Transcript Lecture 3 - Akateeminen talousblogi

Neoclassical Trade Theory:
Tools to Be Employed
Appleyard & Field (& Cobb): Chapters 5–7
Basic Concepts for the
Consumer Theory
• Bundle = combination of goods (that are being
consumed)
• If a consumer gets the same amount of utility from
bundle A as from bundle B, she is indifferent between
A and B
• Indifference curve is a set of all bundles that yield the
same utility
• Slope of the indifference curve = marginal rate of
substitution (MRS) = the increase of one good
needed to compensate the loss of another good
o
diminishing MRS  declining marginal utility  convex
indifference curve  concave utility function
Indifference Curve (two goods)
Good Y
Higher utility
12
Indifference curve 2
4
Indifference curve 1
3
10
Good X
Budget Constraint and the Equilibrium
• Budget constraint (budget line) = maximum
combinations of goods that can be bought with a fixed
level of income (given the prices)
• Consumer maximizes her utility given her income and
prices  consumer chooses the highest indifference
curve available
• In equilibrium: MRS = MUY/MUX = PX/PY
The Consumer Equilibrium
Good Y
Budget Constraint: PX*X+PY*Y= income
 Y=income/PY – PX/PY*X
That is, slope of the budget constraint = –PX/PY
Indifference Curve: MUX*X+MUY*Y=initial utility
 Y = (initial utility)/MUY-MUX/MUY*X
That is, slope of the indifference curve = -MUX/MUY
Equilibrium: PX/PY=MUX/MUY=MRS
y*
x*
Good X
Marginal Utility & Product
• Marginal utility = the additional utility from consuming an
additional (very small) unit of a good.
o
Typically we assume that this is decreasing as consumption of a good
increases, e.g. increasing the consumption of water from zero to one
litre a day increases utility more than a change of consumption from
1000 to 1001 litre a day.
• Marginal product = additional output from using an additional
(very small) unit of factor of production.
o
Typically we assume that if you keep the other factors of production
constant, the marginal product is decreasing, e.g. you have 10 shovels
(capital), then increasing the number of workers from 9 to 10
increases output more than increasing the workers from 10 to 11.
Production: Capital and Labour
Low K/L ratio
High K/L ratio
Capital (K)
Capital (K)
Labour (L)
Labour (L)
Basic Concepts for the
Production Theory
• Isoquant = combinations of inputs that
produce the same level of output
• Slope of the isoquant = Marginal rate of
technical substitution (MRTS) = the increase
of an input needed to maintain the level of output after
a decrease of another input
• Isocost = combination of factors that can be
bought for given input costs
Producer Equilibrium
Capital
Isocost: PK*K+PL*L=cost of production
 K=(cost of production)/PK – PL/PK*L
Isoquant: MPPK*K+MPPL*L=output
 K = (output)/MPPK-MPPL/MPPK*K
Equilibrium: MRTS=MPPL/MPPK=PL/PK
(Firm chooses inputs to minimize the cost
for given output)
K*
Isoquant
Isocost
L*
Labour
Generalizing for the Whole Economy
• Community Indifference Curve
o If a give amount of good X is taken away from the economy
how much of good Y is needed to put all consumers back to
their initial utility level?
• Production Possibilities Frontier
o What can be produced given the resources of the economy
(≈ budget constraint of the country)
• Instead of thinking about individuals, we now use the same
ideas to think about whole countries. Note, however, that while
this gives us the great gain of being able to use the powerful
framework of the decision theory, one should be cautious of
thinking about countries as if they were individuals. This point
will be discussed in more detail later in the course.
Production Possibilities Frontier (PPF):
Constant Opportunity Cost
Good Y
40
20
10
20
Good X
PPF: Increasing Opportunity Cost
Good Y
Why?
1. Rising marginal cost
2. Specific factors
3. Different factor intensities
40
15
5
10
20 22
Good X
Autarky Equilibrium
Good Y
Equilibrium:
MRT = PX/PY = MRS
Y*
Community Indifference Curve
slope = -MUY/MUX = -MRS
Production
Possibilities
Slope = -PX/PY
Slope = -Marginal Rate of Transformation (MRT)
X*
Good X
Gains from Trade
(PX/PY)FT
Equilibrium:
MRT = (PX/PY)FT = MRS
Imports
Assuming:
Good Y
1.
Costless factor
mobility
2.
Full employment of
YC
factors of
production
3.
The indifference
YA
curve can show
welfare changes
YP
For more discussion, see
Appleyard and Field
around page 93-95.
(PX/PY)A
XC XA XP
Exports
Good X
Consumption and Production Gains
Good Y
(PX/PY)FT
production gain
(PX/PY)A
Good X
consumption gain
Mutual Gains
Country 1
Country 2
(PX/PY)FT
Good Y
Exports
Good Y
YC
Imports
(PX/PY)FT
YP
YA
YC
YA
YP
(PX/PY)A
XC XA
XP
Good X
(PX/PY)A
XP XA XC
Good X
Exports
Imports
Note that the graphs are not drawn accurately. In a two-country model, the amount of imports of good Y
from Country 1 must equal the amount of exports of good Y to Country 2 (and similarly for good X…)
Identical PPF,
Different Preferences
(PX/PY)FT
Good Y
(PX/PY)A
(PX/PY)A
Good X
Defining Central Concepts for
Neoclassical Trade Theory
• Terms of Trade = PX/PM
o
o
o
the world price of a country's exports relative to the
world price of its imports
PX/PY in the two-country-two-goods-model
terms of trade “improve” when this index rises, i.e. for
the same amount of exports the country will get a
larger amount of imports
• Offer Curve = reciprocal demand curve indicating
country’s quantity of imports and exports at all
terms of trade
Other Concepts Called “Terms of Trade”
• Income Terms of Trade = (PX/PM)*QX
o
Index of total export earnings PX*QX divided by price
of imports  country’s ability to import
• Single Factoral TOT=(PX/PM)*OX
o
O=productivity index. Intuition: the amount of
imports available for unit of work effort
• Double Factoral TOT=(PX/PM)*(OX /OM)
Note that there is a mistake in A&F
Figure 4 page 99 (in the 4th ed.)
Good Y
Deriving the Offer Curve
Offer Curve
(PX/PY)1
Good Y
Good X
Exports1
Imports1
Imports2
XP
YC
YP
(PX/PY)2
XC XP
Exports2
Good X
(PX/PY)2 =
TOT2
Potential price lines:
PX*QX=PY*QY 
QY=(PX/PY)*QX
i.e. given the prices, the
value of exports equals
the value of imports
Imports2
Imports1
YP
XC
(PX/PY)1 = TOT1
Imports of good Y
YC
Exports of good X
Exports2
Exports1
Putting the Offer Curves to One Graph
Country 2
(PX/PY)1
Offer Curve
Offer Curve
Exports of good Y
Imports of good Y
Offer Curve
Imports of good X
Country 1
(PX/PY)1
(PX/PY)2
(PX/PY)2
Exports of good X
Exports of good Y
Imports of good X
Trading Equilibrium:
The determination of international prices
Good Y:
Imports to country 1
exports from country 2
(PX/PY)E
= TOTE
Country 2’s offer curve
Country 1’s offer curve
Good X:
Exports from country 1
Imports to country 2
(PX/PY)’
Shift of Offer Curves (1)
• Assume that in Country
Imports of good Y
1 there is shift in
preferences and the taste
for imports (good Y)
increases
• That is, for every terms
of trade, country 1 is
willing to trade more
• That is, the offer curve
shifts rightwards
OC1
OC0
(PX/PY)1
(PX/PY)2
Exports of good X
New equilibrium:
• More trade
• New terms of
trade = new
relative prices
• (PX/PY)E’ <
(PX/PY)E
o
i.e. the relative
price of good
Y increase
Good Y:
Imports to country 1
exports from country 2
Shift of Offer Curves (2)
(PX/PY)E
= TOTE
Country 2’s offer curve
Country 1’s offer curves
Good X:
Exports from country 1
Imports to country 2
(PX/PY)E’
= TOTE’
Improvement in Terms of Trade:
Substitution, Production and Income Effects
• Improvement in Terms of Trade  relative
price of the exported good X increases 
relative price of the imported good Y decreases
o
o
o
Substitution effect: consumers shift their
purchases towards the imported goods
Production effect: producers start producing
more exports
Income effect (terms-of-trade effect): real
income of the home country rises (more demand
for both X and Y)