comparative Advantage
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7 If each country exports the goods in which it has comparative advantage (lower opportunity costs), then all countries can in principle gain from trade. The determinants of comparative advantage helps us understand the pattern of trade (which goods a country exports). The Concept of Comparative Advantage
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8 A One-Factor Economy Assume that we are dealing with an economy (which we call Home). In this economy: Labor is the only factor of production. Only two goods (say wine and cheese) are produced. The supply of labor is fixed in each country. The productivity of labor in each good is fixed. Perfect competition prevails in all markets.
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9 Production Possibilities The production possibility frontier (PPF) of an economy shows the maximum amount of a good (say wine) that can be produced for any given amount of another (say cheese), and vice versa. The PPF of our economy is given by the following equation: a LC Q C + a LW Q W = L A One-Factor Economy
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10 L/a LW L/a LC Home’s Production Possibility Frontier A One-Factor Economy Absolute value of slope equals opportunity cost of cheese in terms of wine = a LC /a LW F P Home wine production, Q W , in gallons Home cheese production, Q C , in pounds
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11 L/a LW L/a LC Home’s Production A One-Factor Economy F P Home wine production, Q W , in gallons Home cheese production, Q C , in pounds A
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12 § A Numerical Example The following table describes the technology of the two counties: Unit Labor Requirements Trade in a One-Factor World
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13 The previous numerical example implies that: a LC / a LW = 1/2 < a * LC / a * LW = 2 In world equilibrium, the relative price of cheese must lie between these values. Assume that
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Trade - Trade ECON 0424 Professor Leticia Arroyo Abad Fall...

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