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Notes Jan25

# Notes Jan25 - -Model predicts pervasive specialization One...

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EC340 Sec. 3 Professor Matusz 1/25/11 What determines free trade relative price? Home Foreign X 100 400 Y 200 50 Home: Px/Py = 2 Foreign: Px/Py = 1/8 Trade: 1/8 < Px/Py < 2 Suppose Px/Py = 1 Home will produce 200 units Y and demand 200 units X. Foreign will produce 400 units X and demand 400 units Y. Now Px/Py increases to 3/2 Home will produce 200 units Y and demand 400/3 units X. Foreign will produce 400 units X and demand 600 units Y. Improvement in terms of trade means imports become relatively less expensive compared to exports. Weakness of Ricardian Model - One assumption is that all workers are alike (within a country) so, if trade benefits one person, it benefits all. Probably not true in reality. - No explanation for why countries are different. No reason to believe that technology/productivity really is different. - Relies on comparison of autarkic relative prices between countries but autarky is never observable.

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Unformatted text preview: -Model predicts pervasive specialization. One country (or perhaps both) specializes in production when allowed to trade. Move forward to look for a more complete model of trade. PPF is concave from the origin. What are the implications of a concave PPF?-Slope of the PPF is not constant.-The opportunity cost of producing good x or y increases as more of that good is produced. -Concave PPF means Increasing Opportunity Cost. What are the implications of increasing opportunity cost?-Assume Px/Py = 1-Economy is producing at point A where slope of PPF = -1/4 -To produce one more unit of x we must give up 1/4 unit of y. -Better to produce one more x than to stay at point A.-Continue to produce good x until opportunity cost yx > Px/Py. -Therefore, equilibrium is where the absolute value of the opportunity cost (slope of PPF) of x is equal to the price of x in terms of y....
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