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Ch. 3.

slides international economics

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18 views26 pages

Ch. 3.

slides international economics

Uploaded by

lynakhan53
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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CHAPTER T H R E E

3 International
Economics

The Standard Theory


Of International Trade
In this chapter:
 Production Frontier with Increasing
Costs
 Community Indifference Curves
 Equilibrium in Isolation
 Basis for and Gains from Trade with
Increasing Costs
 Trade Based on Differences in Taste
The Production Frontier with
Increasing Costs

 Increasing Opportunity Costs


 A nation must give up more and more of
one commodity to release just enough
resources to produce each additional
unit of another commodity.
 Increasing cost production possibilities
frontier is concave to the origin (not a
straight line).
FIGURE 3-1 Production Frontiers of Nation 1 and Nation 2 with
Increasing Costs.
The Production Frontier with
Increasing Costs

 The marginal rate of transformation


(MRT) increases as more units of good
X are produced.
 The marginal rate of transformation is
another name for opportunity cost.
 The value of MRT is given by the slope
of the PPF.
Community Indifference Curves

 A community indifference curve shows


combinations of two commodities that
yield equal satisfaction to the community
or nation.
 Represent measure of taste and preference.
 Characteristics of community indifference
curves:
 The higher the curve, the greater the utility.
 Negative slope, convex to the origin.
 Different curves do not cross.
FIGURE 3-2 Community Indifference Curves for Nation 1 and
Nation 2.
Community Indifference Curves

 The marginal rate of substitution (MRS)


falls as more of good X is consumed.
 The MRS of X for Y in consumption is the
amount of Y that a nation could give up for
one extra unit of X and still remain on the
same indifference curve.
Equilibrium in Isolation

 Interaction of forces of demand


(community indifference curves) and supply
(production possibilities frontier) determine
equilibrium for a nation in the absence
of trade (autarky).
 Nations seek the highest possible
indifference curve, given its production
constraint.
FIGURE 3-3 Equilibrium in Isolation.
Equilibrium in Isolation

 The equilibrium-relative commodity


price in isolation = slope of tangency
between PPF and indifference curve at
autarky point of production and
consumption.
 Relative prices are different in Nation 1
and Nation 2 because of different shape
and location of PPF’s and indifference
curves.
Basis for and Gains from Trade with
Increasing Costs

 Relative commodity price differentials


between two nations reflect comparative
advantages, and form basis for mutually
beneficial trade.
 Each nation should specialize in the
commodity they can produce at the
lowest relative price.
 Specialization will continue until relative
prices equalize between nations.
FIGURE 3-4 The Gains from Trade with Increasing Costs.
Basis for and Gains from Trade with
Increasing Costs

 Equilibrium-relative commodity
price with trade = common relative
price at which trade is balanced.
 Balanced trade: quantity of X (Y)
Nation 1(2) wants to export = quantity
of X(Y) Nation 2(1) wants to import.
 Any other relative price could not
persist because trade would be
unbalanced.
Basis for and Gains from Trade with
Increasing Costs

 Under constant cost conditions,


specialization is complete.
 Under increasing cost conditions,
specialization is incomplete:
 As production moves along PPF toward
comparative advantage good, relative
costs change, thus changing basis and
gains from trade.
FIGURE 3-5 The Gains from Exchange and from Specialization.
Trade Based on Differences in Taste

 Even if two nations have identical PPFs,


basis for mutually beneficial trade will
still exist if tastes, or demand
preferences, differ.
 Nation with relatively smaller demand
for X will have a lower autarky relative
price for, and comparative advantage,
in X.
FIGURE 3-6 Trade Based on Differences in Tastes.
Case Study 3-1 Comparative
Advantage of the Largest Advanced
and Emerging Economies
Case Study 3-2 Specialization and
Export Concentration in Selected
Countries
Case Study: Balassa’s Revealed
Comparative Advantage (RCA) Index
 The RCA index of country i for product j:

 RCAij = (xij/Xi) / (xwj/Xw)


where xij and xwj are the values of country i’s exports of
product j and world exports of product j and where Xi
and Xw refer to the country’s total exports and world
total exports.

 A value of less than unity implies that the country has


a revealed comparative disadvantage in the product.
Similarly, if the index exceeds unity, the country is
said to have a revealed comparative advantage in the
product.
Appendix to Chapter 3

 Production Functions, Isoquants, Isocosts


and Equilibrium
 Production Theory with Two Nations, Two
Commodities, and Two Factors
 The Edgeworth Box and Production
Frontiers
FIGURE 3-7 Isoquants, Isocosts, and Equilibrium.
FIGURE 3-8 Production with Two Nations, Two Commodities, and
Two Factors.
FIGURE 3-9 Derivation of the Edgeworth Box Diagram and
Production Frontier for Nation 1.
FIGURE 3-10 Derivation of the Edgeworth Box Diagram and
Production Frontier for Nation 2.

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