1. 1 Comparative advantage: A basic example Productivities Endowments (here, labor forces) WineDrape Portugal845 UK1220 Assumptions Two countries (Portugal and the UK) Two industries (wine and drape) One factor of production (labor), hence one type of agent in each country (workers) Constant returns to scale No transportation costs No government intervention Perfect competition

2. Portugal’s production-possibility frontier and the autarky (before-trade) equilibrium Wine Drape 40 20 Production possibility frontier (supply side) Consumption point without international trade Consumer preferences (demand side)

3. The UK’s production-possibility frontier and the autarky equilibrium Wine Drape 20 40 Production possibility frontier (supply side) Consumption point without international trade Indifference curve (demand curve))

4. The world’s production-possibility frontier and trading equilibrium Wine Drape 40 World production possibility frontier Consumption point with international trade Consumer preferences (common to all countries) United Kingdom Portugal world price ratio (demand-determined)

5. 5 The gains from exchange ProductionConsumption WineDrapeWineDrape Portugal40020 UK04020 Total40

6. 6 The gains from exchange revisited Indifference curves Wine Production Possibility Frontier Drape world price ratio

7. 7 The gains from specialization Indifference curves Wine Production Possibility Frontier Drape world price ratio Production point

8. 8 The Rybszinski theorem initial production possibility frontier steel production possibility frontier after an increase in the capital endowment production possibility frontier after an increase in the labor endowment drape

9. 9 The Heckscher-Ohlin theorem “trade triangle” steel drape (world & domestic) indifference curves domestic price ratio (before trade) domestic PPF world price ratio (drape is cheaper) home steel exports home drape imports

10. 10 The gains from trade (i): initial equilibrium D D* P P S S* PaPa P* a Country F (relatively inefficient) Country H (relatively efficient) Quantities

11. 11 P P* Country H PwPw ab cd P*aP*a PaPa Country F Equilibrium price Method 1: Equate segments ab and cd

12. 12 Home ES abcd ab = cd Foreign ED* ab cd PaPa Pa*Pa* Equilibrium price Method 2 a) Construct excess supply (ES) and excess demand (ED) curves ab = cd Export supply Import demand

13. 13 PwPw S D S* D* ES P* a E=M* ED* Equilibrium price, method 2 b) Match the home ES and foreign ED curves on single « world » market Pa*Pa* PaPa Country H (exporter) Country F (importer) « World » market Quantities

14. 14 A P (a) Importer country’s domestic market(b) same thing seen on world market World price C ED D G B H F J I K papa p* Gains from goods trade Importer country consumers’ gain, producers’ loss = neutral

15. 15 Gains from goods trade Exporter country A ES EFEF F D B papa p* C E G H I World price (a) Exporter country’s domestic market(b) same thing seen on world market producers’ gain, consumers’ loss = neutral

16. 16 Net increase in importer country’s welfare = CS gain – PS loss Who gains from trade Size and « similarity » ED ES Net increase in exporter country’s welfare = PS gain – CS loss ED ES ED ES SIZE SIMILARITY ED ES ED ES More « different » exporter gains more from trade Larger exporter gains less from trade

17. 17 Very similar to trade in G&S: Identical causes: differences in prices (factor rewards) Identical consequences: some gains, other loose, and there is a net potential gain. Gains from factors trade Starting point: autarky r K rara Return to capital Value of marginal product of capital Economy’s capital stock Return to other factors + = GDP (equal to GNP in autarky)

18. 18 Two countries, H relatively well endowed with capital. Initially, r H < r F, so capital has an incentive to migrate from H to F In equilibrium, the marginal products of capital are equalized. Gains from capital movements: EBC for H, EIB for F. rWrW rHrH rFrF E I B C A D G V H = pF K V F = p*F* K Gains from factors trade Capital flow from Home to Foreign Home capital stock (before outflow) Foreign capital stock (before inflow) Extension of foreign capital stock (because of inflow)

19. 19 V H =pF K V F =p*F* K Gains from factors trade GNP vs. GDP, efficiency gain GNPGNP* Home country’s GDP Foreign country’s GDP Efficiency gain from capital flow

20. 20 Openness and size Larger countries trade less (not so obvious) Trade share in GDP GDP at purchasing power parity Not very open given their size (should trade more)

21. 21 “Fob”: free-on-board; “cif”: cum insurance and freight. Transport cost per unit:  P cif = P fob +  = P a +  Condition for trade to take place: P a +   P a * If condition violated, good is said to be non-traded Transportation costs ES cif ED* P* a P w cif PaPa ES fob P w fob Less trade 