Chapter 3 -- Classical Model
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Transcript of Chapter 3 -- Classical Model
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1Chapter 3 -- Classical Model
• INTERNATIONAL ECONOMICS,ECO 486
• Display your name card
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2Learning Objectives
• Understand five more assumptions
• Determine and understand comparative and absolute advantage
• Find international trade equilibrium
• Explain gains from trade
• Derive range of wages that will permit trade
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3Learning Objectives
• Understand five more assumptions
• Determine and understand comparative and absolute advantage
• Find international trade equilibrium
• Explain gains from trade
• Derive range of wages that will permit trade
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4Assumption #8
• Factors of production cannot move between countries
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5Assumption #9
• There are no barriers to trade in goods.
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6Assumption #10
• Exports must pay for imports
• Assumptions 8-10 apply to both the Classical and HO Models
• Assumptions 11 & 12 apply only to Classical Model
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7Assumption #11
• Labor is the only relevant factor of production in terms of productivity analysis or costs of production.
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8Assumption #12
• Production exhibits constant returns to scale, CRS, between labor and output.
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9CRS Implies Linear PPF
• See Figure 3.1, page 68
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10Autarky
• See Figure 3.2, page 69
• Given perfect competition,
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11Autarky
• See Figure 3.2, page 69
• Given perfect competition,
– P = MC
– Autarky price of S equals slope of PPF
– Resource payments correspond to their productivity
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12Learning Objectives
• Understand five more assumptions
• Determine and understand comparative and absolute advantage
• Find international trade equilibrium
• Explain gains from trade
• Derive range of wages that will permit trade
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13Absolute Advantage
• Compare one good across countries.
• Country with lower labor input has an absolute advantage in that good.
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14Comparative Advantage
• Calculate opportunity costs.
• Compare one good across countries.
• Country with lower opportunity cost has a comparative advantage in that good.
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15Which Advantage?
• Absolute advantage is a special case.
• Comparative advantage is the general case.
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16Learning Objectives
• Understand five more assumptions
• Determine and understand comparative and absolute advantage
• Find international trade equilibrium
• Explain gains from trade
• Derive range of wages that will permit trade
![Page 17: Chapter 3 -- Classical Model](https://reader036.fdocuments.net/reader036/viewer/2022062305/56815a95550346895dc81203/html5/thumbnails/17.jpg)
17Terms of Trade
• Once trade begins, an international equilibrium results
• Results in one world price for a good
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18Terms of Trade
• Once trade begins, an international equilibrium results
• Results in one world price for a good
– called the terms of trade
– between the two autarky prices
– determined by reciprocal demand
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19International Trade Equilibrium
• See Figure 3.3, page 71
• Complete specialization in Comparative Advantage good
• CIC & ToT tangent at consumption point
• Congruent trade triangles imply balanced trade
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20Learning Objectives
• Understand five more assumptions
• Determine and understand comparative and absolute advantage
• Find international trade equilibrium
• Explain gains from trade
• Derive range of wages that will permit trade
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21Gains From Trade
• Higher CIC shows a gain
• Measure gains from trade using GDP
• Sources of gain:
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22Gains From Trade
• Higher CIC shows a gain
• Measure gains from trade using GDP
• Sources of gain:
– production (gains from specialization)
– consumption (ToT price lower than autarky)
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23Learning Objectives
• Understand five more assumptions
• Determine and understand comparative and absolute advantage
• Find international trade equilibrium
• Explain gains from trade
• Derive range of wages that will permit trade
![Page 24: Chapter 3 -- Classical Model](https://reader036.fdocuments.net/reader036/viewer/2022062305/56815a95550346895dc81203/html5/thumbnails/24.jpg)
24Perfect Competition Review
(Product & Resource Markets)
• PXC = MC for a good, X, in a country, C
• MC = w/MPPL (Labor, L, is only var. input)
• w=MRPL =(MR) MPPL=(P) MPPL=VMPL
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25Perfect Competition Review
(Product & Resource Markets)• PXC = MC for a good, X, in a country, C
• MC = w/MPPL (Labor, L, is only var. input)
• w=MRPL =(MR) MPPL=(P) MPPL=VMPL
• MRPL = Marginal Revenue Product MR = Marginal Revenue;MPPL = Marginal Physical Product of LVMPL = Value Marginal Product of L
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26Prices & Wages
• PXC = MC = w/MPPL
• MPPL is measured as units of X per hour
• hoursXC is stated as hours per unit of X
• PXC = wC (hoursXC)
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27Exchange Rates
• State exchange rate, E, in US dollars per UK pound
– say $2/£
• A good will be imported if its foreign pre-trade price (x E) is less than the domestic price
PSA < E x PSB
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28Buy Low . . .
• Trade requires
PSA < E x PSB
PTA > E x PTB
autarky prices
A has comparative advantage in S
B has comparative advantage in T
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29Trade & Wages
• Substitute PXC = wC (hoursXC)
wA (hoursSA) < E x wB (hoursSB)
wA (hoursTA) > E x wB (hoursTB)
To solvedivide both sides by (E x wB)
divide both sides by (hoursXA)
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30Trade & Wages (Cont.)
hourshours
WEW
hourshours
WEW
TA
TB
B
A
SA
SB
B
A
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31Trade & Wages (Cont.)
• Trade will occur if the wage ratio does not exceed the productivity ratio hours
hoursWEW
hourshours
WEW
TA
TB
B
A
SA
SB
B
A
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33Trade & Wages (Cont.)
• If one country is technologically advanced, it must have a higher wage rate.
hourshours
WEW
hourshours
WEW
TA
TB
B
A
SA
SB
B
A
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34Losing Comparative Advantage
• If the wage ratio exceeds the productivity ratio, trade will not occur
• If a currency is overvalued (say $1/£ instead of $2/£), both goods may be cheaper in one country
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35
Review Homework
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36
0 2 4 6 8 10
2
4
6
8
10
SOYBEANS, S (millions of bushels per year)
C
Q#8: Degree of Specialization
X
CIC1
CIC2
CIC0
G
Autarky Equilibrium
TE
XT
ILE
S, T
(mill
ions
of y
ards
per
yea
r)
PPF
C = COMPLETE SPECIALIZATION,ALLOWS GREATER CONSUMPTION
X = COMPLETE SPECIALIZATION,P = PARTIAL SPECIALIZATION
P
D
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37
0 2 4 6 8 10
2
4
6
8
10
SOYBEANS, S (millions of bushels per year)
L
Quantity of Soybeans Demanded
H
CIC1
CIC2
CIC0
G
Autarky General Equilibrium|slope PPF| = PS/PT = 2 yd.T/bu.S
TE
XT
ILE
S, T
(mill
ions
of y
ards
per
yea
r)
PPF
PS/PT = 1 yd.T/bu.S
PS/PT = 2.5 yd.T/bu.S
4.71.8