Chapter 5 The Standard Trade Mode
Chapter 5 ▪ The Standard Trade Model
Chapter Organization Introduction A Standard Model of a Trading Economy International Transfers of Income: Shifting the RD Curve Tariffs and Export Subsidies: Simultaneous Shifts in RS and RD Summary Appendix: Representing International Equilibrium ith Offer Curves Copyright C 2003 Pearson Education, Inc Slide 5-2
Copyright © 2003 Pearson Education, Inc. Slide 5-2 Chapter Organization ▪ Introduction ▪ A Standard Model of a Trading Economy ▪ International Transfers of Income: Shifting the RD Curve ▪ Tariffs and Export Subsidies: Simultaneous Shifts in RS and RD ▪ Summary ▪ Appendix: Representing International Equilibrium with Offer Curves
Introduction Previous trade theories have emphasized specific sources of comparative advantage which give rise to international trade Differences in labor productivity (Ricardian model) Differences in resources(specific factors model and Heckscher-Ohlin model) Copyright C 2003 Pearson Education, Inc Slide 5-3
Copyright © 2003 Pearson Education, Inc. Slide 5-3 Introduction ▪ Previous trade theories have emphasized specific sources of comparative advantage which give rise to international trade: • Differences in labor productivity (Ricardian model) • Differences in resources (specific factors model and Heckscher-Ohlin model)
Those models share s number of features The productive capacity of an economy can be summarized by its production possibility frontier Production possibilities determine a country's relative supply schedule World equilibrium is determined by world relative demand and a world relative supply schedule that lies between the national relative supply schedules a The standard trade model is a general model of trade that admits these models as special cases Copyright C 2003 Pearson Education, Inc Slide 5-4
Copyright © 2003 Pearson Education, Inc. Slide 5-4 ▪ Those models share s number of features: • The productive capacity of an economy can be summarized by its production possibility frontier • Production possibilities determine a country’s relative supply schedule • World equilibrium is determined by world relative demand and a world relative supply schedule that lies between the national relative supply schedules. ▪ The standard trade model is a general model of trade that admits these models as special cases
a Standard model of a Trading Economy The standard trade model is built on four key relationships Production possibility frontier and the relative suppl curve Relative prices and relative demand World relative supply and world relative demand Terms of trade and national welfare Copyright C 2003 Pearson Education, Inc Slide 5-5
Copyright © 2003 Pearson Education, Inc. Slide 5-5 A Standard Model of a Trading Economy ▪ The standard trade model is built on four key relationships: • Production possibility frontier and the relative supply curve • Relative prices and relative demand • World relative supply and world relative demand • Terms of trade and national welfare
a Standard model of a Trading Economy Production Possibilities and Relative Supply Assumptions of the model Each country produces two goods, food(F)and cloth(C Each countrys production possibility frontier is a smoo oth curve(IT) The point on its production possibility frontier at which an economy actually produces depends on the price of cloth relative to food, PdP Isovalue lines Lines along which the market value of output is constant Copyright C 2003 Pearson Education, Inc Slide 5-6
Copyright © 2003 Pearson Education, Inc. Slide 5-6 A Standard Model of a Trading Economy ▪ Production Possibilities and Relative Supply • Assumptions of the model: – Each country produces two goods, food (F) and cloth (C) – Each country’s production possibility frontier is a smooth curve (TT) • The point on its production possibility frontier at which an economy actually produces depends on the price of cloth relative to food, PC /PF . • Isovalue lines – Lines along which the market value of output is constant
a Standard model of a Trading Economy Figure 5-1: Relative Prices Determine the Economy's Output Food production, QF Isovalue lines Cloth production, Q Copyright C 2003 Pearson Education, Inc Slide 5-7
Copyright © 2003 Pearson Education, Inc. Slide 5-7 Figure 5-1: Relative Prices Determine the Economy’s Output Q Isovalue lines TT A Standard Model of a Trading Economy Cloth production, QC Food production, QF
a Standard model of a Trading Economy Figure 5-2 How an Increase in the relative price of cloth affects Relative supply Food production, QF W(PC/PE) r、w(PPA2 Copyright C 2003 Pearson Education, Inc Cloth production, @c slide 5-8
Copyright © 2003 Pearson Education, Inc. Slide 5-8 Figure 5-2: How an Increase in the Relative Price of Cloth Affects Relative Supply Q1 VV1 (PC/PF ) 1 Q2 VV2 (PC/PF ) 2 A Standard Model of a Trading Economy TT Cloth production, QC Food production, QF
a Standard model of a Trading Economy Relative Prices and demand The value of an economy' s consumption equals the value of its production PcOc+ PFOF=PCDc+PDF=v The economys choice of a point on the isovalue line depends on the tastes of its consumers, which can be represented graphically by a series of indifference curves Copyright C 2003 Pearson Education, Inc Slide 5-9
Copyright © 2003 Pearson Education, Inc. Slide 5-9 ▪ Relative Prices and Demand • The value of an economy's consumption equals the value of its production: PCQC + PFQF = PCDC + PFDF = V • The economy’s choice of a point on the isovalue line depends on the tastes of its consumers, which can be represented graphically by a series of indifference curves. A Standard Model of a Trading Economy
a Standard model of a Trading Economy Indifference curves Each traces a set of combinations of cloth(C)and food (F consumption that leave the individual equally well off They have three properties Downward sloping The farther up and to the right each lies, the higher the level of welfare to which it corresponds Each gets flatter as we move to the right Copyright C 2003 Pearson Education, Inc Slide 5-10
Copyright © 2003 Pearson Education, Inc. Slide 5-10 • Indifference curves – Each traces a set of combinations of cloth (C) and food (F) consumption that leave the individual equally well off – They have three properties: – Downward sloping – The farther up and to the right each lies, the higher the level of welfare to which it corresponds – Each gets flatter as we move to the right A Standard Model of a Trading Economy