Chapter 8 continued

some violations of H-O assumptions

More Chapter 8 topics
‡ When HO cannot predict trade flows:
± demand intensity reversal ± factor intensity reversal ± no perfect competition (deserves own section)

‡ Monopoly trade models ‡ Effect of immobile capital (next class)

H-O predictions
‡ H-O states that the basis for trade is factor abundance, therefore countries will export goods that use their abundant factor intensively and import goods that use their scarce factor intensively. ‡ H-O also predicts that the abundant factor will benefit from trade and the scarce factor will lose. ‡ This doesn¶t always work

‡ Given two countries ± if both countries really really prefer the good whose production intensively uses their abundant factor (relative to the other good). ± then they may import the good produced by their abundant factor .Demand intensity reversal ‡ The first case where this is violated is when countries have a strong taste for the good that they should be exporting.

. Pc/Ps is high in autarky Cloth Cloth with trade. Pc/Ps rises in country 1 and falls in country 2.Demand intensity reversal Steel Country 1 is capital abundant but likes steel Pc/Ps low in autarky Steel Country 2 is labour abundant but likes cloth.

Demand intensity reversal Steel Country 1 is capital abundant but likes steel Pc/Ps low in autarky Steel Country 2 is labour abundant but likes cloth. . Pc/Ps is high in autarky Cloth Cloth with trade. country 1 exports cloth and country 2 exports steel.

both intensities are measured relative to furniture.Factor intensity reversal ‡ In this case. Let one industry represent gravel and the second represent furniture. . ‡ Gravel is labour intensive at low wage/rental ratios and capital intensive at high wage/rental ratios. industries are not consistent in their factor intensities.

showing a great change in K/L as w/r changes.Factor intensity reversal Capital KG . (Extreme case is straight line) KG . Gravel The isoquant for gravel is very flat. LG LG Labour .

LF LF The isoquant for furniture is very curved. showing that K/L doesn¶t change a lot when w/r changes. Furniture KF Labour . (Extreme case is L-shaped isoquant). .Factor intensity reversal Capital KF .

Gravel uses a lower K/L relative to furniture at low w/r Gravel KF KG ..Factor intensity reversal Capital KG KF . Gravel uses a higher K/L relative to furniture at high w/r. LG LF LF . LG Furniture Labour .

LG2 L 2 F LF1 . Gravel uses a higher K/L relative to furniture at high w/r.Factor intensity reversal (w/r)2 Capital KG2 KF2 . LG1 Furniture Labour .. Gravel uses a lower K/L relative to furniture at low w/r Gravel (w/r)1 KF1 KG1 .

we might ALSO expect it to export gravel. since at high w/r. . we might expect it to export gravel. the capital intensive industry in one country can be the labour intensive industry in the other. ‡ However. ± If country 1 is labour abundant.Factor Intensity Reversal ‡ When these countries trade. gravel is capital intensive. since at low levels of w/r. gravel is labour intensive. ± If country 2 is capital abundant.

we cannot predict the pattern of trade. . ‡ Therefore ± we cannot predict the effect of trade on factor demands in a country ± we cannot predict the effect of trade on incomes of factors.Factor Intensity Reversal ‡ with factor intensity reversals.

. neoclassical trade theory predicts that trade can sometimes be harmful to the countries trading.Monopoly ‡ Any kind of imperfect competition can lower the predictive power of the H-O model. ‡ If an industry is a monopoly. ‡ Monopoly is one special case that deserves its own analysis.

if neo-classical trade theory is defined narrowly. as the theory based on perfect competition. that it does not apply to monopoly. ‡ then neo-classical trade theory says very specifically.Monopoly ‡ To put it another way. .

but the monopoly can export outside the country (not great for country) 2. Monopoly becomes open to competition when the country opens to trade. 3. Monopoly becomes world monopoly with trade (not great for anyone except monopoly). Monopoly can be maintained within a country. .Monopoly and trade There are different scenarios for monopoly and trade 1.

but the monopoly can export outside the country (not great for country) 2. 1. Monopoly becomes open to competition when the country opens to trade. Monopoly joins other country monopolies to become a cartel.Monopoly and trade There are different scenarios for monopoly and trade 1. 3. Monopoly can be maintained within a country. . Monopoly becomes world monopoly with trade (not great for anyone except monopoly).

it falls as monopoly supplies more goods to market. ‡ The marginal cost curve is NOT a supply curve for the monopoly. There is no supply curve for a monopoly. price falls as monopoly increases supply to the market.Monopoly . . ± Monopoly marginal revenue is NOT equal to price.review ‡ Market condition for monopoly ± Monopoly faces a market demand curve.

Monopoly .review Monopoly behaviour ‡ Quantity supplied ± monopoly chooses the quantity to supply based on the marginal cost (MC) and marginal revenue (MR). monopoly will pay more to produce an extra unit of output than it will earn in the market from selling it. ± At MC = MR. with marginal cost rising. ± Monopoly therefore supplies the quantity determined by MR=MC .

.review Monopoly behaviour ‡ Price charged ± Monopoly charges the highest price it can get away with! ± With a market demand curve the price is determined by the demand curve at the quantity supplied by the monopoly.Monopoly .

Monopoly in country Price MC P0 Marginal revenue Q0 Demand curve Quantity .

the downward sloping home demand 2.Monopoly .trade Monopoly market conditions ‡ If the monopoly can maintain a monopoly at home and trade freely on the otherwise competitive international market ‡ then it faces 2 different demand curves 1. reflecting a competitive world market. a flat (MR = Pint) world demand. .

and a competitive international market ± MR is downward sloping until it hits the world price. .Monopoly . then it is a flat line at the world price.trade Monopoly market conditions ‡ Monopoly marginal revenue ± with TWO markets ‡ ‡ home monopoly.

Monopoly in country Price MC P0 Marginal revenue PInt Demand curve Q0 Quantity .

± Home market: it will supply at point where MR home = MR international (kink).Monopoly . below that point.trade Monopoly behaviour ‡ Monopoly chooses output produced based on MC= MR (Q1) ‡ Monopoly separates supply into two markets ± it chooses supply in each market to maximize profits. (Q2) ‡ note. monopolist makes less money selling at home than it does selling exports ± It sells the rest on the world market (Q1 ± Q2) .

Monopoly in country Price MC P0 Marginal revenue PInt Demand curve Q2 Q0 Q1 Quantity .

trade Monopoly behaviour Price charged by monopoly ‡ Monopoly charges the highest price it can get away with in each market ‡ At home. .Monopoly . it charges P2 which is determined by the home demand curve ‡ Internationally. it charges Pint which is determined by the international market.

Monopoly in country Price MC P2 P0 PInt Marginal revenue Demand curve Q2 Q0 Q1 Quantity .

Monopoly with open markets ‡ If markets are opened internally and the monopoly can trade freely on the world market.Monopoly . .trade Case 2. and. if ‡ world markets are competitive then ‡ monopoly loses monopoly power and starts to act like a competitive firm.

then the monopoly will act like a single country monopoly« its country is the world) . (if price discrimination is not possible. it will price discriminate between markets. Monopoly with international monopoly power ‡ ‡ ‡ When a country¶s monopoly because an international monopoly.Monopoly . if it is possible.trade Case 3.

Monopoly . Therefore. it must be able to sell to one market (lower price market) and not have the buyers in that market resell to the higher price market. . one market is paying a lower price for the same good than another market. ‡ That is. ‡ Price discrimination can only occur when a monopoly can separate its markets.trade Price discrimination: Price discrimination occurs when a firm sells the same good to different markets at different prices.

and the income in the country (height of demand curve). if it can charge a higher price in one market than it can in another.trade Price discrimination: If a monopoly can price discriminate. This will be based on the slope of the demand curve. it will. .Monopoly . Therefore. it will sell an amount and charge a price that maximizes the monopolist¶s profits in each market. The higher price will be based on the elasticity of demand.

Monopoly . the monopoly ‡ determines the amount to supply based on MR=MC (profit maximizing amount to supply) ‡ charges the highest price that it can (which is constrained by the demand curve) . monopoly behaviour: In each market.trade Price discrimination.

Price discriminating monopolist with constant MC P Country I Country II PI PII MC MC P QI Quantity QII Quantity .

± letting monopolies have international monopoly power promotes price discrimination. ± letting monopolies export while maintaining the home market can raise price and lower quantity supplied at home. which will lead to higher prices in richer countries or in countries with less elastic demand as compared to poor countries or countries with elastic demand.Summary ‡ Monopoly trade models show that ± exposing monopolies to international competition makes them behave like firms in a competitive market and lowers price and increases output at home. .

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