Download Lecture20(Ch17)

What Determines a Country’s
Comparative Advantage?
• Exogenous factors are the most obvious
Climate (long growing season)
Natural Resources
(petroleum reserves)
But there are also endogenous
factors: education, skills,
capital,...
• Implies that comparative advantage can
change over time:
• electronic goods to pharmaceutical goods to
internet software to ….
Let’s take a closer look at how capital
(K) and labor (L)
affect comparative advantage
– Definitions:
•
•
•
•
capital abundant country: has high K/L
labor abundant country: has low K/L
capital intensive production: uses high K/L
labor intensive production: uses low K/L
• Capital abundant countries: comparative
advantage in capital intensive production
• Labor abundant countries: comparative
advantage in labor intensive production
Factor Price Equalization
• Factor prices:
– wage rate for labor
– rental rate for capital
• Factor price equalization: even if factors are
not mobile, factor prices will tend to
equalize with trade
What causes factor price equalization?
• suppose U.S. has high K/L
• suppose Mexico has low K/L
• then opening up trade will shift
– U.S. production toward capital intensive goods
• thus demand for capital rises in U.S
– M. production toward labor intensive goods
• thus demand for labor rises in Mexico
• U.S. wages fall and Mexican wages rise
– that is a move toward factor price equalization
– assumes ceteris paribus, productivity would rise
Gains from Expanded Markets
• Theory combines two features of production
– economies of scale (declining ATC over the
relevant range of production)
– product differentiation: leads to monopolistic
competition
• Focuses on intraindustry trade (same
industry)
– comparative advantage focuses on
interindustry trade (different industries)
17_03
Getting a sense of the gains from
expanded markets
United States
Germany
Production: 1,000 MRI units
Cost: $300,000 per unit
Production: 1,000 MRI units
Cost: $300,000 per unit
No Trade
Production: 1,000 ultrasound units
Cost: $200,000 per unit
Production: 1,000 ultrasound units
Cost: $200,000 per unit
United States
Germany
U.S. exports
1,000 MRI
units to
Germany.
Production: 2,000 MRI units
Cost: $150,000 per unit
Germany
exports
1,000 ultrasound units
to U.S.
Production: 2,000 ultrasound units
Cost: $150,000 per unit
Now let’s develop a model to show
the gains from expanded markets
• First derive a relationship between
– the number of firms,
– the size of the market
– costs per unit (ATC)
• Second, derive a relationship between the
number of firms and the price
• Third, combine the two relationships
17_04D
Smaller Market
DOLLARS
35
Larger Market
DOLLARS
35
30
30
25
25
20
20
15
15
10
Cost per unit 10
5
5
0
1 of 4
QUANTITY
Cost per unit
0
1 of 4
QUANTITY
17_04C
Smaller Market
DOLLARS
35
Larger Market
DOLLARS
35
30
30
25
25
20
20
15
15
10
Cost per unit 10
5
5
0
1 of 4 1 of 3
QUANTITY
Cost per unit
0
1 of 4 1 of 3
QUANTITY
17_04B
Smaller Market
Larger Market
DOLLARS
35
DOLLARS
35
30
30
25
25
20
20
15
15
10
Cost per unit 10
5
5
0
1 of 4 1 of 3 1 of 2
QUANTITY
Cost per unit
0
1 of 4 1 of 3
1 of 2
QUANTITY
17_04A
Smaller Market
D OLLARS
35
Larger Market
Number Cost
of
per
firms
unit
($)
30
25
1
2
3
4
20
15
10
D OLLARS
35
10
20
25
30
Cost per unit
5
Number Cost
of
per
firms
unit
($)
30
25
15
1
2
3
4
10
Cost per unit
20
5
15
20
25
5
1 of 1
0
1 of 4
1 of 3
1 of 2
1 of 1
Q UANTITY
0
1 of 4
1 of 3
1 of 2
Q UANTITY
Now, summarize the results using
a new curve
17_05
Cost per unit
with smaller
market
DOLLARS
50
45
Cost per unit
with larger
market
40
35
30
Curve shifts down
as market gets larger.
25
20
15
10
5
0
1
2
3
4
5
6
7
8
9
10
NUMBER OF FIRMS
IN THE MARKET
Recall results from monopolistic
competition model
• Product differentiation
• Firms face downward sloping demand curve
• With more firms in the industry, the demand
curve shifts
– and gets flatter (a point we did not emphasize
earlier), so the price falls
– sketch this by hand:
Now, summarize the result that
more firms lead to a lower price
in another new curve
17_06
DOLLARS
50
45
40
35
30
25
20
15
Price in
the market
10
5
0
1
2
3
4
5
6
7
8
9
10
NUMBER OF FIRMS
IN THE MARKET
Put the two new curves in the same
diagram; look at the long run equilibrium
17_07
DOLLARS
Cost per unit
50
The condition of long-run
equilibrium is where price
equals cost per unit.
45
40
35
Long-run
equilibrium
price
Cost per unit at each firm
increases as more firms enter
a market of a fixed size...
30
.... but the price each firm
will charge falls with the
number of firms.
25
20
15
Price (P) in
the market
10
Equilibrium
number of firms
5
0
1
2
3
4
5
6
7
8
9
10
NUMBER OF FIRMS
IN THE MARKET
Finally, open up the economy; curve
shifts showing effect of a larger market
17_08
DOLLARS
Cost per
unit with
smaller
market
50
Cost per unit at each
firm falls as market size
increases.
45
40
35
Cost per
unit with
larger
market
Reduction
in price
30
25
20
15
Price
10
Increase in number
of firms and variety
5
0
1
2
3
4
5
6
7
8
9
10
NUMBER OF FIRMS
IN THE MARKET
End of Lecture