TOOLS OF ANALYSIS FOR INTERNATIONAL TRADE MODELS
topic 2.4
Can we devise a better measure of national welfare than community indifference curves? Ideally we would like to create a GDP measure. Then we can answer question like ‘does trade make a country better off?’
formula for GDP
GDP = Ps S + Pt T
GDP/Pt = (Ps / Pt) . S + T
converts our GDP measure into units of T
Figure 2.7 shows how this equation allows us to convert a production point into a measure of real GDP.
We are going to convert everything into ‘T’ units.
What about tastes? Don’t they matter?
They do matter, and they enter in via the market prices Ps, Pt.
For example, it consumers hade a low preference (on the margin) for good S, then Ps would be low relative to Pt, and the line in figure 2.7 would be flat. Then GDP would increase little in response to greater S production, but it would increase a great deal is T production increased.
We are using T as the ‘numeraire’ good.
The concept of standard of living uses the measure per capita GDP.
An alternative but equivalent approach to national welfare is to use national demand and supply curves.
We will derive these curves from PPFs and CICs.
Figure 2.8 shows how to derive the curves.
Recall that a demand curve is a representation of a function.
‘call out’ a => quantity
market price demanded
Likewise, for supply
‘call out’ a => quantity
market price supplied
So be rotating the line representing different relative prices we can generate demand and supply quantities.
Ps / Pt = ($ /units of S) / ($ /units of T)
Cancel out the $
Ps / Pt = units of T / units of S
The vertical axis is the ‘price’ of S in terms of the numeraire T
Rotating the price line about the PPF generates the supply curve.
As we rotate Ps / Pt about the PPF we find the point of tangency with a CIC. This generates a demand curve.
The position of the PPF ‘anchors’ the consumers so they are only allowed to consume quantities consistent with what they can produce this period. There is no borrowing from the future in this model.
Nwo introduce a second country, country ‘B.’
Figure 2.10 shows the two demand and supply curve diagrams, each one representing the situation in autarky.
If we allow trade between the countries we expect that the new global market price Ps / Pt will be intermediate between the autarky prices.
Because country A has the lower autarky price of S it has the comparative advantage in S. Trade will start out with consumers in country B importing S, and country B producers will export T. Trade will begin by following the pattern of comparative advantage.
Comparative advantage can only be assessed by looking at the countries’ relative autarky positions. But in the real would we don’t observe the autarky state. This is a great challenge for testing trade theories based on comparative advantage.
