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Topic 4

International Economics - NSU ECO328 - JVHN

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24 views9 pages

Topic 4

International Economics - NSU ECO328 - JVHN

Uploaded by

ABU MASROOR AHMED
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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The Standard Trade Model

Topic 4
Thos lecture is covered from KOM (Chapter 6)
Key Relationships
• PPF and the relative supply curve
• Relative prices and relative demand
• Welfare effect of changes in TOT
• Determinng relative prices
Ke Relationships
• PPF and the relative supply curve
✓ A positive relationship between Relative price and relative quantity mirrored
by the PPF
• Relative Prices and Demand
✓ Income effect
✓ Substitution effect
Welfare Effect of Changes in TOT
𝑃𝑐
• A rise in relative price ( ) causes a movement toward higher
𝑃𝑓
indifference curve which makes a country that initially exports cloth
better off.
𝑃𝑐 𝑃𝑓
• A rise in ( ) means a fall in ( ) : a country that initially exports food
𝑃𝑓 𝑃𝑐
will worse off as the relative price of good it exports would drop.
• A rise in the terms of trade increases a country’s welfare, while a
decline in the terms of trade reduces its welfare.
𝑃𝑟𝑖𝑐𝑒 𝑜𝑓𝑒𝑥𝑝𝑜𝑟𝑡
• TOT =
𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑖𝑚𝑝𝑜𝑟𝑡
Determining Relative Prices
• Two countries: Home and Foreign
• Home exports cloth while Foreign exports food.
𝑃𝑐
• Home’s TOT:
𝑃𝑓
• Home and Foreign have different RS curves which is induced by the
respective country’s production possibilities.
• Two countries have same preferences with identical RD curve.
𝑃𝑐 𝑄𝑐 𝑄𝑐∗
• For a given , the relative supply of two countries: >
𝑃𝑓 𝑄𝑓 𝑄𝑓∗
• What is the world relative supply?
Determining Relative Prices
𝑄𝑐 𝑄𝑐∗ 𝑄𝑐 𝑄𝑐 +𝑄𝑐∗ 𝑄𝑐∗
• Prove algebraically, if > , then > > .
𝑄𝑓 𝑄𝑓∗ 𝑄𝑓 𝑄𝑓 +𝑄𝑓∗ 𝑄𝑓∗
• What should be the position of the world relative supply curve?
𝐷𝑐 +𝐷𝑐∗
• The relative demand can be shown by .
𝐷𝑓 +𝐷𝑓∗
• Intersection of world RS and RD provides the equilibrium relative price:
how many units of Home’s cloth exports are exchanged for Foreign’s food
exports.
• The the equilibrium relative price,
• Home’s desired exports of cloth match up with Foreign’s desired imports of cloth.
• Same thing will happen for food.
Growth and PPF
• Economic growth means an outward shift of PPF.
• Biased growth: PPF shifts out more in one direction than in the other.
• It may happen for two reasons:
1. As per the Ricardian model, the technological progress in one sector of the
economy will expand economy’s PP in the direction of that sector’s output.
2. According to H-O model, an increase in a country’s factor of production will
produce bised expansion of PP.
• If the growth biased toward cloth, the RS will shift to the right.
• What will happen to the RS if the growth is biased toward food?
World RS and TOT
• Let the Home experiences growth strongly biased toward cloth.
𝑄𝑐
• ↑ 𝑄𝑐 , ↓ 𝑄𝑓 ⇒↑
𝑄𝑓
• The world RS curve will shift to the right for a given relative price.
• As the RD is unchanged, there will be a fall in relative price.
• Worsening of Home’s TOT and improvement in Foreign’s TOT.
• What will happen if Foreign experiences a growth strongly biased
toward cloth? The result will be same.
• What will happen if Home or Foreign experiences a growth strongly
biased toward food?
In a Nutshell
• Growth that disproportionately expands a country’s PP in the
direction of good it exports (imports) is export-biased growth(import-
biased growth).
• Export-biased growth tends to worsen a growing country’s TOT, to the
benefit of the ROW; import-biased growth tends to improve a growing
country’s TOT at the ROW’s expense.

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