Jan 28 and Jan 30

1/28/09 Opening PPFs to International Trade Figure 3.3 (in slides on CULearn): Post Trade Equilibriums K,L pre-trade points of consumption and production Assume world price ratio: Ps/Pt = ¾ Price ratio needs to be somewhere b/t the two to be desired by either county Classical model makes both countries fully specialize TOT (terms of trade) line = ?consumption possibilities frontier? Trade Triangles Country A J production point I consumption point OH = S consumption OJ = S of production HJ = S exports IH = T imports Country B M = Production point N = Export Point MR = T exports RN = S imports = international consumption of S OR = consumption of T Assume price ratio of one Steeper slope, trade triangle becomes smaller Smaller volume of exports of Textiles; smaller volume of imports of Soybeans A?s trade triangle becomes bigger; has more incentives (profit) to trade 1/30/09 Weakness of Classical Model Implies complete specialization No explanation for source of comparative advantage Greatest gains from trade require large differences in levels of technology Heckscher-Ohlin Model Two factors of production, K and L Two goods: Textile (T) and production is labor intensive; soybean (S) production is capital intensive Two Countries: American (A) is capital abundant; Bangladesh (B) is labor abundant Each country has a comparative advantage in, and will export, that good which is intensive in the use of that country?s abundant factor Important terminology: Intensity (in use) Vs. Abundance (in availability) Implied PPFs PPF for America stretches toward S axis Abundant capital allows high S output PPF for Bangladesh skewed towards T Abundant labor(high T output Scarce capital(low S output Results in curved graphs for both of the countries PPFs Then, when applying the combined CIC for both countries, intersection points (respective to the countries PPF), are the pre-trade point of production and consumption Single CIC to represent the identical preferences in the two countries Tangency points between CIC and each PP are optimal autarky points Slopes at tangency point are relative prices (Ps/Pt) in each country Flatter line (again) is lower relative price of the horizontal axis good, in this case soybeans (S) Production point under trade is the slope of the Terms of Trade line (Ps/Pt of the world price); then, where that same line, TOT, is tangent to the CIC (one higher than the original) is what the country consumes, the rest are traded