International Trade

Why is there an interest in maintaining minimum labor standards?

(1) Protectionist: 1. repressive labor-market practices in South provides artificial advantage to exporting firms. 2. Declining demand for lower-skilled labor in rich nations. 3. downward pressure on labor standards elsewhere, hard for other countries to sustain high levels of labor standards. (2) Altruism: North aware of conditions in the South

Arguments against labor standards

* unions may introduce inefficiencies into economy (distortions in the labor supply) so efficiency gains depends on objectives and practices of labor unions. * with child labor sensible minimum age may vary across countries, may impose constraint on child with limited alternatives. improves educational opportunity and health but maybe rational for poor family for child to work

Welfare benefits from intra-industry trade in a monopolistic context

- Benefit from a greater variety at a lower price. - Firms consolidate their production and take advantage of economies of scale.

Losses for countries that import goods and technologies that may be subject to IPRs

- Higher prices for imports - Potential competitive abuses in the exploitation of IPRS - Employment losses in imitative and copying industries - Restricted access to international technologies

Points in favor of patents

- Incentivizes research and the costs of inventing new technologies and bringing them to the market - Expands public stock of technical knowledge (patents require disclosure, allowing other to incorporate the information into new inventions that do not violate the patent) - Establishes a market for developing and disseminating knowledge (absent patents, these markets may not develop) - Encourages follow-on innovation by the owner or its licenses (without the rights, there is wasteful duplication)

increasing returns to scale or economies of scale definition

- This means that when inputs to an industry increase at a certain rate, output increases at a faster rate. - A larger scale is more efficient: the cost per unit of output falls as a firm or industry increases output.

constant returns to scale: definition

- When inputs to an industry increase at a certain rate, output increases at the same rate. - If inputs were doubled, output would double as well. Model of comparative advantage

International Job Spillovers

- With relation of standards and investment decisions, link arises from link to labor costs, a variable in decision of investor trying to minimize labor costs. Importance greater the more the production is labor-intensive. - Cost considerations only one among many factors determining investment decision of multinationals. - Also firm value in the long run may go down (stocks fall) when consumers lose confidence by realizing that the multinational is exploiting labor. - Multinationals may on the other hand bring or stimulate standards, growth in host country.

Comparative Advantage Model: A firm in a monopolistically competitive industry is expected to sell:

- more as total sales in the industry increase and as prices charged by rivals increase. - less as the number of firms in the industryincreases and as the firm's price increases. Represented in function: Q = S[1/n - b(P - P)] - Q is an individual firm's sales - S is the total sales of the industry - n is the number of firms in the industry - b is a constant term representing the responsiveness of a firm's sales to its price - P is the price charged by the firm itself - P is the average price charged by its competitors

An increase in the relative price of cloth, PC /PF, is predicted to

- raise income of workers (cloth is labor-heavy) relative to that of capital owners, w/r. - raise the ratio of capital to labor services, K/L, used in both industries (now labor is expensive, so substitute with capital) - raise the real income (purchasing power) of workers and lower the real income of capital owners.

Three major developments in the world economy over the last 25 years

1. Information and communication technology revolution (processing power and memory of computers; cost of transmitting information over an optical network) 2. Deepening of trade liberalization and continuing transportation cost reduction (falling trade costs) 3. Political developments expanding the reach of globalization (fall of communism, worldwide ideological shift to the right in large parts of the globe) Implication: gradual disintegration of production processes across borders => slicing the value chain

Justification for core labor standards

1. Reflect shared global vision of morality. Nearly all countries recognize these rights as humane principles within UN declarations; but international ratification of related conventions by ILO far from uniform. → while widespread support, much less agreement for minimum international standards 2. Underpin efficient operation of labor markets. Removes constraints on choices facing labor and access of employers to anti-competitive practices so workers employed more efficiently and welfare higher

Labor Standards: Wages are not equalized internationally because:

1. different production technologies and worker productivities and skills. 2. countries specialize in different goods. 3. Trade in goods not fully integrated with transport/trade barriers 4. Monopsony. 5. labor and capital not fully mobile across countries controversy about role of trade determining employment and wages in North. relating differences in wages to differences in labor standard that low standards=lower wages=higher exports=lower export prices=lower wages in importing country due to competition MAY BE MISLEADING

Standard Trade Model Assumptions

2 countries produce 2 goods that can be traded

Specific Factors Model Assumption

2 countries producing 2 goods with three factors of production (only one factor is mobile)

Heckscher Ohlin Model Assumptions

2 countries, 2 goods, 2 factors of production (factors to each sector are mobile in the long run)

Ricardian Model Assumptions

2 countries, producing 2 goods with one factor of production

Nash Equilibrium

A decision-making theorem within game theory that states a player can achieve the desired outcome by not deviating from their initial strategy. In the Nash equilibrium, each player's strategy is optimal when considering the decisions of other players Two equilibria: (pollute,abate) and (abate,pollute). Neither Pareto- dominated

oligopoly

A market structure in which a few large firms dominate a market In this situation, a single firm has enough market share to influence market aggregates such as total industry output and average industry price (which affects demand conditions for other firms) In this industry, like a monopoly, the marginal revenue generated from selling more products is less than the uniform price charged for each product.

Economics and Trade Issues with Labor Standards

A. Disutility among Northern consumers when aware of labor conditions in South. Demand for standards rises with income. B. Artificially low wages contributing to natural comparative advantage low wage nations have in labor-intensive goods in trade. Competition for low- skilled in North→threat to employment and income in North C. fear that as trade expands with countries with weak standards, competitive pressures placed on higher-standard countries to relax their regulations as multinationals search for competitive locations to produce. low-skilled lose jobs, authorities must lower labor rights to retain employers

Heckscher-Ohlin model: Why does the opportunity cost of a good not constant in PPF

Because when the economy devotes more resources towards production of one good, the marginal productivity of those resources tends to be low so that the opportunity cost is high.

When question asks how much to give parties for cooperation (prisoner's dilemma)

Best strategy for each player when allocating resources in the box that has the greatest benefit to both parties, where The losing party is not penalized for abiding by the agreement (not cheating) The cheating party is worse off by cheating

Standard Trade Model: Biased Growth

Biased growth leads to expansion of PPF more in certain sectors than in others Biased growth and the resulting change in relative supply causes a change in the terms of trade. - Biased growth in the cloth industry (in either the home or foreign country) will lower the price of cloth relative to the price of food and lower the terms of trade for cloth exporters. - Biased growth in the food industry (in either the home or foreign country) will raise the price of cloth relative to the price of food and raise the terms of trade for cloth exporters.

Short-term comparative advantage in labor markets

Companies: short-term competitive advantage by abusing worker freedoms (denial to join trade unions, freedom of association, right to strike, encourage child labor, labor exploitation) Multinationals: Happy to take advantage, escape high wages, stricter laws, strong unions in the North Short term gain outweighed by long term damage to country's skill base by putting children in factories rather than classrooms. Tomorrow's unskilled and unemployed

Do labor unions increase or decrease efficiency?

Depends. Could maintain labor pop. but advocate for improved wages. Would split rent in labor market and reduce inefficiency Could cut labor pop. and advocate for improved wages. Increase inefficiency though wages rise (but there are fewer workers now)

When question ask how much to give parties for cooperation (chicken)

Doesn't really need one because the highest total boxes are the equilibria. But if we were to create cooperation, would reduce cheater's amount between zero and the point where the cheater would be indifferent to cheating

Market Outcomes without Standards: Efficient

Efficient: relative price reflects supply and demand condition of all goods, services, factors traded in economy. Supply and demand must operate freely: 1. Agents free to choose (utility or profit maximizing decision) 2. Perfect competition (no market power)3. Perfect information (accurate and complete information). Govt. intervention impairs free functioning of market, reduce efficiency, because market outcome endogenous→labor standard endogenous and country-specific (determined by market forces)

elasticity

Elasticity is a measure of a variable's sensitivity to a change in another variable. In business and economics, elasticity refers the degree to which individuals, consumers or producers change their demand or the amount supplied in response to price or income changes. When the value of elasticity is greater than 1, it suggests that the demand for the good or service is affected by the price. A value that is less than 1 suggests that the demand is insensitive to price.

Specific Factor Model: Endogenous versus Exogenous

Endogenous (change in quantity of input): can affect workers' welfare Exogenous (opening to international trade): Owners of the exporting product benefit, owners of the importing product lose

opportunity cost of x in terms of y

How much of x you give up to produce one y "in terms of y" = when producing one y x/y

Stolper-Samuelson theorem

If the relative price of a good increases, then the real wage or rental rate of the factor used intensively in the production of that good increases, while the real wage or rental rate of the other factor decreases. Any change in the relative price of goods alters the distribution of income.

Is immigration good for the host country?

Immigration benefits the host country in the specific factors model As wage falls, MPL falls as well (diminishing returns for the additional workers) The difference between the marginal products of the workers and the wage paid is the gain for the Home economy Adding up all the gains from the Foreign workers, we get ∆ABC (space above the equilibrium wage)

Model of Comparative Advantage: Imperfect Competition

In imperfect competition, firms are aware that they can influence the prices of their products and that they can sell more only by reducing their price. This situation occurs when there are only a few major producers of a particular good or when each firm produces a good that is differentiated from that of rival firms. Each firm views itself as a price setter, choosing the price of its product.

Internalization

Internalization occurs when a transaction is handled by an entity itself rather than routing it out to someone else

Equilibrium Economies w/out Trade

Intersection of the demand and supply curve (AC and D curves)

foreign direction investment

Investment in the form of a controlling ownership in a business in one country by an entity based in another country

Characteristics of a monopoly on a graph

MR is always less than price Production at intersection of MR and MC Quantity produced derived from this intersection Profit= (D-AC)(Q)

Equation for MR

MR=P- Q/B OR MR-P=Q/B the gap between price and marginal revenue depends on the initial sales (quantity), Q, of the firm and the slope parameter, B, of its demand curve If sales quantity, Q, is higher, MR is lower, because the decrease in price required to sell a greater quantity costs the firm more

The Standard Trade Model: What Happens when the Relative Price of a Good ↑

Means movement along the PPF to a point where the P₁/P₂ once again is tangent to the PPF Causes movement along the relative demand and relative supply of the lines If domestic-resource-dominant good's P↑ → relative demand ↓ for the good while relative supply ↑ An economy is better off when the export good's relative price increases. Isovalue line gets steeper and a higher indifference curve can be reached

What happens in the economy if wages are held down in a monopsony?

Monopsony wage paid lower than free-market wage, but does not result in higher employment, rather below competitive. In product market, output lower than in absence of monopsony. Concern expressed about absence of labor standards in export sector leading to greater export competitiveness. Monopsonist drives a wedge between foreign and domestic wage through limiting employment in a localized labor market, even at fixed product price.

Model of Comparative Advantage: Impacts on Trade

Mutually beneficial trade can arise as a result of economies of scale. International trade permits each country to produce a limited range of goods without sacrificing variety in consumption. With trade, a country can take advantage of economies of scale to produce more efficiently than if it tried to produce everything for itself.

Specific Factor Model: What happens when both prices change in the same proportion?

No real change - The wage rate (w) rises in the same proportion as the prices, so real wages (i.e., the ratios of the wage rate to the prices of goods) are unaffected. - The real incomes of capital owners and landowners also remain the same.

Market Outcomes without Standards: Inefficient

Not efficient: market distortions & failures in real world. 1. No standards can mean no freedom of choice and distorted labor allocation (i.e. forced labor, child labor, discrimination) 2. (!)Imperfect competition: no standards mean imbalance of market power in the labor market (i.e. monopsony) 3. Dynamic concerns such as no incentive to increase productivity, invest in education (i.e. lack of long-term investment hurts knowledge accumulation), so market forces alone lead to under-investment in education and training

What happens to the country that is getting its good tariffed?

Nothing. Supply and demand remain the same.

Factors that increase relative demand for skilled labor

Offshoring and/or skilled bias technology changes

Pure Coordination

One country's interest to play abate only if other plays abate; if other plays pollute then can do no better than pollute Unlike the dilemma game, outcome (abate,abate) self-enforcing, so is (pollute-pollute)→two equilibria As with chicken, if pure coordination game played sequentially, a unique self-enforcing outcome: (abate, abate) Unlike chicken, does not depend on order of moves. If X moves first and pollutes, Y pollutes. But if X played abate, Y abates. Latter preferable to X (as well as Y) so X plays abate and so would Y if roles reversed. Unique equilibrium would then be (abate,abate) => Pareto efficiency If players make choice simultaneously (imperfect information) then outcome (abate,abate) at least likely, given that it is the unique Pareto-efficient outcome. Sen's reasoning that individuals will pay attention to their collective interest & not just individual interests compelling. Both might play abate, recognizing that to do so is better for respective goal & is equilibrium.

Equation demonstrating the price charged by each firm

P = 1/bn + c = c + √(F/Sb) Demonstrating that an increase in the size of the market leads to lower prices This is the PP curve in Figure 8-3, which relates the price charged by firms to the number of firms, does not shift. b is the parameter in equation that measured the sensitivity of each firm's market share to the price it charges S = total industry sales

Tradeoffs between make-or-buy internalization

Pro for internalization: Control over firm's proprietary technology. Also, there is no clear reason why another firm would be able to replicated the production process at a lower cost than the parent firm

Effects of Offshoring

Raise relative wage for skilled workers (meaning that the relative wage for unskilled workers falls) Lower costs for the firm Lower prices for the consumer

Short-term effect of Migration from Foreign to Home

Setup of specific factors model: labor is mobile, capital and land are not Goods are agriculture and manufacturing (L(agri)+L(manu)=L(total)) in home Assume foreign workers' equilibrium wage = w*, home workers' equilibrium wage = w, and w*<w People move from foreign to home for the higher wage: Effects: - L↑ in home (expansion of the x-axis in model) = ∆L - shift in one of lines (one goes toward's it's new y-axis) =∆L, other line (MPL*P) stays the same - overall wage lowers (b/c of diminishing marginal product of labor) Overall: - Extra workers are distributed b/w two industries - Inflow of labor ↓w

external economies of scale

The cost benefits that all firms in the industry can enjoy when the industry expands (costs go down when industry expands) Ex: Silicon Valley, NYC's investment banking industry, Hollywood's entertainment industry Reasons for this: specialized suppliers, labor market pooling, knowledge spillover

Intra-industry trade

The exchange of similar products belonging to the same industry. The term is usually applied to international trade, where the same types of goods or services are both imported and exported.

Remittances

The fact that immigrants return some of their income back home may not be enough to compensate their home countries for the loss of their labor. To calculate the gains, we need to include all the earnings of the immigrants in their home countries' income. In the case of highly-educated migrants, unless these migrants return most of their earnings back home those countries lose from the outflow of these workers.

Learning Curve

The learning curve shows that unit cost is lower the greater the cumulative output of a country's industry to date. A country that has extensive experience in an industry may have a lower unit cost than a country with little or no experience, even if that second country's learning curve is lower— for example, because of lower wages. The more someone performs a task, the better they get at it.

Chicken

The principle of the game is that while the outcome is ideal for one player to yield (to avoid the worst outcome if neither yield), but the individuals try to avoid it out of pride for not wanting to look like a 'chicken'. So each player taunts the other to increase the risk of shame in yielding. However, when one player yields, the conflict is avoided, and the game is for the most part over. Given X plays pollute, player Y can do no better than play abate. However, if X were to play abate, Y would play pollute. Two equilibria: (pollute,abate) and (abate,pollute). Neither Pareto- dominated Starting from either equilibria, a move to (abate,abate) makes one worse off At the same time aggregate payoff highest when both play abate If X goes first it would play pollute as it could see that if itplayed pollute then Y would play abate. X has "1st-mover-advantage"; if Y moves 1st same (pollutes). [[ORDER OF PLAY MATTERS though result doesn't change]] Chicken creates incentives for parties to behave strategically. Make irreversible investment in a preliminary round for purpose of changing its payoffs in the chicken game making pollute a dominant strategy

Effect of offshoring increasingly higher skilled labor in terms of relative demand for skilled labor

The relative demand for high skilled labor in both countries increases (one country becomes more high skill intensive, while the other country becomes more high skill intensive through producing the least high skill intensive products), and relative wages for high skilled countries increase

Migration: Determining real wage and real rent

The wages and rentals are determined by the marginal products of labor and capital. The marginal products are determined by the capital- labor ratio in each industry. If there is a higher capital-labor ratio, then by the law of diminishing returns, the marginal product of capital and real rental must be lower and the marginal product of labor and real wage must be higher; the opposite holds for a higher L/K ratio. Because each line in the box diagram is a particular capital-labor ratio, it is also a particular wage and rental.

How can trade liberalization exacerbate environmental issues?

Trade allocation dirty firm move to countries with poor environmental regulations, which increases world pollution as a whole

Effect of trade versus effect of technology

Trade causes movement along the input cost(A)/input cost(B) - quantity of input (A)/quantity of input(B) Technology change causes a shift

Inter-industry trade

Trade of products that belong to different industries. For instance, the trade of agricultural products produced in one country with technological equipment produced in another country can be classified to be an inter-industry trade

Punchline for Migration

Use specific factors model in the short run to explain where migration leads to a fall in wages Use the Heckscher-Ohlin model to explain where an increase in labor will not lower wages Overall: It comes down the domestic countries' ability to expand exports that use the immigrants' skills

Dumping

When a country or company exports a product at a price that is lower in the foreign importing market than the price in the exporter's domestic market.

Outsourcing: Hold-up Problem

When a party to a future transaction (input supplier) has to make non- contractible future relationship-specific investments before the transaction takes place The buyer can renegotiate down the price of an input Foreseeing this hold-up problem, supplier will underinvest and this will reduce efficiency. Williamson showed that these transaction costs tended to be larger the harder the contracting and the larger the relationship-specificity Ex) 1. Parts and components are frequently customized to the needs of the intended buyers (growth in trade in differentiated intermediate goods) 2. Global production entails intensive contracting between parties subject to distinct legal systems (irrelevant in a world with perfect contracting across borders, but real-world commercial contracts are incomplete--can't be 100% enforceable) -Causes contract disputes, difficult b/c which country's laws apply, complicated enforcement remedies The detrimental effects of imperfect contract enforcement are particularly acute for transactions involving intermediate goods

Exportation of Goods: Market expansion effect versus market/monopoly effect (IPR)

When transport costs and tariffs low in comparison to costs of FDI and licensing. Volume of exports depends on strength of local IPRs Impact of stronger IPRs protection on technology transfer occurring through imports depends on two contradictory effects: a 'market expansion' effect and a 'market power' effect. Strengthening IPRs protection can positively affect trade if the 'market expansion' effect dominates the 'market power' effect. market expansion effect: trade is positively correlated with the effectiveness of protection in the importing country. Strengthening IPRs protection can reduce counterfeits, resulting in an increase in the request for innovative businesses. Strong IPRs provide protection for exporting firms against local copying of the product, suggesting that they would increase the market size facing exporters and induce them to sell more (strongest in large markets with significant technical capabilities for imitation) market power: strengthening IPRs protection may have a negative effect on trade flows. Greater protection allows the patent holder firm to reduce the quantities exported through its monopoly power in the host country market, and increases its price. The total effect depends on the imitation capacity of the importing country

Equation of sales per firm

X = S/n = √(SbF)

monopsony

a market situation in which there is only one buyer

Relationship between economies of scale and competition

external economies of scale = more closer to perfect competition internal economies of scale = closer to a breakdown of perfect competition

How to find the number of firms in the industry?

n = √(S/bF)

Outsourcing and Gains from Trade

obtain (goods or a service) by contract from an outside supplier (substitute for horizontal FDI) Outsourcing can shift the relative demand for labor, and raise the wage for skilled workers. Since the wage for unskilled workers is the reciprocal of that for skilled workers, that means that outsourcing will decrease the relative wage for unskilled workers. However, outsourcing reduces production costs which, in a competitive market, reduces prices so outsourcing benefits consumers.

unit labor requirement

the number of hours of labor required to produce one unit of output (1 unit labor requirement = 1 hour of labor needed to produce one unit of a good)

intra-industry trade

two-way exchange of similar goods

Main differences between inter-industry and intra-industry trade:

• Interindustry trade reflects comparative advantage, whereas intraindustry trade does not. • The pattern of intraindustry trade itself is unpredictable, whereas that of interindustry trade is determined by underlying differences between countries. • The relative importance of intraindustry and interindustry trade depends on how similar countries are.

Why is the production possibilities frontier curved?

- Diminishing returns to labor in each sector cause the opportunity cost to rise when an economy produces more of a good. - Opportunity cost of cloth in terms of food is the slope of the production possibilities frontier - the slope becomes steeper as an economy produces more cloth.

Types of patents

- Invention patents (requires a significant non obvious advances, meaning they embody discrete advances in technology) - Utility models (mechanical inventions, which tend to be incremental improvement sin existing products and technologies) - Industrial design (protects aesthetic or ornamental aspects of a useful commercial article)

Gains for countries with greater IPR protections

- More domestic innovation, which would be better suited to local needs than foreign innovation - expands incentives for trade and inward FDI - Reduces costs of writing and monitoring contracts for technology licenses

The Standard Trade Model: What happens to PPF when there is no trade

- The relative price of cloth to food is determined by the intersection of relative demand and relative supply for that country. - Consume and produce at point D3 where the indifference curve is tangent to the production possibilities frontier.

trade costs

-Extra costs involved in transportation and communication (esp. if other country is developing) -Extra costs from tariffs if Foreign imposes a tax on goods

Specific Factor Model: Relationship b/w relative prices and relative output

-MPLF/MPLC = -PC/PF -PC/PF = slope of production possibilities frontier

IPR Concerns

-Rent seeking (a strong IPR system may cause duplication in R&D and costly efforts to assert ownership rights) -Technical and judicial actions to enforce rights through excluding free riders may be costly -The costs of transferring rights to information can be high if there is uncertainty about the value of the information, about monitoring its use by those who buy or license it, or about other contracting costs

Ricardian model

2 countries producing two goods w/ one factor of production Demonstrates concept of comparative advantage and opportunity cost The Ricardian model examines differences in the productivity of labor (due to differences in technology) between countries.

Equation for Firm's total costs

C = F + MR * Q Q=output F=fixed cost

Comparative Advantage: Environmental Standard Countries (Capital Intensive) versus None-Envionmental Standard Countries (Labor Intensive)

Capital-intensive countries specialize in capital intensive industries that are dirtier Labor-intensive countries specialize in labor intensive industries that are cleaner World pollution is ∴ ↓ b/c capital intensive countries have environmental standards to abide by

Is immigration good for the country whose residents are leaving?

If immigrant earnings with Foreign income are included then emigration benefits the Foreign country, too Foreign Wage W* = MPL*P As foreign workers emigrate, MPL in Foreign rises, Foreign wages rise from W* to W′ Each of these higher marginal products or wages, between W* and W′, equals the drop in foreign output from workers leaving. The wage Foreign workers earn in Home is much higher than their Foreign marginal products of labor: between W* and W′. The difference between the wage earned by the migrants and their Foreign marginal products is the gain to Foreign. Adding up all the gains to foreign immigrants we obtain the triangle A*BC. ▪ This gain represents the earnings of the emigrants over and above the drop in output that occurs when they leave Foreign.

How to eliminate prisoner's dilemma?

Penalizing cheaters Penalty must reduce cheaters incentive below abating If both abate or pollute payoffs unchanged X now plays abate no matter what Y does and Y likewise abates whatever X does Playing abate is a dominant strategy. dilemma removed. - only fixes things if contract is binding on both countries, otherwise nothing but communication (communication can not alter equilibrium of the game) - third party must be able to enforce the contract - easy for most domestic conflicts. But there does not exist a world government that can enforce agreements between countries (WTO?)

Internal economies of scale

The cost benefits that an individual firm can enjoy when it expands (costs go down for an individual firm's expansion) Internal economies of scale occur when the cost per unit depends on the size of an individual firm but not necessarily on that of the industry • Internal economies of scale imply that a firm'saverage cost of production decreases the more output it produces. • Perfect competition that drives the price of a good down to marginal cost would imply losses for those firms because they would not be able to recover the higher costs incurred from producing the initial units of output. • As a result, perfect competition would force those firms out of the market.

opportunity cost

The cost not being able to produce something when you choose to produce a different good

What happens to demand when market integration occurs?

The demand curve flattens out: increase in competition pushes the demand curve in (which means that there is a lower output quantity) as well as an outward shift for larger firms Intercept of demand curve: P° + [1/(b * n)] Slope of demand curve: 1/(S+b) Increase in number of firms (n) lowers the intercept of the demand curve Increase in the market size (S) flattens the slope of the curve

Heckscher-Ohlin model: where does the country produce?

The economy produces at the point that maximizes the value of production, V. • An isovalue line is a line representing a constant value of production, V: V = PC QC + PF QF - where PC and PF are the prices of cloth and food. - slope of isovalue line is - (PC /PF) Produces at the point where the the relative price of cloth equals the slope of the PPF, which equals the opportunity cost of producing cloth - The trade-off in production equals the trade-off according to market prices

Production possibility frontier (Ricardian model)

a curve illustrating the different possible amounts that two separate goods may be produced when there is a fixed availability of a certain resource that both items require for their manufacture slope: opportunity cost between goods on x and y axes x and y intercept: total quantity of good if just producing that good

monopolistic competition

a market structure in which many companies sell products that are similar but not identical Assumes that each firm: 1. can differentiate its product from the product of competitors, and 2. takes the prices charged by its rivals as given Product differentiation and internal economies of scale lead to trade between similar countries with no comparative advantage differences between them. - This is a very different kind of trade than the one based on comparative advantage, where each country exports its comparative advantage good.

comparative advantage

an economy's ability to produce goods and services at a lower opportunity cost than its trade partners

Example of the Rybczynski theorem

• Assume an economy's labor force grows, which implies that its ratio of labor to capital L/K increases. • Expansion of production possibilities is biased toward cloth. • At a given relative price of cloth, the ratio of labor to capital used in both sectors remains constant. • To employ the additional workers, the economy expands production of the relatively labor- intensive good cloth and contracts production of the relatively capital-intensive good food PPF expands, favoring output of cloth, but the point of production (PC/PF, with QC on the x-axis) stays the same => PC/PF moves down the curve

Specific Factors Model: Income Distribution and the Gains from Trade

• International trade shifts the relative price of cloth to food, so factor prices change. • Trade benefits the factor that is specific to the export sector of each country, but hurts the factor that is specific to the import- competing sectors. • Trade has ambiguous effects on mobile factors.

Specific Factors Model: Who wins and who loses when the price of cloth increases (in a market between food and cloth, where food uses land and labor and cloth uses capital and labor)

• Owners of capital are definitely better off. • Landowners are definitely worse off. • Workers: cannot say whether workers are better or worse off: - Depends on the relative importance of cloth and food in workers' consumption.

Migration in the Long Term: Effect on Factor Prices

Notice that the change in outputs in the Rybczynski Theorem goes hand-in-hand with the finding that wage and rental will not change due to the increase in labor (or capital). That is because the economy can absorb the extra amount of labor by changing output (Factor Price Insensitivity)

Types of FDI

(1) The affiliate replicates the production process (that the parent firm undertakes in its domestic facilities) elsewhere in the world (horizontal FDI). Driven b/c of production cost differences b/w countries. Dominated by flows in developed countries meant to produce products closer to consumers (seeks to reduce export trade costs) (2) the production chain is broken up, and parts of the production processes are transferred to the affiliate location (vertical FDI) (skill-unskilled labor intensive--what we learned about) Internalization motive:

Export Subsidies

Payments given to domestic producers that export

Pareto efficiency or Pareto optimality

A state of allocation of resources from which it is impossible to reallocate so as to make any one individual or preference criterion better off without making at least one individual or preference criterion worse off An outcome is Pareto efficient if there is no other outcome that increases at least one player's payoff without decreasing anyone else's.

Average Cost Equation for Monopoly

AC=C/Q=(F/Q)+MR F=fixed costs Alternatively: AC = F/Q + c = (n * F/S) + c Where S = total industry sales and n = number of firms in the industry (therefore Q=S/n), c = marginal cost This equation tells us that the more firms in the industry, the higher the average cost As the number of firms n in the industry increases, the average cost increases for each firm because each produces less. As total sales S of the industry increase, the average cost decreases for each firm because each produces more.

Standard Trade Model: Export-biased growth

Growth that expands a country's production possibilities disproportionately in that country's export sector. - Biased growth in the food industry in the foreign country is export-biased growth for the foreign country Export-biased growth reduces a country's terms of trade, reducing its welfare and increasing the welfare of foreign countries

Reasons to trade

Comparative Advantage Increasing returns to scale (a tendency of unit costs to be lower with larger output)

Features of Prisoner's Dilemma

Countries play simultaneously Two individuals acting in their own self-interests do not produce the optimal outcome. The typical prisoner's dilemma is set up in such a way that both parties choose to protect themselves at the expense of the other participant. As a result, both participants find themselves in a worse state than if they had cooperated with each other in the decision-making process. X's best strategy to play pollute no matter what Y does: dominant strategy Y's best strategy to play pollute no matter what X does: dominant strategy Transparency won't change outcome. If X moves before Y, then whatever X does, Y pollutes. Knowing that, best for X is to pollute. So (pollute,pollute).

Standard Trade Model: Import-biased growth

Growth that expands a country's production possibilities dispro- portionately in that country's import sector. - Biased growth in cloth production in the foreign country is import-biased growth for the foreign country. Import-biased growth increases a country's terms of trade, increasing its welfare and decreasing the welfare of foreign countries

Rybczynski theorem

If you hold output prices constant as the amount of a factor of production increases, then the supply of the good that uses this factor intensively increases and the supply of the other good decreases

Gains from Immigration

Immigration creates world gains as labor moves from countries with low marginal products to countries with high marginal products. Combining the gains to the Home and Foreign countries we obtain the triangular region ABA*, the world gains due to immigration. We can measure the area of this triangle but we need to know the difference in wages before any migration and the number of people who would emigrate. One way to think about world gains from migration is that it equals the increase in world GDP due to immigration. We can then say the difference between the Home and Foreign wages therefore equals the net increase in world GDP due to migration. Adding this up across all migrants, we get the triangle ABA*, the increase in world GDP and the world gains due to migration. In practice, however, there are other costs that immigrants bear which would make the gains from immigration less than the increase in world GDP. ▪ Moving costs, payments to traffickers of illegal immigrants. These costs must be subtracted from the increase in GDP in order to obtain the net gains.

diminishing marginal returns

In specific factors model, demonstrates that adding one more worker to the production process (and not increasing other inputs) means that the worker has less inputs to work with Therefore each additional unit of labor adds less output than the last

Factor price insensitivity

In the Heckscher-Ohlin model with two goods and two factors, an increase in the amount of a factor found in an economy can be absorbed by changing the outputs of the industries, without any change in the factor prices.

Rybczynski Theorem

In the Heckscher-Ohlin model with two goods and two factors, an increase in the amount of a factor found in an economy will increase the output of the industry using that factor intensively and decrease the output of the other industry.

Equilibrium Economies w/ Trade

International trade lead to specialization, and lower prices below both economies' original prices of the good (b/c of external economies of scale)

How is intellectual property have the traits of a public good?

It's non-rivalrous (one person's use does diminish another's use) It's non-excludable through private means (it may not be possible to prevent others from using the information without authorization)

Trade in the Heckscher-Ohlin Model

Like the Ricardian model, the Heckscher- Ohlin model predicts a convergence of relative prices with trade. With trade, the relative price of cloth rises in the relatively labor abundant (home) country and falls in the relatively labor scarce (foreign) country. W/ trade: relative price of the good w/ the abundant input ↑ (while that same good w/ the same but scarce resource relative price ↓) Leads to a ↑ in relative production of cloth in input abundant country, but a ↓ in demand in input abundant country (country exports the good that is input abundant, imports the good that is input scarce)

What does n = √(S/bF) mean?

Means that an increase in the market size, will lead to an increase in the number of firms, but not a proportional increase

Consumer benefits from integrated trade

More variety at a lower cost because firms can consolidate their production destined for both locations and take advantage of economies of scale

Effects of immigration on industry output (short term)

More workers, but same capital and land amounts Expansion of the PPF Relative price of goods stay the same (short run)

Specific Factor Model: Change in Prices for both goods by the same proportion

No real change - The wage rate (w) rises in the same proportion as the prices, so real wages (i.e., the ratios of the wage rate to the prices of goods) are unaffected. - The real incomes of capital owners and landowners also remain the same. - Labor distribution stays the same

Comparative Advantage: Environmental Standard Countries versus No-Envionmental Standard Countries

Polluting goods move to countries w/out environmental standards, while clean good are in countries with environmental standards Moral of story: trade liberalization must be accompanied by multilateral agreements to safeguard the global environment.

Tradeoffs between outsourcing and vertical FDI

Pro for outsourcing: independent firm can specialize in a part of the production process (economies of scale) Pro for vertical FDI: avoid a potential costly renegotiation conflict

The Standard Trade Model: When Trade Exists

Production Where the relative price intersects the PPF Consumption Where the isovalue line is tangent to the indifference curve

Determining market clearing relative price

Q(y-axis)/Q(x-axis) for global production

Composition Effect

Refers to the industrial restructuring that takes place when a country exposes itself to the world market. Trade-induced specialization in world. Countries used to produce wide range of products to satisfy local demand now specialize in subset of product range and import others. Net effect on environment positive if expanding export sectors less polluting on avg. than contracting import competing sectors; negative if opposite Composition effect mitigates pollution in North and magnifies in South

Offshoring

Represents the relocation of parts of the production chain abroad but retaining ownership of operations

Long-term effect of Migration from Foreign to Home

Setup of box model: labor and capital are mobile Goods are shoes (labor-intensive) and computers (capital-intensive) L(shoes)+L(comp)=L in home, earning wage w K(shoes)+K(comp)=K in home, earning rent R Box Diagram: L and on axes, slope of lines are the K/L for each industry Real wage and real rent is determined by the marginal products of labor and capital (MPL and MPK), which is determined by the ratio of capital and labor in the industry Since each industry has a particular K/L, their wage and rents are different Immigration: ∆L → allocation is only given to shoes Some K(comp) moves to shoes To maintain L/K for computers, some L is also allocated from comps to shoes Results: - Expansion of box on the shoe side's labor side - K/L is unchanged in both industries (slopes for both lines are the same, real wage and rent is the same) - Shoes get more K (from comp) and L (from migration and comp) - PPF: PPF expands, with shoes more so than comp on axis. But, as shoe production expands, computer production shrinks (production point is tangent to the relative prices that hasn't changed) - When capital and labor can move freely, there is no impact on wage and rent

The Heckscher-Ohlin model

The Heckscher-Ohlin model examines differences in labor, labor skills, physical capital, land, or other factors of production between countries. - Countries have different relative abundance of factors of production. - Production processes use factors of production with different relative intensity The Heckscher-Ohlin model proposes that countries export what they can most efficiently and plentifully produce - and will import goods that are relatively intensive in using its relatively scarce factors of production

What happens when firms produce at different cost levels? (page 216-217)

The firm with the higher marginal cost level ends up having less of an operating profit than the firm with the lower marginal cost level (we know this because demand and MR stays the same, so they produce at the price level where c=MR (but on the demand curve)) The firm with the lower cost level can (1) set a lower price but at a higher markup over MC, (2) produce more output, and (3) earn higher profits

terms of trade

The terms of trade refers to the price of exports relative to the price of imports. - When a country exports cloth and the relative price of cloth increases, the terms of trade rise. Because a higher relative price for exports means that the country can afford to buy more imports, an increase in the terms of trade increases a country's welfare. A decline in the terms of trade decreases acountry's welfare

Specific Factors Model: When judging gains from trade, what should we look at

The workers The owners of inputs To determine whether there is welfare benefits, look at MPL (real wages). When MPL↑ → owners of inputs lose (workers can gain if the factor that changes trade is endogenous)

International Trade in the Specific Factors Model

Trade and Relative Prices - The relative price of cloth prior to trade isdetermined by the intersection of the economy'srelative supply of cloth and its relative demand. - Free trade relative price of cloth is determined by the intersection of world relative supply of cloth and world relative demand. - Opening up to trade increases the relative price of cloth in an economy whose relative supply of cloth is larger than for the world as a whole. Gains from Trade - Without trade, the economy's output of a good must equal its consumption. - International trade allows the mix of cloth and food consumed to differ from the mix produced. - The country cannot spend more than it earns:PC xDC +PF xDF =PC xQC +PF xQF • The economy as a whole gains from trade. - It imports an amount of food equal to the relative price of cloth times the amount of cloth exported: DF - QF = (PC / PF) x (QC - DC )- It is able to afford amounts of cloth and food that the country is not able to produce itself. - The budget constraint with trade lies above the production possibilities frontier

Standard Trade Model: How to Determine Relative Prices of Goods

Use relative demand and relative supply curves (x-axis: Q₁/Q₂, y-axis: P₁/P₂) - World supply of cloth relative to food at each relative price. - World demand for cloth relative to food at each relative price. - World quantities are the sum of quantities from the two countries in the world: (QC + QC*)/(QF + QF*) and (DC + DC*)/(DF + DF*)

Specific Factors Model: International Trade

W/out trade: the economy's output of a good must equal its consumption International trade allows the mix of cloth and food consumed to differ from the mix produced • The economy as a whole gains from trade. - It imports an amount of food equal to the relative price of cloth times the amount of cloth exported: DF - QF = (PC / PF) x (QC - DC ) - It is able to afford amounts of cloth and food that the country is not able to produce itself. - The budget constraint with trade lies above the production possibilities frontier • Trade benefits a country by expanding choices. - Possible to redistribute income so that everyone gains from trade. - Those who gain from trade could compensate those who lose and still be better off themselves. However, redistribution usually hard to implement.

Terms of Trade with Offshoring

When comparing to a no-trade situation to the equilibrium with offshoring, and assuming that the world relative price differs from the home country, there are always gains to offshoring Terms of trade improve for Home country when the relative price of the good that it imports abroad falls (relatively) Terms of trade decrease for Home when the relative good that it exports becomes more competitive around the world, and therefore the price falls (though there is still a gain from trade compared to a no-trade country)

Dynamic Increasing Returns

When costs fall with cumulative production over time rather than with the current rate of production

Specific Factor Model: When price of one good rises

When only PC rises, labor shifts from the food sector to the cloth sector and the output of cloth rises while that of food falls. The wage rate (w) does not rise as much as PC since cloth employment increases and thus the marginal product of labor in that sector falls. • Owners of capital are definitely better off. • Landowners are definitely worse off. • Workers: cannot say whether workers are better or worse off: - Depends on the relative importance of cloth and food in workers' consumption.

Specific Factor Model: What happens when one price changes?

When only PC rises, labor shifts from the food sector to the cloth sector and the output of cloth rises while that of food falls. The wage rate (w) does not rise as much as PC since cloth employment increases and thus the marginal product of labor in that sector falls. Causes movement along PPF (slope changes)

Import Tariffs

taxes levied on imports Tax on import → Pimport/Pexport ↓ domestically for consumers→ Likewise Pexport/Pimport ↑ domestically for consumers → Domestic producers receive a lower Pexport/Pimport, ∴ domestic producers will prefer to produce the imported good → relative supply of exported good ↓ Domestic consumers will pay a lower price for exported good and will ↑ consumption of exported good