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Unformatted text preview: TRADE WITH INCREASING MARGINAL COSTS 1 Overview Question • Why might countries with the same (or similar) technologies trade? U.S. & Canada; U.S. & Japan; France & Germany • How do the Ricardian conclusions change if we allow for increasing marginal costs of production? 6 Review Ricardo 2 countries, 2 goods produced only by labor Costs are constant We will change or “relax” these 2 assumptions; we’ll work on trade barriers later in the course No trade barriers, perfect competition These stay: Labor fully mobile domestically Labor not mobile internationally Full employment No MONEY, which means no money prices 7 •1 Review Ricardo (cnt) cnt) • Ricardian supply curves Average Cost = Marginal Cost = Constant PR-Aut High Demand Low Demand PH-Aut Intermediate Demand Good X 8 Review Ricardo (concl) concl) • That is why either The world price is the same as the “large” country’s autarky price and the Large country produces both goods or The world price is between the two autarky prices and each country produces only one of the goods 9 Increasing Marginal Costs • To get increasing marginal costs we need: 1. At least 2 factors of production We’ll keep it at 2! These can be Labor and Capital, or Labor and Land (or something else) Their supply is fixed (for now) 2. Production functions with the usual attributes Constant returns to scale Diminishing returns to factors 11 •2 Increasing Marginal Costs (cnt) cnt) 3. A consequence of these assumptions is that one of the two goods will be “capital intensive” and the other will be “labor intensive” If good X is Capital intensive compared to Capital good Y, if the K/L ratio in the production of X is higher than in the production of Y Bananas require more land/labor than cars 12 Increasing Marginal Costs (cnt) cnt) • Start with 0 production for X; the economy is producing only Y • Take enough resources from the production of Y to produce 1 unit of X If marginal costs are rising, this is the cheapest X the economy is going to produce! The marginal cost is the Y the economy gives up It means you’ll give the least amount of Y for this 1st unit of X 13 Increasing Marginal Costs (cnt) cnt) • If you want to produce one more unit of X You’ll have to give up a little more Y than you did for the 1st unit of X This process continues as you wish to produce more X The meaning of rising marginal costs 14 •3 Increasing Marginal Costs (cnt) Y 100 67 The bowed-out productionpossibility frontier The slope at the tangency is the relative price for that combination of output X 100 15 Increasing Marginal Costs (concl) concl) • This production-possibility frontier tells you Given X (produced efficiently), the maximum Y that the economy can produce efficiently OR Given Y (produced efficiently), the maximum X that the economy can produce efficiently Given the amount of fixed total labor, land, capital, etc. The relative price of X and Y Same as the trade-off 16 Community Indifference Curves Better Worse 17 •4 Increasing Marginal Costs and Preferences Each country has 100 hours available Wheat Wheat 100 United States 100 Rest of the World 67 50 25 Cloth 100 Cloth 100 18 To Summarize The theory of Relative Productivity Advantage says: • A country imports goods that imports Are relatively more efficient to produce abroad Are relatively more desired at home • A country exports goods that exports Are relatively more efficient to produce at home Are relatively more desired abroad 19 • What happens if countries are equally productive in the production of all goods? They use the same technology 20 •5 Fundamental Principle of Trade • For trade to take place, there must be some differences between countries If Production technologies are identical Factor endowments are identical Labor, Land, Capital Consumer tastes are identical Increasing or constant marginal costs then there is no reason to trade in this static framework “Static” means we are only considering one period • There would still be intertemporal reasons to trade 21 Heckscher-Ohlin Theory of Trade • Countries may share the same technologies and have the same types of skilled labor • But they generally don’t have factors of production in the same proportions The U.S. is land-abundant relative to Japan The U.S. has much higher proportion of skilled labor than Mexico Chicago is less land-rich than California The Dominican Republic has better banana-growing weather than Oregon 22 Heckscher-Ohlin Theory (cnt) cnt) • Absent major trade distortions (a lot more on this later) you would not expect to find Japan exporting rice or wheat to the U.S. Mexico exporting supercomputers to the U.S. Chicago exporting tomatoes to California Oregon exporting bananas to the Dominican! 23 •6 Heckscher-Ohlin Theory (cnt) cnt) The Hecksher-Ohlin theory says that • If production factor K is relatively more abundant in county A then country A will export products that use K relatively intensively, and import products that use L relatively intensively • In a 2-country setting, this makes production factor L by definition more abundant in country B • This makes “horse sense” as the previous examples illustrate Hardest thing about this theorem is to spell Hechsher Hekscher Heckscher and Ohlin correctly (Ohlin is easier)! 24 Heckscher-Ohlin Theory (cnt) cnt) • H-O comparative advantage is actually a triple comparison: across countries across products across factors of production • Also note that the cost of a product depends on how much is being produced 25 Heckscher-Ohlin Theory (cnt) cnt) • The Heckscher-Ohlin theory predicts a country exports products that use its abundant factors intensively • A country is labor-abundant if it has a high(er) ratio of labor to other factors, like land and capital (plants, machines, computers, etc.) • A product is labor-intensive if labor costs are a greater share of its value 26 •7 Example Wheat is land-intensive Cloth is labor-intensive Wheat United States Land-abundant Wheat 100 Rest of the World Labor-abundant 100 50 50 100 Cloth 100 27 Cloth Heckscher-Ohlin Theory (cnt) cnt) • Relative factor abundance provides an economic reason for comparative advantage Seems more satisfactory than saying The country is just more productive The country has better technology • This explanation does not preclude the previous ones does 28 Heckscher-Ohlin Theory (concl) concl) Heckscher Examples • The U.S is a major exporters of agricultural goods because agriculture can be both capital and land intensive Agriculture is peculiar in that it is very labor-intensive in poor countries (defines poor countries), and very capital intensive in developed countries China is not land-abundant and is shifting out of agriculture 20% of the world population, 6% of its arable land • The U.S. imports textiles from 3rd world countries Textiles don’t require highly skilled labor and are labor intensive 29 •8 Heckscher-Ohlin Theory (concl) concl) Examples • The U.S and Europe are the only manufacturers and exporters of large commercial planes, because that production requires lots of skilled labor and lots of capital • The “factor abundance” or “factor intensity” is unambiguous in a 2x2x2 model It is less clear when you consider many goods, many factors, and many countries But the intuition is still valid 30 TO SUMMARIZE The Heckscher-Ohlin theory completes the previous theories by clarifying that countries may have different production costs • not necessarily because they have access to different technologies, but also • because they have different availability of production factors This is an additional reason to trade, not a competing one 31 Key Summary Points 1. Countries trade because: They may have an absolute advantage, or They have a comparative advantage 2. Increasing returns to scale means that both countries will continue to produce both goods They will export the good they can produce relatively cheaply; it is their comparative advantage They will import the good the RoW produces more cheaply 3. Comparative advantage can arise from technological differences factor abundance differences 4. Trade is welfare-improving for both countries 32 •9 THE END 33 •10 ...
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