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Learning Objectives
Describe economic equilibrium in a country that has no trade. Discover the welfare enhancing impact of opening a country to trade. Demonstrate that either supply differences or demand differences between countries are sufficient to generate a basis for trade. Distinguish the implications of key assumptions in the neoclassical trade model.
6-2
6-3
Autarky Equilibrium
In the absence of trade
producers will seek to maximize profits. consumers will seek to maximize utility.
6-4
6-5
E
Autarky Price Line
PPF X
6-6
6-7
Consumer Equilibrium
Y
Budget constraint
E CI3 CI2
CI4
CI1
X
6-8
Autarky Equilibrium
In equilibrium, supply and demand jointly determine PX/PY, and therefore how much X and Y is produced (and consumed).
6-9
Autarky Equilibrium
Y Community indifference curve
Price line PPF X1 X
6-10
E
Y1
6-11
Production in Trade
Lets suppose that Country A has a comparative advantage in good X. What will happen to the relative price of good X as Country A moves to trade? It will rise (otherwise, Country A would not wish to produce more of good X in order to export it).
6-12
Production in Trade
Y
Steeper intl price line means PX/PY has increased.
E
Y1 Y2 E' Autarky Price Line Intl Price Line X1 X2 X
6-13
Trade Equilibrium
Y Y3
Country A exports X3X2 (the distance FE), and imports Y3Y2 (the distance FC).
C'
imports Y2 F exports X3 X2 X
6-14
E'
6-16
Consumption Gains
Y
C Even if producers dont change production levels in response to a change to (Px/Py)2, the new consumer equilibrium at C is on a higher indifference curve.
C'
E E' (Px/Py)2 X
6-17
Production Gains
Y
C Eventually producers adjust production levels to E. This permits additional gains to C.
C'
E E' (Px/Py)2 X
6-18
6-19
Country B
Y3 Y1 Y2
C' E
Imp.
6-21
(PX/PY)T
CI1
Y5 Y2 Y3
f
C, c CI2
F (PX/PY)T
X5
X2
X3
6-23
6-24
6-25
6-26
Y1
Y4
e (PX/PY)B
(CI1)B X1 X4 X
6-27
Y1
Y3
E, e' e (PX/PY)T
Y4
X1
X3
X4
6-28
Y1
Y3
E, e' e c'
Y4 Y5
X2 X1
X3
X4
X5
6-29
6-30