goods prices and factor prices: the distributional consequences of international trade nothing is...
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![Page 1: Goods Prices and Factor Prices: The Distributional Consequences of International Trade Nothing is accomplished until someone sells something. (popular](https://reader030.vdocument.in/reader030/viewer/2022033105/56649d405503460f94a1a5d1/html5/thumbnails/1.jpg)
International Economics
Goods Prices and Factor Prices: The Distributional Consequences of International Trade
Nothing is accomplished until someone sells something.
(popular business saying)
Chapter 4
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International Economics
The Goals of this Chapter for ECN 665
• Use the general equilibrium model to understand how price changes lead to winners and losers.
• Use different models to identify these winners and losers.
• Introduce a two-country partial equilibrium model to see how shocks to supply and demand affect the terms of trade.
• Use the partial equilibrium model to illustrate how consumers and producers are affected by international trade.
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International Economics
Who Wins and Who Loses?
• Trade affects relative prices.• Changes in domestic relative prices
influence factor rewards (e.g. wages) as well as the prices of goods we buy.
• We can use different characterizations of the economy (i.e. models) to predict how real factor rewards respond to a price change.
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International Economics
Trade in a one-factor model
• The Ricardian model assumes there is only one factor, labor.
• Trade occurs because of differences in labor productivity.
• Trade raises real GDP. Because everyone is alike, everyone gains.
• Distribution is simple and unrealistic!
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International Economics
Trade based on factor proportions
• Opening a country to trade (or reducing tariffs or quotas) raises the relative price of the exportable relative to the importable.
• What happens to factor rewards depends on how this price change affects the demand and supply of each factor.
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International Economics
The Heckscher-Ohlin Model
• Two industries: labor-intensive and capital-intensive
• Two factors: labor and capital
• Both factors are assumed to be in fixed supply and perfectly mobile across sectors. THIS MOBILITY ASSUMPTION IS VERY IMPORTANT.
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International Economics
The Heckscher-Ohlin Model (2)
• Suppose freer trade raises the relative price of the labor-intensive good ( as it would in a labor-abundant country).
• The higher price for the labor-intensive good leads this industry to expand and the capital-intensive industry to contract.
• These production responses raise the wage and lower the rental on capital.
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International Economics
The Heckscher-Ohlin Model (3)
• We summarize this analysis with the Stolper-Samuelson Theorem: an increase in the relative price of the labor (capital) intensive good raises the real return to labor (capital) and lowers the real return to the other factor.
• Notice the REAL return is driven up or down.
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International Economics
What if factors are not mobile?
• Then the demand for factors is linked only to the sector in which the factor works.
• We summarize this insight in the specific factors model: specific factors gain in real terms when the price of the product they produce increases (and lose when it falls).
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International Economics
What if gains come because trade increases scale and/or variety?
• We need to introduce increasing returns to scale and differentiated products.
• It is possible for everyone to gain when trade is based on IRS industries.
• There is a danger only in a small subset of cases: when countries are large enough to produce IRS goods but not large enough to do so on a big scale.
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International Economics
Measuring the Welfare Gains from Exchange:Producer Surplus and Consumer Surplus
• Producer surplus: The net gains to producers of a product, equal to the total revenue minus the sum of marginal (variable) costs.
• Consumer surplus: The net gains for consumers of a product, equal to the sum of all marginal gains minus the market price paid for the products.
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International Economics
The Market for T-shirts
• Equilibrium price = $6
• Equilibrium quantity = 50 S
P
T-shirts 0 50
$6
$1
D
$9
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International Economics
Producer Surplus
• Equilibrium price = $613
• Equilibrium quantity = 50
• Producer surplus = $125 ($5x50 = $250/2 = $125)
S
P
T-shirts 0 50
$6
$1
D
$9
ProducerSurplus
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International Economics
Consumer Surplus
• Equilibrium price = $6
• Equilibrium quantity = 50
• Producer surplus = $125 ($5x50/2 = $250/2 = $125)
• Consumer surplus = $75 (3x50/2 = $150/2 = $75)
S
P
T-shirts 0 50
$6
$1
D
$9
Consumer Surplus
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International Economics
The Total Gains from Exchange
• Equilibrium price = $6• Equilibrium quantity = 50• Producer surplus =
($5x50)/2 = $250/2 = $125
• Consumer surplus = $75 ($3x50)/2 = $150/2 = $75
• Total gains from exchange equals consumer surplus plus producer surplus
• Gains from exchange = ($8x50)/2 = $400/2 = $200
S
P
T-shirts 0 50
$6
$1
D
$9
Consumer Surplus
Producer Surplus
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International Economics
The Two-Country Partial equilibrium Model
• The textbook emphasizes two-country models in order to remind you that what happens in one country affects markets in other countries.
• Partial equilibrium models assume “all other things remain equal” in other markets, obviously an unrealistic assumption.
• But, a two-country partial equilibrium model can isolate how, all other things equal, a change in a market in one country affects the market for the same product in another country.
• Specifically, the two-country partial equilibrium model lets us estimate the changes in consumer and producer surplus in the two countries.
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International Economics
Figure 4.5 The Markets for Corn in Heartland and Orient
0 Tons 0 Tons 0 Tons
2
0.5
Heartland The International Market Orient
P P
PS S
DD
75 35
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International Economics
The International Market for Corn: Heartland’s International Supply Curve
0 Tons 0 Tons 0 Tons
2
0.5
Heartland The International Market Orient
P P
PS S S
DD
75 35
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International Economics
0 Tons 0 Tons 0 Tons
2
0.5
Heartland The International Market Orient
P P
PS S S
DDD
75 35
The International Market for Corn: Orient’s International Demand Curve
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International Economics
The International Market for Corn: Where Heartland’s International supply and Orient’s International Demand Meet
0 Tons 0 Tons 0 Tons
2
1
0.5
Heartland The International Market Orient
P P
PS S S
DDD
60 75 90 25 35 5530
Exports Trade Imports
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International Economics
The International Market for Corn: Heartland’s Producers Gain Surplus
0 Tons 0 Tons 0 Tons
2
1
0.5
Heartland The International Market Orient
P P
PS S S
DDD
60 75 90 25 35 5530
Added Producer Surplus
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International Economics
The International Market for Corn: Heartland’s Consumers Lose Surplus,But Heartland’s Net Welfare Gain Is Positive
0 Tons 0 Tons 0 Tons
2
1
0.5
Heartland The International Market Orient
P P
PS S S
DDD
60 75 90 25 35 5530
Heartland’s Net Welfare Gain
ConsumerSurplus Lost
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International Economics
The International Market for Corn: Orient’sConsumers Gain Surplus
0 Tons 0 Tons 0 Tons
2
1
0.5
Heartland The International Market Orient
P P
PS S S
DDD
60 75 90 25 35 5530
Gain in Consumer Surplus
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International Economics
The International Market for Corn: Orient’s Producers Lose Surplus, But Orient’s Net Welfare Gain Is Positive
0 Tons 0 Tons 0 Tons
2
1
0.5
Heartland The International Market Orient
P P
PS S S
DDD
60 75 90 25 35 5530
Orient’s Net Welfare Gain
Loss of Producer Surplus
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International Economics
The Welfare Gains from Trade
• Heartland producers gain surplus.
• Heartland consumers lose surplus.
• Orient producers lose surplus.
• Orient consumers gain surplus.
• But remember that we do not trade in one good – these changes are only for one market.
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International Economics
Applying the Two-Country Partial Equilibrium Model
• Now that you understand the two-country partial equilibrium model and how to calculate the welfare gains from international exchange, you are ready to apply the model.
• One interesting case is to examine the welfare effects of an increase in foreign demand for a product.
• Specifically, suppose that in a certain market, demand increases in the foreign country that currently imports the good.
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International Economics
The International Market for Corn: An Increase in Demand in Orient
0 Tons 0 Tons 0 Tons
2
1
0.5
Heartland The International Market Orient
P P PS S S
DDD
60 75 90 25 35 5530
D’
2.50
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International Economics
The International Market for Corn:Adjustments in Heartland and the International Market after the increase in demand in Orient
0 Tons 0 Tons 0 Tons
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Heartland The International Market Orient
P P PS S S
DDD
60 75 90 25 35 5530 40
D’
2.50
2.25
D’
27 6755 95
Exports Trade Imports
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International Economics
The International Market for Corn:
In both countries, the net gains from trade increase after the rise in demand in Orient
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Heartland The International Market Orient
P P PS S S
DDD
60 75 90 25 35 5530 40
D’
2.50
2.25
D’
27 6755 95
Exports Trade Imports
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International Economics
The Net Gains from Trade Increase in Both Countries after the Rise in Demand in Orient
• An increase in foreign demand raises the price of corn in both countries.
• Producers in Heartland gain welfare.
• Consumers in Orient gain welfare.
• The net gains from exchange increase in both countries.
0 Tons 0 Tons 0 Tons
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1
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Heartland The International Market Orient
P P PS S S
DDD
60 75 90 25 35 5530 40
D’
2.50
2.25
D’
27 6755 95
Exports Trade Imports
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International Economics
Analyzing the Effect of Transport Costs on International Trade
• The partial equilibrium model can be used to analyze how transport costs affect international trade.
• Transport costs in effect drive a wedge in between the price received by an exporter and the price paid by a foreign importer.
• Transport costs increase the cost of products to the final user, and it should not be surprising that they reduce both the volume of trade and the gains from trade.
• The analysis of transport costs uses the concepts of consumer and producer surplus.
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International Economics
• Consumer surplus is equal to the area A
• Producer surplus is equal to the area B
• The net gains from exchange are equal to the areas A + B
Figure 4.10The Market Equilibrium in the Absence of Transport Costs
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0 40 Q
P
B
A
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S
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International Economics
Figure 4.11 Transport Costs Reduce theVolume of International Trade
• Transport costs of $40 raise the effective international supply curve from S to ST.
• Transport costs drive a “wedge” between what suppliers receive and consumers pay.
• The volume of trade falls from 40 to 20.
• Producer surplus is reduced to area b.
• Consumer surplus is reduced to area a.
30
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0 20 40 Q
P
$40
a
d
ST
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D
a
b
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International Economics
Figure 4.12A Decline in Transport Costs from $40 to $20
• Decreasing transport costs increase trade.
• The international supply curve shifts down to ST2.
• The equilibrium price falls to $60.
• The gains from trade rise from a + b to a + b + c + d.
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P
$20
a
b
e
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ST2
ST1
Db
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International Economics
Trade and Transport Costs
• An increase in transport costs reduces the gains from trade for both the importing and exporting countries.
• A decline in transport costs increases the gains from trade.
• Most of the increase in trade during the past two centuries is due to improvements in the efficiency of transportation.
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International Economics
The Effect of Trade on Price Competition
• The partial equilibrium model is also useful for analyzing the gains from trade under imperfect competition.
• International trade increases the number of potential suppliers, which tends to increase price competition.
• Increased price competition reduces monopoly profit and deadweight losses.
• The effect of increased competition can be visualized by comparing consumer and producer surplus under imperfect competition and under perfect competition.
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International Economics
Figure 4.16Profit in an Imperfectly-Competitive Market
• Imperfectly competitive firms face a downward-sloping demand curve D.
• Profit-maximizing firms equate marginal revenue equal marginal cost.
• Prices exceed marginal cost.• The quantity supplied, q, is
less than the quantity, Q, that would be supplied under perfect competition.
• Total welfare is reduced by the “deadweight” loss, which is equals to area D.
MC
MR D
0
Price
Quantityq
p
w
D
Q
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International Economics
Figure 4.17International Competition Can Eliminate the Deadweight Loss of Imperfect Competition
• When firms face the horizontal demand curve in a competitive global market, price declines from p to P.
• Consumption shifts from c to C.
• The competitive market eliminates the deadweight loss.
MC
MR D
0
Price
Quantityq
p
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DINTPC
c