TOOLS OF ANALYSIS FOR INTERNATIONAL TRADE MODELS
Topic 2.1
Questions
· Why does trade occur?
· What goods will a country export/import?
· What will be the volume of trade?
· What will be the prices at which trade occurs?
· What is the effect of trade on factors of production?
Methodology
· Models
· Abstraction from reality
· Positive and normative analysis
· General Equilibrium
· Abstract thinking
· Link real trade and international finance
The basic model
Agents are rational (maximizing)
Note:
Disagree with that text that ‘rationality’ is synonymous with ‘utility maximizing’
‘Predictably irrational ‘
‘Behavioral economics’
The human element matters
There are two countries in the world
This is standard, but a very restrictive assumption. Many elements of trade do not make sense except in a multi-country world.
Ideally, we will get to multi-country models.
In addition, there are only two goods in the world.
Some issues require more than two goods.
There is no money illusion
This is really an assumption about international finance models. In a ‘real trade’ model there isn’t any ‘money’
The essence of the assumption is that only relative prices matter.
The confusion between nominal and real prices is a non-issue in real trade models.
In each country endowments are fixed and the technologies available to each country are constant
This assumption generates a single production possibility frontier for each country
The PPF can have different shapes. A concave PPF represents increasing opportunity costs. A linear PPF represents constant opportunity costs.
Generally, concavity/convexity gives ‘nicer’ solutions to a model.
The concavity/convexity does not have to arise from the production side –it could arise from the consumption side of the model.
There is perfect competition and no externalities exist
These assumptions support an equilibrium solution where there is no divergence between private and social costs. Also there is no scope for strategy by firms in production or pricing.
Factors of production are perfectly mobile between industries within a country
This assumption allows returns to factors to be variable as they move between industries and their marginal product changes.
Reallocating factors of production allows a country to react to changes in demand for its two products.
Community preferences can be represented by a consistent set of community indifference curves
This basically says that we can represent preferences by one huge utility function (or one huge indifference curve) for the whole country. There is no heterogeneity in tastes. In effect, every individual is identical on the consumption.
