GWLecture6 - Part IIa Paper 1 General Equilibrium and...

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Part IIa: Paper 1 General Equilibrium and Welfare Economics Dr Sönje Reiche
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2 Outline: Trade and Production What happens to factor prices when the price of a final good changes? Stolper-Samuelson Result What happens to production when factor endowments change? Rybczynski Effect Explaining the pattern of trade: Heckscher-Ohlin Books Heffernan & Sinclair, Ch. 2 Krugman & Obstfeld, Ch. 4
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3 Oy Ox L K A B Each point on the contract curve represents a different combination of x and y. If x and y have different factor intensities, then each point will have different w/r solutions. For example, if x is labour intensive relative to y , then w/r will be greater at B than at A.
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4 Contract curve translates into a production possibility frontier x y B A y x p p - Increase in P x shift towards x . x is labour intensive, so increase in demand for labour r w MRT = Px/Py Introduce Prices of Final Goods This is the effect just seen in the MRTS diagram
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5 So, given relative prices, we can tell the split between x and y in production using y x xy p p MRT = This ties down the point on the contract curve, and so determines the ratio, w/r. So, given the technology and output prices, we have a unique value of w/r Gives a relationship between the final goods price and factor prices.
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6 What does it mean to say x is more labour intensive than y ?
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