Lecture 2
September 13, 2022 11:02 AM
Title: Gains from trade
HD we know there are • Gains from trade
gains from trade?
• There must be gains, because (almost) no trade is always an option
WR the mainstream • Trade enables division of labor and specialization
gains from trade? ○ Trade as production technique at the border: Inputs are exports and
outputs are imports.
▪ Therefore, trade is about imports.
• Trade allows a better consumption possibilities when countries specialize in
their comparative advantages (division of labor)
○ Trade increases the capacity of consuming outside of the production
possibility frontier (these are gains from trade)
• Autarky equilibrium:
• Prices adjust in the autarky equilibrium to ensure that point A (production) =
HD prices adjust in
autarky to reach point B (consumption)
equilibrium? • The autarky equilibrium is optimal, given no trade
○ No higher indifference curve (consumption) is possible
Draw the graph of the
autarky equilibrium… • Autarky equilibrium is characterized by :
○ MRT = price ratio
Is the autarky ○ MRS = price ratio
equilibrium optimal?
○ Domestic demand = domestic supply
•
Draw the free-trade • Free trade equilibrium: production (in export good) and consumption (in import good)
equilibrium. have increased (yellow arrows).
• Optimal consumption is at a point of tangency
H did consumption and
production change in ○ This leads to a higher welfare level ( ), which are gains from
each good? trade!
• Country exports food and imports manufactures.
HD we see gains from
trade on the graph? • Trading position is captured by the trade triangle
○ Equilibrium requires world consumption = world production
HD we see the trading ▪ Mirrored image of trade triangle for the rest of the world
position?
• Income line (red) is necessarily the consumption in either of the 2 possible
HD the trade triangle products (closed economy in which all is consumed)
look like for the ○ Income line allows to derive the quantity of
trade partner?
imports/exports depending on their relative price.
WD you compute the
income line? ▪
FDI Page 10
, •
WI the Balassa Index • Revealed comparative advantage (Balassa Index): to empirically evaluate a country's
(BI) and WD it 'strong' sectors, we can measure in which sector it is actually exporting a lot in relative
measure?
terms.
WI revealed • Balassa Index ( ) for sector in country :
comparative advantage
(RVA)? WI the
revealed part of it? •
HI it computed? • If the index is above 1 ( ), country is said to have 'revealed' comparative
W a mean? advantage in sector , as it is exporting relatively more in this sector than the
group of reference countries.
Can one compare BI ○ NB: Balassa Indexes cannot be compared across countries.
across countries?
• According to Ricardo/HOS:
W motivates trade • Trade is motivated by comparative advantages due to differences in technology
acc. to…
*Ricardo? (acc. Ricardo) or factor endowment (acc. HO).
*HOS?
○
W is determined by • Impact of comparative vs. absolute costs:
comparative costs? ○ Only comparative costs are important to determine direction of trade
WI determined by flows
absolute costs? ○ Absolute costs are important only determining a country's welfare (wage)
level
• Comparative advantages are difficult to measure in practice!
YR old trade theories ○ Problem: old trade theory assumes that there are only 2 countries and 2
(comparative homogeneous goods.
advantages) difficult
to measure in ○ Possible solution: Bernhofen & Brown (2004) measure it by building a
practice? vector of traded goods, with pre- and post-trade prices available, which
allows a test:
HD Bernhofen & Brown
(2004) overcome this ▪ the negative sign implies that goods with relative high autarky prices
challenge? will be imported on average, vice versa for exports.
WI the condition for
data on expenditures
in net exports (
to reflect
comparative ▪
advantage?
Using a graph,
explain why:
*
* ▪ Fictional example:
□ In autarky, value of consumption is equal to value of
production
If prices change:
◊
One cannot conclude that the income went
YD you have to down. Not only prices changed but also
calculate changes in consumption bundle
welfare (income)
using autarky prices Evaluate at original prices:
FDI Page 11
September 13, 2022 11:02 AM
Title: Gains from trade
HD we know there are • Gains from trade
gains from trade?
• There must be gains, because (almost) no trade is always an option
WR the mainstream • Trade enables division of labor and specialization
gains from trade? ○ Trade as production technique at the border: Inputs are exports and
outputs are imports.
▪ Therefore, trade is about imports.
• Trade allows a better consumption possibilities when countries specialize in
their comparative advantages (division of labor)
○ Trade increases the capacity of consuming outside of the production
possibility frontier (these are gains from trade)
• Autarky equilibrium:
• Prices adjust in the autarky equilibrium to ensure that point A (production) =
HD prices adjust in
autarky to reach point B (consumption)
equilibrium? • The autarky equilibrium is optimal, given no trade
○ No higher indifference curve (consumption) is possible
Draw the graph of the
autarky equilibrium… • Autarky equilibrium is characterized by :
○ MRT = price ratio
Is the autarky ○ MRS = price ratio
equilibrium optimal?
○ Domestic demand = domestic supply
•
Draw the free-trade • Free trade equilibrium: production (in export good) and consumption (in import good)
equilibrium. have increased (yellow arrows).
• Optimal consumption is at a point of tangency
H did consumption and
production change in ○ This leads to a higher welfare level ( ), which are gains from
each good? trade!
• Country exports food and imports manufactures.
HD we see gains from
trade on the graph? • Trading position is captured by the trade triangle
○ Equilibrium requires world consumption = world production
HD we see the trading ▪ Mirrored image of trade triangle for the rest of the world
position?
• Income line (red) is necessarily the consumption in either of the 2 possible
HD the trade triangle products (closed economy in which all is consumed)
look like for the ○ Income line allows to derive the quantity of
trade partner?
imports/exports depending on their relative price.
WD you compute the
income line? ▪
FDI Page 10
, •
WI the Balassa Index • Revealed comparative advantage (Balassa Index): to empirically evaluate a country's
(BI) and WD it 'strong' sectors, we can measure in which sector it is actually exporting a lot in relative
measure?
terms.
WI revealed • Balassa Index ( ) for sector in country :
comparative advantage
(RVA)? WI the
revealed part of it? •
HI it computed? • If the index is above 1 ( ), country is said to have 'revealed' comparative
W a mean? advantage in sector , as it is exporting relatively more in this sector than the
group of reference countries.
Can one compare BI ○ NB: Balassa Indexes cannot be compared across countries.
across countries?
• According to Ricardo/HOS:
W motivates trade • Trade is motivated by comparative advantages due to differences in technology
acc. to…
*Ricardo? (acc. Ricardo) or factor endowment (acc. HO).
*HOS?
○
W is determined by • Impact of comparative vs. absolute costs:
comparative costs? ○ Only comparative costs are important to determine direction of trade
WI determined by flows
absolute costs? ○ Absolute costs are important only determining a country's welfare (wage)
level
• Comparative advantages are difficult to measure in practice!
YR old trade theories ○ Problem: old trade theory assumes that there are only 2 countries and 2
(comparative homogeneous goods.
advantages) difficult
to measure in ○ Possible solution: Bernhofen & Brown (2004) measure it by building a
practice? vector of traded goods, with pre- and post-trade prices available, which
allows a test:
HD Bernhofen & Brown
(2004) overcome this ▪ the negative sign implies that goods with relative high autarky prices
challenge? will be imported on average, vice versa for exports.
WI the condition for
data on expenditures
in net exports (
to reflect
comparative ▪
advantage?
Using a graph,
explain why:
*
* ▪ Fictional example:
□ In autarky, value of consumption is equal to value of
production
If prices change:
◊
One cannot conclude that the income went
YD you have to down. Not only prices changed but also
calculate changes in consumption bundle
welfare (income)
using autarky prices Evaluate at original prices:
FDI Page 11
