Lecture 1: Introduction



International EconomicsExam notes and practice answers TOC \o "1-1" Lecture 1: Introduction PAGEREF _Toc182889502 \h 2Lecture 2: Gains from trade PAGEREF _Toc182889503 \h 2Lecture 3: Specific Factors Model and Rybcyznski’s Theorem PAGEREF _Toc182889504 \h 8Lecture 4: Trade Equilibrium PAGEREF _Toc182889505 \h 13Lecture 5: Trade Policy PAGEREF _Toc182889506 \h 15Lecture 6: Environmental economics PAGEREF _Toc182889507 \h 20Lecture 9: Immigration PAGEREF _Toc182889508 \h 25Lecture 11: developmental economics PAGEREF _Toc182889509 \h 27Lecture 1: IntroductionIntroductory lecture not examinedLecture 2: Gains from tradeThis topic will analyze 2 modelsRicardo’s model (comparative advantage in labor productivity)Specific Factors model (comparative advantage based on different resource endowments)Definitions:Comparative advantageBeing able to produce a good with the lowest opportunity costOpportunity costThe value of the next-best alternative foregoneAbsolute advantageThe ability to produce with the least cost – in terms of resources usedRicardo’s model – not in examBasics of the model/assumptionsOnly two countriesOnly input is labourThe only difference between the countries is their relative productivity in producing different goodsThis allows for an analysis of comparative advantage, via the opportunity cost of production for each country.The PPF and Indifference curves The ability to produce is described by the Production Possibility Frontier (the PPF) (see REF _Ref182296930 \h Figure 1 Production Possibility Frontiers, below)This shows how much of each product is able to be produced by a countryAt production point “C”, on the graph, Y1 units of guns and X1 units of butter are producibleAt production point “A” on the graph, Y2 units of guns and X2 units of butter are producible. Figure 1 Production Possibility FrontiersThe preference towards consumption are described by indifference curves, (see REF _Ref182296961 \h Figure 2 Indifference Curves, below)At any point on these curves, the consumers are equally happyThe further away from the origin the indifference curves, the happier the consumers.At consumption points A, B and C, consumers are equally happyHowever, at curve 3, they are happier than at curve 1, since they can consume moreFigure 2 Indifference CurvesCobb-Douglas production functionThe Cobb-Douglas production function, simply, is as followsThe marginal product of labour (MPL) is the increase in output from a one unit increase in labour (with capital fixed) the marginal product of labour is the change in output divided by the change in labourThe marginal product of capital (MPK) is the increase in output from a one unit increase in capitalthe marginal product of capital is the change in output divided by the change in capitalGraphing a Cobb-Douglas Production Function against Labour (see REF _Ref182297440 \h Figure 3 Cobb Douglas (y;L), below)Production is increasing, but at a decreasing ratei.e. there is a decreasing but positive marginal product of labourNote, a Cobb Douglas function for capital looks identicalFigure 3 Cobb Douglas (y;L)Constant returns to scaleIf you double inputs, outputs double A Cobb Douglas function necessarily has constant returns to scaleMarginal productsThus, Marginal Product of Capital (MPK) is inversely related to the Capital Labour Ration (K/L)The Marginal Product of Labour (MPL) is directly related to (K/L)The PPF, Indifference Curves, and TradeProduction Possibility Frontiers – Production BiasFigure 4 Production BiasOn this PPF, Country A has a production bias towards food, and Country B has a production bias towards clothingi.e. Country A has a lower opportunity cost for producing foodConsumption preferenceJust as production may be biased, consumption may be as wellFigure 5 Consumption BiasIn this diagram, Country A has a consumption bias towards Clothing (less units of clothing would satisfy the same as more units of foodConsidering an economy with a Food production bias and a Clothing consumption biasWithout TradeWithout trade, production and consumption must occur at the same point – a “kissing point”Figure 6 Kissing Point EquilibriumWith TradeTrade allows a separation of the PPF and the Indifference Curve: goods produced can be sold, to purchase the goods to be consumed: a budget line is createdFigure SEQ Figure \* ARABIC 7 Trade EquilibriumThis allows greater consumption, with the production at point A, sold, and with the money, consumption bought at point BGains from tradeThe distance between the two indifference curves represents the gains from tradeSummaryWithout trade, there is a lower, “kissing point equilibrium”Trade allows a different basket of goods to be consumed than producedSell excess food at PfQf and buy clothing at PcQcCreates a budget lineTrade, if not required, won’t occur, thus, trade is an unrestricted optimum, whereas no trade restricts the optimum, necessarily less than or equal to the unrestricted one.Lecture 3: Specific Factors Model and Rybcyznski’s TheoremCreating the PPF via the Specific Factors ModelFigure 8 SFM1 - Labor is interchangeableLabor is interchangeable between the two industries (Food and Manufactures) – i.e. one unit of labor leaves manufactures, one unit of labor enters food production.Figure 9 SFM2 - Production function for foodCreate a production function for food (labor (food); food production) with diminishing returns to labor (as per a Cobb-Douglas production function)Figure 10 SFM3 - Production function for manufacturesAnd the same for manufacturesAllows us to construct a production possibility frontier (A PPF – in Blue) by creating a 4 segment graph and plotting relevant points)Figure 11 SFM4 - The PPFTwo countries with different factor endowmentsTaking the example of England (blue) and France (red)They have the same labor forceFrance has double the land (therefore, a higher returns to land (land/labor ration))Figure 12 SFM5 - TradeThat France has more land gives it a PPF in which it has a comparative advantage over England in the production of food (less manufactures are wasted in the production of food)Thus, it is more efficient, between the two economies if England solely produces manufactures and France solely produces foodRybcyznski’s TheoremAt constant product prices, when you add to a specific factor, you increase the production of the good that relies on that factor, and decrease production of the other good in the SFMThis is because of the good which is more produced (i.e. the good with the increased factor) will provide more profit per unit of labor (because of an increased factor-labor ratio), therefore, the wages in that area will increase (to PfMPLf)Labor then shifts away from the other factor to the increased factorIncreasing production of the increased factor at the expense of the other factorFigure 13 Rybcynzki's TheoremAn increase in food technology increases the MPL of food shifting the PfMPLf curve upwards.Wages increase for labor in food production, Labor shifts (diff between two dotted lines) from Manufactures to FoodThus, the production of food increases because of increased labor and capital input, and the production of manufactures decreases because of equal capital and decreased laborProofFigure 14 Proof of Rybcyznski's theoremThe SFM model shows the proof: for a fixed price level (shown as the diagonal dashed lines) an increase in food tech (purple arrow) leads to a change in the PPF’s (it gets pushed out, blue to red), a decrease in manufactures and an increase in food production.Lecture 4: Trade EquilibriumStep 1 Define PPF’sIn this example, a mini US and Australia (same manufacturing output, US has higher food output)Figure 15 PPF'sStep 2: Autarky pricesDetermine the autarky prices for the smaller economyFigure SEQ Figure \* ARABIC 16 Autarky (AUS)Determine the autarky price for the other economyFigure SEQ Figure \* ARABIC 17 Autarky (US)Step 2: determine trade price [check]For trade, the prices must be the same (with the same “trade trianges”).You export what you are relatively better at producing (what is relatively cheaper in autarky (Stolper Samuelson)Thus, the price lines must be parallelFigure 18 TradeThus, Australia produces at A and consumes at BThe Uroduces at D and consumes at CThe US sells food to buy manufacturesAustralia sells manufactures to buy foodRelationships – The Hecksher Ohlin TheoremYou sell what you can produce relatively cheaply, buying what is relatively more expensiveThe Stolper Samuelson TheoremAn increase in the relative price of a good increases the real return to its specific factor and reduces the return to the other specific factor via marginal products and wages, as per Rybcyznski’sWelfare analysisWho receives more money and who has to pay more? (Oz rel prices of manufactures increases, food prices decrease: capitalists get more, poor pay more)Lecture 5: Trade PolicyBasic trade policy instruments:TariffSubsidyQuotaVoluntary export restraintsTradeFigure 19 without trade, supply and demand equilibrate domesticallyFigure 20 where the world price is lower than domestic price, goods are importedFigure 21 when the world price is above the domestic equilibrium, excess production is exportedTariffsTariffs are a government “fee” on imported items, which serves to raise the “world price” in the above diagramFigure 22 A tariff“a” is the cost of tariff (i.e. the increase in price)“d” is government revenue (calculated by “cost of the tariff” multiplied by the amount of goods imported)“b+c+d+e” is the consumer loss“c+e” is the deadweight loss“b” is the producer gainQuotasQuotas have the same effect as tariffs, but instead of increasing the price, they restrict the quantity of imports (“d”). But the government doesn’t make any money.Optimal TariffWhere a nation is a huge market, a tariff may dent a market so much (by reducing demand) that the world price decreases Terms of Trade are the ratio of export prices to import prices (an measure of, relatively, how many exports are required to fund imports)An increase in the terms of trade is an increase in welfare for the country, since they are able to purchase more imports for the same amount of exportsAn optimum tariff works by reducing the world prices enough that the terms of trade benefit outweighs the deadweight loss of the tariffThis works by creating a tariff where the world price falls as a result, and government revenue increasesThis is irrelevant to Australia which does not have the market share to influence the world markets to such an extentsExport subsidiesThese work to increase the competitiveness of domestic goods, so that they may be exported.Figure 23 An export subsidy“c+d+e” is the government cost of the subsidy“b+c+d” is the producer surplusConsumer loss is “b+c”“c+e” is deadweight lossVoluntary export restraintlike a quota, limits exportsLecture 6: Environmental economicsConcerns of environmentalistsPollution, environmental degradation, global warming etc. caused by:Population growth and industrialization Market failure via externalitiesThere is an argument as to whether pareto (economic) efficiency should take precedence over sustainabilityInternalizing externalitiesGlobal populationIncreasing wages have increased the opportunity cost of child bearing, reducing fertility (from 6 children per woman in 1800 to 2.5 in 2000) and causing a global aging populationThis is enforced by a doubling of life expectancy in the past 200 yearsIn 1950 there was a population explosion, but population growth is said to decrease by 2050Population growth is said to plateauGlobal warming0.8 degree temperature rise since the 1800’slarge increase in co2 stock since industrial revolutionSources of co2 emmissions:Land useEnergyAgricultureTransportIn 2100, worst projection is 5 degrees higher, best is 1.5 degrees (we are currently tracking worse than the worst projectionsEnvironmental economicsFigure 24 the difference between MDS and MDF is the externalityInternalizing externalitiesFigure 25 A tax increases the cost to the firm so that MDF=MDS at social optimumFigure 26 A subsidy reduces the MC of Abatement so that the firm outputs at the socially optimum levelFigure 27 A legal limit illegalizes output where pollution is greater than the legal limitPolicy issuesCostsDifficulty of determining the social optimumMultiple pollutersThe social optimum creates a target, which is the allowable output for the two firms in this modelFigure 28 with a "0" target, each firm produces nothingWith a current output of 20, and a target of 10 (a halving of pollution)Figure 29 A legal limit would force each firm to output no more than 5 unitsFigure 30 At this tax level, firm 1 outputs 1 unit, firm 2 outputs 4 units: the tax is too highFigure 31 At this tax level, firm 1 outputs 4, and 2 outputs 6, ideal output with no knowledge of internal costsTradable rights to pollute similarly equilibrate without knowledge of costs of each firmThrough trade: price equilibrates at unit outputs required, easier than taxLecture 9: ImmigrationAllocation of revenue to factors of production leaves 0 net income, therefore wages are equal to the MPL at the point of labour employment multiplied by wages divided by price, or Figure 32 An initial allocation of labourFigure 33 Equilibrium (with immigration)Figure 34 Welfare analysisFigure 35 Deadweight loss of no immigrationLecture 11: developmental economicsAid is complex, sometimes political (e.g. eastern Europe and Israel)Africa is still the hotspot of population on less than 1 dollar a dayAs well as under 5 year old mortality rateHIPC – highly indebted poor countries (centered on Africa)Three scourges of the developing worldCurrency riskCommodity riskDebt trapRose in the ‘70’s because of OPECDebt reliefIncreases value of debt via increasing chance of payback via “effort”Super-incentives tooReduce food subsidiesThough this might increase food pricesThe MathsKeyEffort is the chance of repayment, L is the original loan value, R is the “asked for” loan valueThe Creditor’s perspectiveThe valuation of a loan in this model takes into account the likeliness of repayment, in the form of “e”Thus, it is in the creditor’s interest to increase “e”The creditor can only do this by changing “”The creditor will end up halving “” to maximize “”The debtor’s perspectiveThe debtor can only change “”There is, in this model, an assumption that the debtor nation is only able to produce, at maximum effort , an output equal to L.Thus, the most the debtor nation is able to get is (L-R), multiplied by the “effort”, that is .Utility to the debtor = The debtor seeks to maximize Thus (to maximize) This is called the debtor reaction functionIf R=L, e=0If R-0, Simultaneously equateThus, the optimum “R” in this model is “L/2” ................
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