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1、2. Free Trade and Protection,Summary,Theory of Comparative Advantage: Why trade is good. Where comparative advantage comes from: Heckscher-Ohlin Model (factor endowments) Equalization of factor income Welfare Effects of a Tariff : Consumers Lose Govt gains Local producers gain Arguments for protecti
2、on: Optimal tariff Infant industry Employment,Ricardos Theory of Comparative Advantage,Suppose: Country A and Country B. Equally sized. Country A is better at producing both wine and wheat than B.,Ricardos Theory of Comparative Advantage,Suppose: Country A and Country B. Equally sized. Country A is
3、better at producing both wine and wheat than B. Even then, both countries can benefit from trade.,Ricardos Theory of Comparative Advantage,Suppose: Country A and Country B. Equally sized. Country A is better at producing both wine and wheat than B. Even then, both countries can benefit from trade. K
4、ey is relative advantage.,Ricardos Theory of Comparative Advantage,Suppose: Country A and Country B. Equally sized. Country A is better at producing both wine and wheat than B. Even then, both countries can benefit from trade. Key is relative advantage. For example, assume A is relatively better at
5、wheat production than wine.,Before trade: Country A,Before trade A produces a=wine and 120-2a=wheat.,a,120-2a,Before trade B,Before trade B produces b=wine and 15-(b/4)=bread. Total world production is (a + b wine, 135 - 2a - 0.25b wheat).,b,15-(b/4),Now let trade occur,Let B produce 1 more unit of
6、wine (its comparative advantage) and therefore 0.25 less units of wheat.,Now let trade occur,Let B produce 1 more unit of wine (its comparative advantage) and therefore 0.25 less units of wheat. At the same time the A produces one less unit of wine and two more unit of wheat (its comparative advanta
7、ge).,Now let trade occur,Let B produce 1 more unit of wine (its comparative advantage) and therefore 0.25 less units of wheat. At the same time the A produces one less unit of wine and two more unit of wheat (its comparative advantage). Total wine production has not changed, but total wheat output h
8、as increased by 1.75 units!,Now let trade occur,Let B produce 1 more unit of wine (its comparative advantage) and therefore 0.25 less units of wheat. At the same time the A produces one less unit of wine and two more unit of wheat (its comparative advantage). Total wine production has not changed, b
9、ut total wheat output has increased by 1.75 units! Everyone is better off.,Theory of Comparative Advantage,What are the prices? A was prepared to swap 1 unit of wine for 2 wheat so: Price of WheatA = 1/2 X (Price of Wine)A,Theory of Comparative Advantage,What are the prices? A was prepared to swap 1
10、 unit of wine for 2 wheat so: Price of WheatA = 1/2 X (Price of Wine)A B (Supplies Wine) was prepared to swap 1 unit of wine for of wheat so: Price of WheatB = 4 X (Price of Wine)B,Theory of Comparative Advantage,What are the prices? A was prepared to swap 1 unit of wine for 2 wheat so: Price of Whe
11、atA = 1/2 X (Price of Wine)A B (Supplies Wine) was prepared to swap 1 unit of wine for of wheat so: Price of WheatB = 4 X (Price of Wine)B As long as X (World Price of Wine) World Price of Wheat 4 X (World Price of Wine),Some Pictures: Country A Production Possibilities,Wine,Wheat,A Autarky,A,Some P
12、ictures: Country A Production Possibilities,Wine,Wheat,A Autarky,Prices in A,A,Country Bs Production Possibilities,Wine,Wheat,B Autarky,B,Country Bs Production Possibilities,Wine,Wheat,B Autarky,B,Prices in B,Who has higher prices?,Wine,Wheat,A Autarky,B Autarky,A,B,Trade raises the price of wheat i
13、n B and raises the price of wine in A,Wine,Wheat,A,B,Trade raises the price of wheat in B and raise the price of wine in A,Wine,Wheat,A Autarky,A,B,Trade raises the price of wheat in B and raises price of wine in A,Wine,Wheat,A,B,Same Prices = lines are parallel,At the new prices B is better off,Win
14、e,Wheat,B,It produces more wheat,Wine,Wheat,It produces more wheat and consumes more wine,Wine,Wheat,Export Wheat,It produces more wheat and consumes more wine,Wine,Wheat,Export Wheat,Import Wine,2. Sources of Comparative Advantage,1) Preferences: Even if we were completely identical but just liked
15、different things trade would be a good idea. Example Country A has 100 units lamb and 100 units pork Country B has 100 units lamb and 100 units pork One really likes Kebabs the other really likes Sausages!,2. Sources of Comparative Advantage:,2) Factor endowments Set Up: 2 Countries (A,B) 2 Goods (W
16、heat, Wine) 2 Inputs (labour, capital) Assumption: Capital and Labour can move between industries within their own country but not across countries.,Technologies,Both countries have identical technologies at their disposal these have constant returns to scale. Wheat production requires a lot of capi
17、tal and B has a lot of capital. Wine production requires a lot of labour and A has a lot of labour.,Wine,Wheat,A Autarky,B Autarky,A,B,Trade occurs to move immobile inputs around,Country A is rich in labour and exports the good that requires a lot of labour. Hence Before trade the price of labour in
18、 A will be low relative to the price of capital.,Trade occurs to move immobile inputs around,Country B is rich in capital and export the good that is rich in capital. Before trade the price of capital in B will be low relative to the price of labour. They cant move the factors but they can move good
19、s.,Consequence=Factor Price Equalization,As a result of trade the prices of labour and capital in each country will tend to be the same.,Income Distribution and Growth,An increase in the price of wine (labour intensive) will increase the wages (relative to the price of wine and wheat) It will also d
20、ecrease the reward to capital (relative to the prices of wine and wheat).,3. Protection,Instruments of Public Policy: Tariff (Taxes) Quotas (quantity restrictions) Non-tariff barriers (Product standards, voluntary restraints etc.),Effect of Tariff on Value,We will assume the country is small relativ
21、e to the rest of the world. If there was no trade the domestic supply and demand would look like:,Domestic Equilibrium Price and Quantity (No trade),Domestic Supply,Domestic Demand,Quantity,Price,Once Imports are allowed there is infinite supply at the world price.,Domestic Supply,Domestic Demand,Qu
22、antity,Price,World Supply,Efficient domestic producers continue to produce.,Domestic Supply,Domestic Demand,Quantity,Price,World Supply,Supply From Local Firms,But there is an increase in supply from importers.,Domestic Supply,Domestic Demand,Quantity,Price,World Supply,Supply From Local Firms,Suppl
23、y From Importers,Consumers value with trade:,Domestic Supply,Domestic Demand,Quantity,Price,World Supply,Local Producers value:,Domestic Supply,Domestic Demand,Quantity,Price,World Supply,The Government Imposes a Tax/Tariff,We could describe this as a shift in the demand function. Or We could think
24、of this as an increase in the price of imports,Before Tariff,Domestic Supply,Domestic Demand,Quantity,Price,World Supply,After Tariff,Domestic Supply,Domestic Demand,Quantity,Price,World Supply,World Supply with Tariff,Who gains who loses?,Domestic Supply,Domestic Demand,Quantity,Price,World Supply,
25、Tariff,Consumers lose this,Domestic Supply,Domestic Demand,Quantity,Price,World Supply,Tariff,Producers gain this,Domestic Supply,Domestic Demand,Quantity,Price,World Supply,Tariff,Government gains this much tax,Domestic Supply,Domestic Demand,Quantity,Price,World Supply,Tariff,Net the country loses
26、,Domestic Supply,Domestic Demand,Quantity,Price,World Supply,Tariff,What Justification is there for Protection,The above shows that if your country is small you always lose form protection. If your country is large this may not be so. (2) Infant Industries: Government is necessary to protect industr
27、ies until they are grown up enough to face international competitors. (3) Revenue. (4) Employment.,Infant Industries,Need LR profits in country to exceed SR costs of subsidization. This implies industry itself should be willing to undergo the SR costs (contradiction) Unless there is a market failure
28、 that stops such projects being undertaken,Examples of Market Failure,Failure in human capital: (skills, education, health) Information: (Government has better knowledge?) Capital market failure (hard for firms to get loans),Employment Argument,The above assumes the labour market is in equilibrium (i.e. full employment). If this is not so, then the opportunity cost of labour being used in the exporting industries is less than the equilibrium wage = may increase welfare.,