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by: skenan


Marketplace > George Washington University > Economics > ECON 2181 > ECON 2181 PROF BUTT WEEK 4 NOTES

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These notes cover the fourth week's material. Based on lecture and powerpoint notes.
International Trade Theory and Policy
Ahsan Butt
Class Notes
gwu, Econ, Economics, econ2181, International, trade, Theory, and, Policy
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This 6 page Class Notes was uploaded by skenan on Wednesday October 5, 2016. The Class Notes belongs to ECON 2181 at George Washington University taught by Ahsan Butt in Fall 2016. Since its upload, it has received 4 views. For similar materials see International Trade Theory and Policy in Economics at George Washington University.


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Date Created: 10/05/16
ECON 2181 WEEK 4 KEY TERMS IMPORTANT PEOPLE IMPORTANT CONCEPT IMPORTANT FORMULAS CHAPTER 4: TRADE AND RESOURCES- THE HECKSCHER- OHLIN MODEL Review: Specific factor model: 3 factors of production, short-run model (hasn’t come back to equilibrium yet) 1. Land: agriculture 2. Labor: both 3. Capital: manufacture Heckscher-Ohlin (HO) model: a model that assumes that trade occurs because countries have different resources. • Canada exports agricultural goods b/c it has a large amount of land. • The US, Europe, Japan have highly skilled workers and much capital, they export manufactured goods. • China has a large amount of workers; they export less sophisticated manufactured goods. Comparing models: o Unlike Ricardian model, HO model has multiple factors of production. o Unlike specific-factors model, all factors of production can move between industries. So, H-O model is a long-run model. H-O Model Assumptions: Assumption1: 2 factors of production, labor and capital, can move freely between the industries. Assumption2: Shoe production is labor-intensive; that is, it requires more labor per unit of capital to produce shoes than computers. Labor Intensity of each Industry: Shoe production being more labor-intensive than computers implies: LS/K S L CK .C(shoes are labor intensive) These two curves slope down just like regular demand curves, but in this case, they are relative demand curves for labor. K SL S K /C (Computers are capital intensive) (If goodA in labor intensive, goodB must be capital intensive) Assumption3: Foreign is labor-abundant, by which we mean that the labor–capital ratio in Foreign exceeds that in Home, Equivalently, Home is capital-abundant, so that Assumption4: The final outputs, shoes and computers, can be traded freely (i.e., without any restrictions) between nations, but labor and capital do not move between countries. Assumption5: The technologies used to produce the two goods are identical across the countries. FOPs remain within the boarders of a country, however they can export the final good. Assumption6: Consumer tastes are the same across countries, and preferences for computers and shoes do not vary with a country’s level of income. No-Trade Equilibrium in Home and Foreign: Home PPF is skewed toward computers because Home is capital abundant and computers are capital intensive. (Vice versa for Foreign) Point A: The Home no-trade (Autarky) equilibrium. The flat slope indicates a low relative price of computers, (PC/P S . Point A*: The Foreign no-trade equilibrium. The steeper slope indicated a high relative price of computers, (P* CP* )S*. Foreign has higher relative price because doesn’t have enough capital so it costs higher to produce. Indifference curve: summarize preferences. International Free-Trade at Home: • With free trade, home produces at point B, and consume at point C, exporting computers and importing shoes. • Triangle: o Base of the triangle=export. (Q − Q ) is the difference between computers C2 C3 produced and consumed at home. o Height of the triangle= import. (Q −S3 ) isS2he difference between the amount consumed of shoes and the amount produced with trade. • At point A (no-trade relative price): home exports of computers = ZERO • In panel (b): zero exports at relative price of (P /P ) , W C S o At (P /PC) S (Q C2 − Q C3amount of exports. International Free-Trade Equilibrium in Foreign: • With free trade, Foreign produces at point B*, and consume at point C*, exporting shoes and importing computers. • Triangle: o Base of the triangle=import (Q* C3 − Q* C2is the difference between computers produced and consumed at foreign. o Height of the triangle= export. (Q* –S2* ) iS3the difference between the amount consumed of shoes and the amount produced. • At point A* (no-trade relative price): home exports of computers = ZERO A* • In panel (b): zeroWexports at relative price of (C* /PS ) , o At (P /C )S, (Q* C3 – Q* C2amount of exports. Determination of Free-Trade World Equilibrium Price: World Relative price is determined at the intersection of the Home export supply and Foreign import demand, at point D. At this relative price, the q. of computers that Home wants to export, (Q C2− Q C3 just equals the q. of computers that Foreign wants to import, (Q* C3 − Q* C2 Because Home exports = Foreign imports, there is no reason for the relative price to change and so this is a free-trade equilibrium. Pattern Of Trade: Home exports computers, which is capital intensive and home is capital abundant. Foreign exports shoes, which is labor intensive and home is labor abundant. This result is called the Heckscher-Ohlin theorem. • Heckscher-Ohlin theorem states that, with 2 goods and 2 factors, each country will export the good that uses intensely the factor of production it has in abundance and import the other good. • Assumption 1: Labor and capital flow freely between the industries. • Assumption 2: The production of shoes is labor-intensive as compared with computer production, which is capital-intensive. • Assumption 3: The amounts of labor and capital found in the two countries differ, with Foreign abundant in labor and Home abundant in capital. • Assumption 4: There is free international trade in goods. • Assumption 5: The technologies for producing shoes and computers are the same across countries. • Assumption 6: Tastes are the same across countries. Reversal of Factor Intensities: one industry may be relatively capital intensive compared to the other at high relative wages and labor intensive at low relative wages. Leontief’s paradox: The first test of H-O theorem was performed by economist Wassily Leontief in 1953. o Supposed that after 1947, the U.S. would be capital abundant, therefore, would export capital-intensive goods. o Used numerical data. Contrary to the H-O model, he found that K/L ratio for exports was less than K/L ratio for imports. Why? • U.S. and foreign techs are not the same, contrary to H-O theorem and Leontief’s assumptions. • Only focused on capital and labor, but neglected LAND. • Did not distinguish between skilled and unskilled labor. (U.S. exports are skilled- labor intensive) • WWII aftermath still in play for unusual consequences. • U.S. was not engaged in completely free trade, contrary to H-O theorem. What makes a country abundant in one factor? We compare the country’s share of that factor with its share of world GDP. • If its share of a factor > its share of world GDP, then the country is abundant in that factor. • If its share in a certain factor is < than its share of world GDP, then the country is scarce in that factor. Leontief had found that the United States was exporting labor-intensive products even though it was capital-abundant at that time. • One explanation would be that labor is highly productive in the U.S and less productive in the rest of the world. • If that is the case, then the effective labor force in the U.S. is much larger than it appears to be when we just count people. Effective Labor Force = Labor Force * Productivity • To allow factors of production to differ in their productivities across countries, we define the effective factor endowment as the actual amount of a factor found in a country times its productivity. Effective factor endowment = Actual factor endowment • Factor productivity We compare the country’s share of that effective factor with its share of world GDP. • If its share of an effective factor exceeds its share of world GDP, the country is abundant in that effective factor; • If its share of an effective factor is less than its share of world GDP, the country is scarce in that effective factor. Effective R&D scientists = Actual R&D scientists • R&D spending per scientist The U.S. was scarce in labor in 1947, but it was abundant in effective labor. Which makes the U.S. labor more productive. Effect of Trade on the Wage and Rental at Home: Determination of Home Wage/Rental: RD: the economy-wide relative demand for labor. (Average of L CK aCd L /K SurvSs, in the middle) !/!: the relative supply. Vertical because the total amount of resources in Home is fixed. A: equilibrium point, intersection determines the wage relative to the rental, W/R. Relative Relative supply demand Increase in the price of computers: Initially, Home is at equilibrium A, with relative A price of computers (P CP S . ! in the rel. price of computers to the world price line (C /PS) (steeper) pushes production from A to B. In return, more production of computers, less of shoes. Effect of a Higher Relative Price of Computers on Wage/Rental: ! in the rel. price of computers shifts the RD curve towards demand of computers, which causes relative wages to fall. As a result, (W/R) 1alls to (W/R) 2 Since, labor is cheaper, both industries increase their labor to capital ratios. (shown by changes from L C/K Cnd LS /K s.


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