Notes Jan18 - The good in the numerator is relatively...

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EC340 Sec. 3 Professor Matusz 1/18/11 Ch. 3 Comparative Advantage Why do prices differ across countries in the absence of trade? Think about a world with two goods and two countries. Prices in an economy only have meaning when compared with other prices in the economy. Consider two goods [x, y] Px = price of x measured in monetary terms [ex. dollars] Py = price of y measured in same monetary unit Px/Py = price of x relative to the price of y, or the relative price of x in terms of y Suppose Px = 30 and Py = 10. Then the relative price of x in terms of y is 3 times. Therefore, good x is three times as expensive as good y. One way of interpreting Px/Py = 3 is that the same money used to produce one unit of x can be used to produce 3 units of y. Consequently, 3 units of y trade for 1 unit of x. Home Foreign Ptshirts $30 M 240 Psocks $10 M 24 Relative Price (Pt/Ps) 3 times 10 times Relative Price (Ps/Pt) 1/3 1/10 T-shirts are relatively cheap compared with socks in the home country. Socks are relatively cheap compared with t-shirts in the foreign country.
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Unformatted text preview: The good in the numerator is relatively cheaper than the good in the denominator in the country with the lowest relative price. What determines relative price in Autarky? Qsocks 600 200 Qtshirts PPF shows how many socks can be produced given the number of t-shirts we produce. In Autarky, Pt/Ps is the absolute value of the slope of the PPF where t is on the vertical axis and s is on the horizontal axis. Relative price is the same as opportunity cost in this case. If Pt/Ps is greater than opportunity cost then the producer specializes in t. If Pt/Ps is less than opportunity cost then the producer specializes in s. The only way for this economy to produce both goods is if Pt/Ps = 3. Now consider that under trade, Pt/Ps = 5. Home (Pt/Ps = 3) only produces t-shirts and foreign (Pt/Ps = 10) only produces socks. (See diagram online) In Autarky, Consumption Frontier and PPF are the same thing. In Trade, CPF lies outside PPF except at on point....
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Notes Jan18 - The good in the numerator is relatively...

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