Appunti di International Economics

LC

a =amount of labor to produce whine

LW some algebraic manipulation, we can rewrite

⇒With

the PPF equation into the standard form:

y = mx + b Q(w) =L/a – a /a *Q

⇒ LW LC LW c

N.B*: the absolute value of a /a is the slope of

LC LW

the PPF line, it equals the opportunity cost of

cheese in terms of wine (=how many gallons of wine

a country has to give up to make one more pound of

cheese)

→In conclusion, trade is beneficial for both countries

because it expands consumption possibilities (PPF)

since world production increases when each country 2

specializes in producing good in which has comparative advantage=before trade Country A and Country

B could consume anywhere within the gray lines, thanks to trade they can consume within blue

lines⇒What happens to relative price of products with international trade? Let’s look at prices in both

countries involved:

HOME (Country A) FOREIGN (Country B)

Pc P*c

Pw P*w

In autarchy (no trade), Pc>P*c and Pw<P*w, meaning that in Country A cheese costs more (so Country A

imports cheese), while in Country B wine costs

more (so Country B imports wine). If Country A

and Country B start trading, we need to find

relative prices when trade occurs=to do so we

look at the Relative Supply (RS) and Relative

Demand (RD)

- RD is a decreasing function of Pc/Pw

- RS is an increasing function of Pc/Pw

In the graph, the intersection of RD and RS

(point 1) is Pc/Pw before trade. If trade occurs,

RD moves to RD’, so Pc/Pw decreases (point

2)=this means that thanks to trade the relative

price of imported good decreases

FOCUS: RELATIVE PRICE

The relative price is defined as the price of one good or service in terms of another good or service at a

specific moment in time=that means that it is the ratio of two prices that helps understanding the value

of one good compared to the other⇒Pr=P1/P2

→ex. P =100; P =50 Pr =100/50=2

C W C THE HECKSCHER-OHLIN MODEL

SITUATION: 2 countries that produce 2 products (cloth and food) with 2 factors (labor and capital)

The Heckscher-Ohlin Model was built upon the Ricardo model, but it adds some elements: 1)

technology isn’t the only variable that triggers a difference between countries, but also differences in

resource endowment; 2) labor isn’t the only factor of production, but also capital (K)→Moreover, this

model introduces 2 key differences:

● RELATIVE ABUNDANCE: countries may have different amounts of factors of production, so

one country may have more labor/capital than the other (and viceversa)

● RELATIVE INTENSITY: when a country produces a certain good, it may use more of one

factor of production than the other

The H-O theorem affirms that: a country exports the good whose production uses with relative

intensity the factor of production of which that country has relative abundance (ex. a labor-abundant

country tends to export labor-intensive goods)

WEAKNESS: Leontief Paradox: in his studies Leontief analyzed the US finding a paradox in their

behavior. In fact, the US is a capital-abundant country, so it should export capital intensive goods, and

import labor-intensive goods=actually, the US exports were less intensive than US imports, so it

detached from the predictions of the model analyzed 3

→Now let’s look at the PPF, here here’s more than one factor of

production, so the opportunity cost is no longer constant,

therefore PPF is not a straight line, but a curve⇒in this case,

the PPF would be: L=a Q + a Q

LC C LW W

K=a Q + a Q

KC C KW W

What’s the output mix that a country chooses to produce? To

understand it, we need to draw the so-called isovalue lines that

are lines used to indicate the value of production: V=P Q +P Q

C C F F

A country chooses to produce at the point that maximizes the

value of production, this corresponds to point Q that touches the

highest possible isovalue line=at that point, the relative price

of cloth (Pc/Pf) equals the slope of the isovalue line

● What happens if one factor of production doubles? the

PPF will expand, since the country will be able to produce more

● What happens to output if relative prices are constant? If

one factor increases (ex. labor) and relative prices remain the

same, the PPF will expand disproportionately towards the

labor-intensive good=so the country will produce more

labor-intensive goods, less capital-intensive ones

→In conclusion, in this model trade is positive because it leads

to the convergence of relative prices, in fact if we take cloth (labor-intensive good), the relative price of

cloth will rise in the labor-abundant country and will fall in the labor scarce country until it converges

to a post-trade equilibrium price

TRADE AND DISTRIBUTION OF INCOME (H-O)

As we have seen, with international trade there’s a convergence of relative prices, this can affect the

distribution of income: owners of a country’s abundant factors gain from trade, but owners of a

country’s scarce factors lose⇒is trade responsible for increasing inequality? The H-O would suggest so,

but there’s little evidence that increasing inequality in advanced economies was causes by trade=actually,

the real main reason is the skill-biased technological change, so people who can utilize a certain

technology are advantaged compared to less educated ones

DUTCH DISEASE

The Dutch disease is the relationship between the increase in development of a specific sector (ex.

natural resources) and a decline in other sectors (ex. manufacturing; agriculture)→ex.) in 1959, the

Netherlands found out a great availability of natural gas, but instead of causing a growth in the country’s

economy, it provoked a drastic decrease in all other sectors⇒How to avoid Dutch disease? The most

logical thing is to stock resources instead of extracting and exporting it

SPECIFIC FACTOR MODEL ​

(RICARDO-VINER)

SITUATION: 2 countries that produce 2 products with 3 factors (labor and capital and land)

(T)⇒let’s remember that to produce cloth we use capital and labor (Q =Qc (K,L ); and to produce

C C

food we use land and labor (Q = QF (T, L )=so we can say that:

F F

● labor is a mobile factor

● land and capital are specific factors (used only in the production of one good) 4

The specific factor model states that there are some specific (fixed) factors which are necessary to

produce certain products, so a country cannot move factors of production as it wants⇒In this case, the

PPF would be:

Given this PPF (blue graph), we can consider

different situations→ex.) what happens if we

transfer labor (mobile factor) from the production

of one good to the other? If we put more labor in

cloth, the cloth production will rise, but not in a

linear way (gray graph)=in fact, additional labor

has diminishing returns=each additional

person-hour increases output by less than the

previous one because there is less capital per

worker

→Now let’s focus on the PPF: like in the H-O model, we see

that a country produces at the point where the isovalue slope

equals the relative price of cloth=therefore, an increase in

P /P causes the production to move down and to the right,

C F

corresponding to higher output of cloth, and lower output of

food

TRADE AND DISTRIBUTION OF INCOME (R-V)

Let’s assume the price of cloth increases (reminder: cloth is

capital-intensive good)⇒what’s the impact in terms of

income?

1) Capital owners will gain;

2) Land owners will lose;

3) Workers may benefit or not, since it depends on the importance of the good in their

consumption→N.B*: gains from trade are not evenly distributed across consumers due to

different consumption patterns that depend on distribution of income=so low-income people

will benefit the most, because if prices go lower, they can access a higher portion of goods

CONSUMPTION CHOICE

A consumption choice is based on consumers’ preference and relative price of goods→Let’s assume

that the economy’s consumption decisions were based only on tastes of a single consumer=if we look at

the graph, we see an indifference curve (IC), that shows the

consumer preference, so the combination of goods that leave the

consumer equally well off (indifferent)⇒They have some

characteristics:

● Downward sloping: if you have less good X, then you

must have more good Y to be equally satisfies

● The farther from the origin, the more consumers are

satisfied: consumers prefer having more of both goods

● IC become flatter when you move to the right: with more

good X than good Y, an extra unit of good X becomes less valuable

in terms of how many units of good Y you are willing to give up 5

TERMS OF TRADE

The terms of trade refers to the price of exports relative to the price of imports that determines the

amount of imported goods that you can purchase per unit of exported goods

Terms of trade (TT): Pex/Pimp

GENERAL RULE: an increase in terms of trade increases a country’s welfare, while a decline in

terms of trade decreases a country’s welfare

→When two countries trade (A and B), they have different PPFs,

but their relative prices are the same (=because trade convergences

relative prices)=let’s assume Country A exports cloth, if it has a

big growth on cloth, then the supply curve will increase⇒what’s

the effect on terms of trade? If the biased growth is in the cloth

industry, the price of cloth will decrease, that means that it will

lower the terms of trade for cloth exporters→ex.) Let’s analyze

the situation for Country A

Pc=3 (cloth: export)

Pw=2 (wine: import)

TT=3/2=1.5

=We said that Country A has a growth on cloth, so Pc decreases

going from 3 to 2, this means that TT change⇒TT=2/2=1→the

general rule affirms that if TT decreases, a country’s welfare

decreases as well, so in this case Country A looses (being the

country with a decrease in TT), while country B wins (being the country with an increase in

TT)→SUMMARY:

● Export-biased growth reduces a country’s terms of trade, reducing its welfare and increasing the

welfare of foreign countries

● Import-biased growth increases a country’s terms of trade, increasing its welfare and decreasing

the welfare of foreign countries

ECONOMIES OF SCALE AND INTERNATIONAL LOCATION OF PRODUCTION

Economies of scale are a source of international trade, and they depict a situation in which the more input

you put in, the more disproportionately the outputs will go up⇒Until now, we have seen models of

comparative advantage that had constant returns to scale, meaning that when inputs to an industry

increase at a certain rate, output increases at the same rate. However, there may be increasing returns to

scale, meaning that output increases at a faster rate=in this w