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This is lecture and discussion notes from Week 3....

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Lecture: Trade Models Ricardo’s Absolute Advantage ● In a 10 hr day, Italy

England

Textiles

10 lbs clothes

50 lbs clothes

Wine

10 cases wine

1 case wine

● Since Italy specializes in wine and England specializes in textiles ○ If trade were to happen… ■ Italy and England would get 5 cases of wine and 25 lbs of clothes ■ More advantage to trade Ricardo’s Comparative Advantage ● In a 10 hr day Czech Republic

Spain

Food

100 tons

400 tons

Cloth

100 tons

200 tons

● Doesn’t matter the overall production, what matters is the opportunity cost of producing one good over the other ○ If these 2 countries specialized in trade where the OC of production is less, give up the product with more OC so that there is more to share at the end of the day ● EX: ○ The opportunity cost of one ton of food in Czech Rep. is one of cloth ■ Czech should specialize in cloth ○ The opportunity cost of one ton of food in Spain is ½ ton of cloth ■ Spain should specialize in food production ● Why was the model of comparative advantage better than an absolute advantage? ○ It is clear that trade is advantageous even when one country is better at all types of production Hecksher-Ohlin Factor Endowment Theory ● Norway

800 units capital 200 units of labor

Ecuador

400 units of capital 200 units of labor

○ Norway is capital abundant relative to Ecuador because ■ CapitalNorway/LaborNorway > CapitalEcuador/LaborEcuador

■ 800/200 > 400/200 ○ Agriculture is labor-intensive Manufacturing is capital intensive ■ (Pag/Pmanu)Norway > (Pag/Pmanu,)Ecuador ● Is it possible that Norway has cheaper agricultural goods and cheaper manufacturing goods? ○ Yes ■ It is the difference in the ratio that matters. As long as agriculture is relatively less expensive in Ecuador, the countries should specialize and trade. ● Production Possibilities Frontier (PPF)

○ At A and A’, both countries do not trade ○ At B and B’, both countries begin to trade and shift their prices to international pricing PA(bar)/PM(bar) ○ At C and C’, trade is complete. Both countries consume off of their PPF. ■ Ecuador, specializing in agriculture, trades with Norway for manufactured goods ■ Norway, specializing in manufacturing, trades with Ecuador for agricultural goods

Discussion 1. What is the fundamental difference between the Ricardian Comparative Advantage Model and the Heckscher-Ohlin Model? a. Ricardian model → total and complete specialization i. Not offer partical specialization because opportunity cost is constant b. Heckscher-Ohlin → partial specialization (more real) i.

When shortage → labor gets more expensive

2. Draw the PPF of a developing country that looks relative to a developed country? What would be an example of a price line in autarky (meaning no trade) and an example of a price line when there is international trade with a developed country? a.

3. Which is worse for a developing country, specializing in a low-value commodity or a high-value commodity? a. Low-value commodity is worse off, but it really depends… 4. Does a country that Alternative Assumption ● The problem with specializing in primary products “commodities” ○ “The resources curse” or “export pessimism” ■ Developing countries tend to have a comparative advantage in the primary products but economic gains and economic growth gained by trading primary products have been disappointing ● If you are a producer of coffee beans, you do not get the same economic growth than a producer of computers → TRADE MATTERS ● Prebisch-Singer hypothesis (for low-value commodities): In the long run, prices for primary product exports in the world market tend to fall relative to the prices of manufactured goods. So… developing countries have to keep exporting more and more to get same amount of imports. Why? Because… ○ Engel’s Law: demand for staple foods grows more slowly than income so growth in staple foods will lag

behind economic growth ○ New technologies reduce consumption of raw materials like rubber, copper, iron, ore. ■ EX: When raw materials get more expensive, manufacturing companies make synthetic materials instead ○ Manufacturing companies have market power. Primary product producers face greater competition. ○ Sensitive to weather ○ Subject to rapid changes in foreign demands ● Dutch Disease: commodity prices rise instead of fall relative to manufacturers (high-value commodity) ○ EX: Netherlands- after 1960, natural gas was found ■ Led to inflation ■ Decline export of manufacturer ■ Lower rate of income growth ■ Rising unemployment ○ Increase demand for Dutch resources (natural gas) led to an increase in demand for Dutch currency → →

value of Dutch currency increase

price of all Dutch goods for foreigners

just went up → decreases in other Dutch manufactures that were previously exported → unemployment ○ Influx of foreign money into the Dutch natural gas industry led to an increase of nontradable goods (EX: think Silicon Valley and how everything there is so expensive) ■ Housing ■ Haircuts ■ Restaurant meals ● The Renter state ○ Can be a result of high-value commoditing country ○ Few people are needed to collect or “produce” a highvalue commodity ○ State is primary recipient of the profits ○ No strong alternative productive sector develops...