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Class Outline

Increasing Marginal Costs. Modern theories of International Trade assume Increasing Marginal Costs:As one industry expands at the expense of others, increasing amounts of the other products must be given up to get each extra unit of the expanding industry's product.PPC curves looks

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Class Outline

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    1. Class Outline Increasing Marginal Costs PPC with Increasing Marginal Costs Community Indifference Curves Production and Consumption Together No Trade Free Trade The Gains from Trade The Heckscher-Ohlin (H-O) Theory (Introduction)

    2. Increasing Marginal Costs Modern theories of International Trade assume Increasing Marginal Costs: As one industry expands at the expense of others, increasing amounts of the other products must be given up to get each extra unit of the expanding industry’s product. PPC curves looks “bowed out”

    3. PPC with Increasing Costs

    4. Increasing Cost Marginal Cost of producing Cloth 20 billion yards?extra yard=1 bushel of Wheat 40 billion yards?extra yard=2 bushels of Wheat 60 billion yards?extra yard=3 bushels of Wheat Marginal Cost of producing Wheat 0 billion bushels?extra bushel=1/3 yard of Cloth 50 billion bushels?extra bushel=1/2 yard of Cloth 80 billion bushels?extra bushel=1 yard of Cloth

    5. What’s Behind the PPC? Several kinds of factor inputs (land, skilled labor, unskilled labor, capital) Different products use factor inputs in different proportions Example: Wheat uses relatively more land and less labor than cloth. This basic variation in input proportion can set up an increasing cost production possibility curve.

    6. Community Indifference Curves We need to describe the demand side of the economy Individuals receive well-being from the consumption of goods and services In order to measure the level of well being economists use Indifference Curves

    7. Indifference Curve Indifference curve shows the various combinations of consumption quantities (wheat and cloth) that lead to the same level of well-being of happiness.

    9. Consumer Budget Constraint

    10. Budget Constraint

    11. Indifference Curve

    12. Problems of Indifference Curves First: Shapes of Indifference curves vary from individual to individual Second: the concept of national well-being or welfare is not well defined. Levels of satisfaction are difficult to compare between individuals

    13. Production and Consumption

    14. Production and Consumption

    15. Gains from Trade First: Both countries consume more than during no-trade (C1 compared with S0) Second: Both communities can reach a higher community indifference curve (I2 compared with I1) Third: how much is the gain of trade depends on the relative international prices. Higher price for exports relative to imports International term of trade (Price of Exports/Price of Imports)

    16. Heckscher-Ohlin (H-O) Theory The Heckscher-Ohlin theory predicts that a country exports the product(s) that use its abundant factor(s) intensively and imports the product(s) using its scarce factor(s) intensively.

    17. A country is relatively labor-abundant if it has a higher ratio of labor to other factors than does the rest of the world A product is relatively labor-intensive if labor costs are a greater share of its value than they are of the value of other products Heckscher-Ohlin (H-O) Theory

    18. In our example, the H-O theory predicts that the U.S. exports wheat and imports cloth because wheat is land-intensive and cloth is labor intensive and Heckscher-Ohlin (H-O) Theory

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