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Transcript of Chapter 2 Extend the Ricardo’s Model 1. Loose the assumptions of Ricardo’s Model A. Review the...
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Chapter 2
Extend the Ricardo’s Model
1. Loose the assumptions of Ricardo’s Model
A. Review the Assumptions of Ricardo’s Model, Loose those assumptions and see what will happen to Ricardo’s model
B. Summary
2. Other extensions
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Chapter 2
Review the Main Assumptions
1. 2*2*1 model: One input(L), Two outputs, Two countries
2. Costs are constant and there are no economies of scale.
3. Factors of production are perfectly mobile.
4. Perfect Competition (Goods are identical)5. No transaction costs (No transport costs,
No tariffs or other trade barriers, Perfect knowledge, etc)
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Chapter 2
Loose the Assumptions 1(1)
One input Two or more inputs
H-O Model Specific Factor Model
Talk about it later
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Chapter 2
Loose the Assumptions 1(2)
Two outputs &Two countries
Ricardo Model with Many
Goods or Many Countries
Ricardo’s model no essential change
1. Many Goods and Two Countries
2. Many Countries and Two Goods
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Chapter 2
Many Goods and Two Countries 1. Setting up the model: list relative
productivity by order (note: * is US)
2. Deriving the relative demand for labor3. Determining the relative wage4. Determining the comparative advantages
**LiLi ww *
*
w
wa
Li
Li
If or than china has
advantage in product i
*/ ww
αL1*/ αL1> αL2
*/ αL2>…… > αLi*/ αLi
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Chapter 2
Example
If = 5 , then China has advantage in apple and Banana, US has advantage in other three goods;
If =4,then China and US both can produce caviar; If =1 , then China can export apple, banana, caviar and Dates.
*/ ww
*/ ww*/ ww
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Chapter 2
Many Countries and Two Goods
1. Setting up the model: list relative costs by order
2. Deriving the relative supply3. Determining the relative price4. Determining the comparative
advantages
1
LW
LR
a
a
2
LW
LR
a
a
NLW
LR
a
a
< <…<
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Chapter 2
Principle
In the case of two products and many countries, one
country’s comparative advantage is determined by
the relative costs of the products it produces
and the relative price in the world market .
If < , this country has comparative
advantage in product 1.
21 / LL
21 / PP
21 / LL 21 / PP
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Chapter 2
Example
USAFrance
ChinaThailand
NationL per Unit Relative cost
Rice Wheat
Suppose the relative price of Rice in equilibrium is 2,
then Thailand and China produce and export Rice, while
USA and France produce and export Wheat.
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Chapter 2
Determining the relative price
Relative productions of Rice
Relative Demand
Relative price of Rice
4
2.5
2
1.5
1
Relative Supply
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Chapter 2
Determining the relative price
Relative price of Rice is determined by the produce capability of Thailand in Rice, that of USA in Wheat and the relative demand of 4 countries.
If the produce capability of Thailand in Rice is strong, while that of USA in Wheat is weak, the relative supply of Rice is large; or else it is small.
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Chapter 2
Determining the relative price
When the relative demand of Rice is given, the larger the relative supply of Rice is, the lower the relative price of Rice in equilibrium, and the less countries Rice productions will need, even just Thailand is enough.
But if the produce capability of USA in Wheat is strong, while that of Thailand in Rice is weak, the relative price of Rice will be higher.
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Chapter 2
Loose the Assumptions 2(1)
Costs are constant
Increasing opportunity costs or decreasing returns to scale
QC
QW
PPFQC
QW
PPF
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Chapter 2
International Trade under Increasing Opportunity Cost
1. Autarky2. The Patten of Production and Tra
de3. Comparison4. Conclusion
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Chapter 2
Autarky
4
1Ap
y
x
0E
Home
y
x
4Bp
0'E
Foreign
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Chapter 2
The Patten of Production and Trade
4
1Ap
y
x
0E
Home
C
1WORLDPTOT=
Export
Import
P
x
y
4Bp0'E
Foreign
C’
1WORLDPTOT=
Export
Import
P’
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Chapter 2
Comparison
Constant Cost Increasing Opportunity Cost
y
x4
1Ap
0E
Home
C
4
1Ap
y
x
0E
Home
C1WORLDPTOT=
1WORLDPTOT=
Import
Export
Export
Import
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Chapter 2
Conclusion
The principle of comparative advantage is still effective under the increasing opportunity cost.
However, pure specialization is impossible.
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Chapter 2
Loose the Assumptions 2(2)
Costs are constant
Decreasing opportunity costs or decreasing returns to scale
QC
QW
PPFQC
QW
PPF
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Chapter 2
Trade gains under decreasing costs
QC
QW
PPF
A
B
A’
B’C’
CTrade gain TOT
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Chapter 2
Loose the Assumptions 2(3)
No economies
of scale
Economics-of-scale and imperfect
competition model
Talk about it later
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Chapter 2
Loose the Assumptions 3
Factors of production are
perfectly mobile
Factors of production can’t move freely among sectors
Transfer Costs
Industry Obstruct
Increasing the production costs of export
Reduce the volume of
international trade
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Chapter 2
Loose the Assumptions 4
Goods are identical
Goods are idiosyncratic
Intra-sector Trade
Talk about it later
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Chapter 2
Loose the Assumptions 5(1)
Perfect knowledge
Imperfect knowledge
More difficult to find the right goods and reach contractions
Reduce the volume of
international trade
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Chapter 2
Loose the Assumptions 5(2)
No transport costs
transport costs
Non-traded Goods
Reduce the volume of
international trade
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Chapter 2
Loose the Assumptions 5(3)
No tariffs or other trade
barriers
Trade Barriers
Increasing the Transaction
Costs
Reduce the volume of
international trade
Talk about it later
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Chapter 2
Summary
1. Loosing some assumptions of Ricardian Model will not affect the Law of Comparative Advantage substantially, but increase the transaction costs in international trade, and lead to imperfect specialization, reduce the volume of international trade.
2. But loosing the assumptions that goods are identical and there are no economies of scale is the base of intra-sector trade and economics-of-scale model.
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Chapter 2
Increasing Transaction Costs
1. What is transaction costs?—— expenses of searching for a trading
partner, specifying the product(s) to be traded, negotiating the price and contract,and the ex post costs.
2. Who find the “transaction costs”?3. Reasons of transaction costs especially in IT Imperfect Information(Knowledge) Transport Cost Trade Barrier Political Risk
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Chapter 2
Ronald H. Coase1. Great Britain
2. University of Chicago, USA
3. Major Work
“The Firm , the Market , and the Law”
“The Nature of the Firm”
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Chapter 2
Trade gains with transaction costs
Before trade (autarky) A country: 1 Wheat=a Cloth B country: 1 Wheat=b Cloth1 Cloth=1/b Wheat
After tradeTOT: 1 Wheat=P Cloth1 Cloth=1/P Wheat Transaction costs: F per unit Wheat or Cloth
A country: exchange 1 Wheat not less than a Cloth, ie P-F>a
B country: exchange 1 Cloth not less than 1/b Wheat, ie (1/P)-F>1/b
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Chapter 2Trade with transaction costs and increasing opportunity
costs
y
xO
A
P
P’
CC’
A: no trade
P & C: Productions & Consumptions under trade without transaction costs
P’ & C’: Productions & Consumptions under trade with transaction costs
TOTTOT-F
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Chapter 2
Imperfect Specialization
1. Increasing Opportunity Cost2. Transaction Costs3. The Size of Trader (talk about it later)4. The existence of more than one factor
of production reduce the tendency toward specialization
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Chapter 2
Other Extensions for Ricardian’s Model
1. Trade Between Big Country and Small Country
2. Trade with Currency (not barter)
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Chapter 2
Trade Between Big Country and Small Country
There is an implicit assumption in Ricardian two-country model that the size of the two countries are similar, so they can give up the productions without comparative advantage, and input all the resources to the production with comparative advantage.
But in reality, the size of the trading countries may be very different. For example, China’s population as well as land is hundreds of times of Sri Lanka’s, so even China has comparative advantage in Cloth, while Sri Lanka in Wheat, China can’t produce Cloth only under free trade. Because even all Wheat produced by Sri Lanka are exported to China, they still can’t meet the consumption need in China.
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Chapter 2
Trade Between Big Country and Small Country
So, If trade happens between big country and small country, small country can only produce the product with comparative advantage, but big country still need to produce both products.
Case Study:Who will feed China?
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Chapter 2
Imperfect Specialization for Big and Small Countries
QCO QC
P
Qw
Qw
O
C
P
China
Sri Lanka
TOT
TOT
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Chapter 2
Trade with Currency
Suppose RMB/Dollar=X
For Bicycle, if 100X>400(ie X>4), no trade in Bicycle and Toy(25×4 = 100>50);
For Toy, if 25X<50(ie X<2), no trade in Toy and Bicycle(100×2 = 200<400).
So X must be between 2 and 4, if there is trade
Bicycle Toy
USA (Dollar)
100 25
China (RMB)
400 50