Transcript ECONOMICS 3150B

ECONOMICS 3150N
Winter 2013
Professor Lazar
Office: N205J, Schulich
[email protected]
736-5068
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Lecture 7: March 7
Ch. 2, 3, 4, 5
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Basis for Trade
• Gravity Model
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T(i, j) = Y(i)Y(j)/D(i, j)
T(i, j): value of trade between country i and j
Y: GDP
D(i, j): distance between country i and j
• 1% increase in distance between two countries is
associated with 0.7-1.0% decrease in trade
• Transportation costs, similarities (familiarities) –
language, tastes
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Gravity Model: NAFTA (2010)
% of Exports to
NAFTA Countries
Canada
% of Imports from
NAFTA Countries
76%
57%
US
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Mexico
84
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Gravity Model: EU (2010)
EU27
• %of exports
– EU27: 68%
– Europe: 74%
• % of imports
– EU27: 65%
– Europe: 70%
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US Exports, 2011: Top 10 Countries
Exports
(US$ B)
GDP per
Capita (US$)
Canada
281
50,345
Mexico
198
10,047
China
104
5,445
Japan
66
45,903
UK
56
39,038
Germany
49
44,060
South Korea
43
22,424
Brazil
43
12,594
Netherlands
42
50,076
Hong Kong
36
35,156
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US Imports, 2011: Top 10 Countries
Imports
(US$ B)
GDP per
Capita (US$)
China
399
5,445
Canada
315
50,345
Mexico
263
10,047
Japan
129
45,903
Germany
99
44,060
South Korea
57
22,424
UK
51
39,038
Saudi Arabia
48
20,540
Venezuela
43
10,810
Taiwan
41
NA
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Basis for Trade
• Differences in relative prices
– [P1/P2]A  [P1/P2]B
– Countries differ
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Resources
Culture, tastes
Demographics
Rules
Incentives/motivation
• Differences in availabilities of products
(goods, services)
– Companies create competitive advantages
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General Equilibrium: Closed Economy
Model
• Objective: maximize production subject to resource and technology
constraints  production possibility frontier
• Assumptions:
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Two factors of production: X1, X2
Two goods: Y1, Y2
Full employment
Given state of technology: T
No convexities – no economies of scale, no externalities
No public goods
Production functions: Y(i) = Fi [X1, X2, T]
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Optimization Solution: 1
• Maximize production:
– Max Y1, Y2
– S.t.
• production functions [Fi , i = 1,2]
• Maximum availabilities of X1, X2
• Production functions, isoquants
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Optimization Solution: 1
• Maximize production:
– Max Y1
– S.t.
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Y1 = F1 [X1, X2, T]
Y2 = 0Y2
X1  0X1
X2  0X2
• Box diagram with isoquants
• Production possibility frontier [G(Y1, Y2)]
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PPF
• Efficient production
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knowledge of production functions
producing on frontier of production function
given state of technology
full employment
• PPF can also be derived by minimizing costs of producing various
quantities of the two products
– Min: C1X1 + C2X2
– S.t.
• Y1  F1 [X1, X2, T]
• Y1  0Y1
[isoquant and isocosts]
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Optimization Solution: 2
• Optimal level of production of two products: Y1, Y2
• Maximize value of output
– Max: P1Y1 + P2Y2
– S.t.: PPF
[PPF and income lines]
• Max utility
– Max: U(Y1, Y2)
– S.t.: PPF
• Solution: GE model with perfect competition  P1, P2, C1, C2, Y1,
Y2
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Changes in Relative Prices
• Equilibrium P2/P1 will change if:
– Change in shape of PPF – changes in relative supplies
• Change in relative availabilities of X1, X2
• Change in production functions
• Change in state of technology
– Changes in tastes – changes in relative demands
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Basis for Trade
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Different relative prices
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Different technologies – different p.f., different states of technology
Different relative quantities of factors of production, climate
Different tastes – different utility functions, income per capita, culture
Absence of perfect competition: monopolistic markets
Different products
– Different factors of production
– Absence of perfect competition
– Different tastes
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Low trade costs
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Transportation costs (infrastructure, oil prices, containers, jet aircraft)
Trade barriers (carbon taxes)
Information
Other – hedging, insurance, etc. (piracy)
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Basis for Trade
• Bottom Line: firms produce goods
– Firms need info on products (characteristics, p.f.); technology
– Agents need info on relative and absolute prices and access to
distribution channels in foreign countries
– Costs for information increase with distance – geographic, culture
• Value chain: production of final product entails various
intermediate stages – examples: gasoline at retail; laptops;
autos; cell phones; aircraft; drugs
– Trade in intermediate products
– Trade in intermediate services
– Who is control?
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Comparative Advantage Models
1. Single Factor, Ricardian Model
• Assumptions:
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One factor of production: X1
Two goods: Y1, Y2
Constant returns to scale [Y = F(X1), δ=1]
PF: Yi = i1 X1 [i1: units of product i per unit of factor of production 1]
• Resulting PPF:
– Y1/ i1 + Y2/ 21  0X1
– Opportunity cost of Y1 in terms of Y2: 21/ 11
– No adjustment problems since sole factor of production can move
costlessly and instantaneously between products
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Single Factor Ricardian Model
• Utility maximization  optimal production and
consumption point, P1, P2
– Slope of straight line PFF:
• P2/P1
• 11/ 21
– Relationship between relative prices and opportunity costs
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Single Factor Ricardian Model
• Two countries, two products, one factor of production
– Conditions for pre-trade relative prices to differ [i.e. {P1/P2}A 
{P1/P2}B]
• Different production functions: i1(A)  i1(B)
• Different tastes will not produce different relative prices
• Absolute advantage vs. comparative advantage
– Implications for productivity, incomes per capita, migration
• Comparative advantage
– Country has comparative advantage in product with lower relative
opportunity cost
– Country A has comparative advantage in product 1 if
• [21/ 11 ]A < [21/ 11]B
• {P1/P2}A < {P1/P2}B
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Single Factor Ricardian Model
• Trade between A and B will equalize relative prices 
{P1/P2}A = {P1/P2}B
– Equilibrium relative prices post-trade between original pre-trade
ratios
– If A is large country and B a small country, equilibrium relative
prices post-trade closer to pre-trade ratio in A
• Specialization – small country, not necessarily for large
country
– Transportation costs
– Protection of industries
• Terms of trade: price of exported product relative to price
of imported product
– For country: P1/P2
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Single Factor Ricardian Model
• Gains from trade
– Consumption, production – pre-trade and post-trade
– Exports, imports
– Higher level of utility, higher level of real income/GDP
• Equilibrium in currency market will result in current
account balance = 0
– Total value of exports = total value of imports
– D/S of country’s currency depend upon current account
transactions only
– For Country A: P1AEX(Y1) = P2BIM(Y2)E*
– With no trade costs: P1A = P1BE* and P2A = P2BE*
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Single Factor Ricardian Model
• Conclusions:
– Extreme degree of specialization
– No impact on distribution of income within each
country – no losers (full employment, one factor of
production)
– Gains from trade
– No explanation of differences in production functions
and relative and absolute productivities
– Volumes of exports and imports not determined
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Extension of Ricardian Model
• Many products (i = 1, N), one factor of production
• Assumptions:
– Constant returns to scale
– Perfect competition: Pi = MCi
– MCi = P(X1)/i1
• Allocation of production in two country world (A, B)
– Product i produced in country with lower MC
– Produced in A: {P(X1)E/ i1}A < {P(X1)/ i1}B 
{[P(X1)]AE /[P(X1)]B} < {i1}A / {i1}B
– Produced in B: {[P(X1)]AE /[P(X1)]B} >{i1}A / {i1}B
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Extension of Ricardian Model
• Order the products 1 to N so that
{11}A / {11}B < {21}A / {21}B < …….. < {N1}A
/ {N1}B
• All products 1 through K are produced in B
and exported by B:
{[P(X1)]AE /[P(X1)]B} > {K1}A / {K1}B and
{[P(X1)]AE /[P(X1)]B} < {K+11}A / {K+11}B
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Extension of Ricardian Model
• Products K+1 through N are produced and
exported by A
– Not all products may be traded – depends upon
trade costs  non-traded products
– Specialization, but if B is a large country, B
also may produce, but not export some or all of
the products 1 through K
– Assumes that E is at equilibrium level so that
value of A’s exports = value of B’s imports
– If value of E changes so too does cut-off point
“K”
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Services
• 2010
– World merchandise exports: US$15.2 T
– World commercial services exports: US$3.7T (20%)
• P. 21: “”current dominance of world trade by
manufactures…may be only temporary. In the long run,
trade in services, delivered electronically, may become the
most important component of world trade.”
• Measurement problem with services
– Unit of financial service; consulting service, legal service, call
center service, etc.
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Heckscher-Ohlin Model
• 2X2X2 model
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Two countries
2 factors of production
2 products – different factor intensities
Identical production technologies and state of technology
Different relative resource availabilities: {X1/X2}A  {X1/X2}B
• Basis for trade: different resource availabilities which give rise to
different pre-trade relative prices
– Comparative advantage: interaction between relative abundance
(supply) of resources (factors of production) and technology of
production (relative intensity with which different factors of
production used in production of different goods)
– Counties export goods whose production is intensive in factors
with which the countries are abundantly endowed
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Heckscher-Ohlin Model
• Factor intensity: {X1/X2}i
– Min TC = P(X1)X1 + P(X2)X2
s.t. 0Y1 = F1(X1, X2, T)
– Factor intensity determined by intersection of isoquant and budget line
– Constant returns to scale and factor intensity
• Factor intensity {X1/X2}1 depends upon {P(X2)/P(X1)}
– If {P(X2)/P(X1)}   {X1/X2}1 
• Relative prices of factors of production depend upon relative
availabilities of factors of production
– If {X1/X2}A   {P(X2)/P(X1)}A 
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Heckscher-Ohlin Model
• Relative prices of products {P1/P2} depend
upon relative prices of factors of production
[P=MC] {P(X1)/P(X2)} and relative factor
intensities
– Assume Y1 uses X1 relatively more intensively
than Y2 
{X1/X2}1 > {X1/X2}2
– As {P(X1)/P(X2)}  so too does P1/P2
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Heckscher-Ohlin Model
• If {X1/X2}A > {X1/X2}B then {P(X1)/P(X2)}A <
{P(X1)/P(X2)}B and {P1/P2}A < {P1/P2}B
– A has comparative advantage in Y1 (Y1 uses X1
relatively more intensively and A has relative
abundance of X1)
– A will export Y1 and import Y2
– Specialization not necessary outcome even if one of the
countries is a small country and the other is a large
country
– Trade will tend to equalize relative prices of products
and factors of production
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Heckscher-Ohlin Model
• Winners and losers
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Net utility/income gains
Full employment and no transition costs
 D for Y1 post-trade   D for X1 in A  P(X1) in A
 S of Y2 post-trade   D for X2 in A   P(X2) in A
• Welfare effects of changes in terms of trade: {P1/P2} for A
– Assume improvement in terms of trade for A
– Leads to improvement in aggregate welfare in A and increase in trade
volumes
– Owners of a country’s abundant factors gain from trade; owners of
country’s scarce factors lose relatively and may lose in absolute values as
well
– Implications for income distribution between X1 and X2
•  D for X1 in A
•  D for X2 in A
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Heckscher-Ohlin Model
Increase in availability of factors of production in country A
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Proportionate increase in both factors of production  no change in
relative availabilities
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Increase in volume of trade
Change in terms of trade  deterioration because of  S of Y1 from
country A and  D for Y2 from country A
Increase in X1 (or disproportionate increase in X1)
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Biased growth
Change in shape of PPF for country A  change in relative prices,
change in terms of trade
Larger impacts on volume of trade and terms of trade
Growth leads to more trade
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Heckscher-Ohlin Model
Determinants of relative abundance of factors of production
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Natural resources including climate
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Exploration/development
Climate change
Labor
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Skill level
Education, training
Population growth, demographics
Capital
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Types
Investment
Technology
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R&D
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Production, products
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