genie seminar 04

General EconomicsInternational EconomicsSeminar 4 The Standard Trade Model: 

General Economics International Economics Seminar 4 The Standard Trade Model J.Tyrpak 23.10.2007

Slide2: 

Questions and Problems for Review 1. Which four key relationships is the Standard Trade Model built on (acc. Krugman)? 2. Assume that Norway and Sweden trade with each other, with Norway exporting fish to Sweden, and Sweden exporting Volvos (automobiles) to Norway. Illustrate the gains from trade between the two countries using the standard trade model, assuming first that tastes for the goods are the same in the both countries, but the production possibilities frontiers differ: Norway has a long coast that borders on the north Atlantic, making it relatively more productive in fishing. Sweden has a greater endowment of capital, making it relatively more productive in automobiles. 3. In the trade scenario in Problem 2, due to over fishing, Norway becomes unable to catch the quantity of fish that it could in previous years. This change causes both a reduction in the potential quantity of fish that can be produced in Norway, and an increase in the relative world price for fish, Pf/Pa. a) Show how the over fishing problem can result in a decline in welfare for Norway. b) Also show hot it is possible that the over fishing problem could result in and increase in welfare for Norway. 4. Japan primarily exports manufactured goods, while importing raw materials such as food and oil. Analyze the impact of Japan’s terms of trade of the following events: a) A war in the Middle East disrupts oil supply. b) Korea develops the ability to produce automobiles that it can sell in Canada and the U.S. c) U.S. engineers develop a fusion reactor that replaces fossil fuel electricity plants. d) A harvest failure in Russia. e) A reduction in Japan’s tariffs on imported beef and citrus fruit. Seminar discussion

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5. The Internet has allowed for increased trade in services such as programming and technical support, a development that has lowered the prices of such services relative to manufactured goods. India in particular has been recently viewed as en “exporter” of technology-based services, an area in which the United States had been a major exporter. Using manufacturing and services as tradable goods create a standard trade model for the U.S. and Indian economies that shows how relative price declines in exportable services that lead to the “outsourcing” of services can reduce welfare in the United States and increase welfare in India. 6. Countries A and B have two factors of production, capital and labour, with which they produce two goods, X and Y. Technology is the same in the two countries. X is capital intensive; A is capital-abundant. Analyze the effects on the terms of trade and the welfare of the two countries of the following: a) An increase in A’s capital stock. b) An increase in A’s labour supply. c) An increase in B’s capital stock. d) An increase in B’s labour supply. 7. It is just as likely that economic growth will worsen a country’s terms of trade as that it will improve them. Why, then, do most economists regard immiserising growth, where growth actually hurts the growing country, as unlikely in practice? Article for discussion - Krugman: Does third world growth hurt first world prosperity? Seminar discussion

Questions # 1: 

Questions # 1 Which four key relationships is the Standard Trade Model built on (acc. Krugman)? a) The relationship between the production possibility frontier and the relative supply curve. b) The relationship between relative prices and relative demand. c) The determination of world equilibrium by world relative supply and world relative demand d) The effect of the terms of trade (the price of a country’s exports divided by the price of its imports) on a nation’s welfare.

Questions # 2: 

Questions # 2 Assume that Norway and Sweden trade with each other, with Norway exporting fish to Sweden, and Sweden exporting Volvos (automobiles) to Norway. Illustrate the gains from trade between the two countries using the standard trade model, assuming first that tastes for the goods are the same in the both countries, but the production possibilities frontiers differ: Norway has a long coast that borders on the north Atlantic, making it relatively more productive in fishing. Sweden has a greater endowment of capital, making it relatively more productive in automobiles. Welfare in both countries increases as the two countries move from production patterns governed by domestic prices (dashed line) to production patterns governed by world prices (straight line).

Questions # 3: 

Questions # 3 In the trade scenario in Problem 2, due to over fishing, Norway becomes unable to catch the quantity of fish that it could in previous years. This change causes both a reduction in the potential quantity of fish that can be produced in Norway, and an increase in the relative world price for fish, Pf/Pa. a) Show how the over fishing problem can result in a decline in welfare for Norway. b) Also show how it is possible that the over fishing problem could result in and increase in welfare for Norway.

Questions # 4: 

Questions # 4 Japan primarily exports manufactured goods, while importing raw materials such as food and oil. Analyze the impact of Japan’s terms of trade of the following events: The terms of trade of Japan = the world relative price of manufactures in terms of raw materials (pM/pR). The terms of trade change → shifts in the world relative supply and demand (M relative to R) curves. a) A war in the Middle East disrupts oil supply. =>The world relative supply curve shifts out, decreasing the world relative price of manufactured goods and deteriorating Japan’s terms of trade. b) Korea develops the ability to produce automobiles that it can sell in Canada and the U.S. => The world relative supply curve shifts out, decreasing the world relative price of manufactured goods and deteriorating Japan’s terms of trade. c) U.S. engineers develop a fusion reactor that replaces fossil fuel electricity plants. => world relative demand curve shifts out, increasing the world relative price of manufactured goods and improving Japan’s terms of trade.

Questions # 4: 

Questions # 4 d) A harvest failure in Russia. e) A reduction in Japan’s tariffs on imported beef and citrus fruit. => The world relative supply curve shifts out. Russia’s demand for manufactures ↓ => ↓ world demand so that the world relative demand curve shifts in. Outcome: ↓ world relative price of manufactured goods and deteriorate Japan’s terms of trade. => ↑ Japan’s RS and ↓Japan’s RD which => ↑ world RS and ↓ world RD (i.e., world RS shifts out and world RD shifts in). The world relative price of manufactures declines and Japan’s terms of trade deteriorate.

Questions # 5: 

The Internet has allowed for increased trade in services such as programming and technical support, a development that has lowered the prices of such services relative to manufactured goods. India in particular has been recently viewed as en “exporter” of technology-based services, an area in which the United States had been a major exporter. Using manufacturing and services as tradable goods create a standard trade model for the U.S. and Indian economies that shows how relative price declines in exportable services that lead to the “outsourcing” of services can reduce welfare in the United States and increase welfare in India. Questions # 5 The declining price of services relative to manufactured goods shifts the iso-value line clockwise so that relatively fewer services and more manufactured goods are produced in the United States, thus reducing U.S. welfare.

Questions # 6: 

Countries A and B have two factors of production, capital and labour, with which they produce two goods, X and Y. Technology is the same in the two countries. X is capital intensive; A is capital-abundant. Analyze the effects on the terms of trade and the welfare of the two countries of the following: a) An increase in A’s capital stock. b) An increase in A’s labour supply. c) An increase in B’s capital stock. d) An increase in B’s labour supply. Questions # 6 - An increase in the capital stock favors production of good X - An increase in the labor supply favors production of good Y - Country A exports good X to country B and imports good Y from country B Heckscher-Ohlin: economy exports good that uses intensively the relative abundant factor. (a) A’s terms of trade worsen, A’s welfare may increase or, less likely, decrease, and B’s welfare increases. (b) A’s terms of trade improve, A’s welfare increases and B’s welfare ↓ (c) B’s terms of trade improve, B’s welfare increases and A’s welfare ↓ (d) B’s terms of trade worsen, B’s welfare may increase or, less likely, decrease, and A’s welfare increases.

Questions # 7: 

It is just as likely that economic growth will worsen a country’s terms of trade as that it will improve them. Why, then, do most economists regard immiserising growth, where growth actually hurts the growing country, as unlikely in practice? Questions # 7 Immiserising growth occurs: welfare deteriorating effects (worsening economy’s terms of trade) > welfare improving effects of growth Condition: - economy must undergo very biased growth - economy must be a large enough actor in the world economy => actions alter the terms of trade to a large degree

Slide12: 

Krugman, Does third world growth hurt first world prosperity? TOPIC: Economic growth in the Third World is seen as threat Article discussion Background Traditionally, world is divided into a) rich with high productivity and high wages b) poor with low productivity low wages Commonly understood as deteriorating advanced nations standards of living through wage cuttings => low wage competition from the Third World However today – some countries exercise high productivity and low wages However: With rise of the world productivity – average world living standards must rise => Higher Third Word wages, NOT lower First World income (ex. Korea – cars)

Slide13: 

Article discussion 1. One-Good & One Input World - wages = productivity, due to arbitrage – prices overall same - situation: increase in productivity => rise in wage of that country (0 impact) Krugman’s analysis – economic model AND 2. Nationally – producers = consumers (assumption) - Foreign competitors cutting prices => lower wages BUT higher purchasing power 2. Many Goods & One - countries specialise in production and trade their goods - impact either positive or negative: - depending on the sector - countries do not tend to compete in less interesting sectors - discussion idea - without lower costs – no trade from NIC Countries may be not threatened by losing markets from NIC, but by paying more in future for these products (Korean cars)

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