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Lecture 17 - ECO100 (2) - ECO ECO 100Y Introduction to...

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ECO 100Y I d i Introduction to E i Economics Lecture 17: International Trade © Gustavo Indart Slide 1
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Why Does Trade between Two Countries Take Place? Both partners gain from trading Trade increases the quantity of commodities available for consumption Overall production of commodities increases © Gustavo Indart Slide 2
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Gains from Trade Main sources of gains from trade: ¾ Difference in climate and natural resource endowment ¾ Reduction in cost of production through economies f l of scale ¾ Technological differences ¾ ff f d Different factor endowments We will examine two models that take technology as the We will examine two models that take technology as the basis for trade ¾ Absolute Advantage model ¾ Comparative Advantage model © Gustavo Indart Slide 3
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Simplifying Assumptions Only 2 countries Only 2 goods Labour is the only factor of production Constant returns to scale © Gustavo Indart Slide 4
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Model of Absolute Advantage A country can produce a commodity utilizing less A country can produce a commodity utilizing less labour than the other country Absolute advantage implies more efficiency Both countries can gain by specializing in the production of the commodity in which they have an absolute advantage © Gustavo Indart Slide 5
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Example: Absolute Advantage Output of One Unit of Labour Canada Mexico Wheat 6 1 Cloth 4 5 D i T f T d Domestic Terms of Trade: • Canada: 6W = 4C Æ 1W = (2/3)C • M i 1W = 5C • Mexico: International Terms of Trade: 5C > 1W > (2/3)C © Gustavo Indart Slide 6 5C > 1W > (2/3)C
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Example (continued) Example Canada should specialize in the production of wheat and Mexico should specialize in the production of cloth Suppose that the international terms of trade are Suppose that the are given by 1 W = 1 C ¾ 5 C > 1 W > (2/3) C Suppose that Canada transfers one unit of labour from the cloth industry to the wheat industry Suppose that Mexico transfers one unit of labour from the wheat industry to the cloth industry © Gustavo Indart Slide 7
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Canada: Changes in Production d C i and Consumption Transfer of 1 unit Transfer of 1 unit of labour from the cloth to the wheat Change in Consumption Wheat Cloth industry Change through P d i + 6 4 Production 6 Change through Trade 6 + 6 Net change 0 + 2 © Gustavo Indart Slide 8
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Mexico: Changes in Production d C i and Consumption Transfer of 1 unit Transfer of 1 unit of labour from the wheat to the cloth Change in Consumption Wheat Cloth industry Change through P d i 1 + 5 Production 5 Change through Trade + 5 5 Net change + 4 0 © Gustavo Indart Slide 9
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Absolute Advantage Model Gains from trade depends on international terms of trade Model doesn’t explain how terms of trade are Model doesn t explain how terms of trade are determined Both countries gain from specializing in production of commodity in which they have an absolute advantage What if one of the two countries has an absolute advantage in the production of both commodities?
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