CDAE 272 International Economic Development Spring 2008

Class 14 Feb. 28 Last class 4. International trade theories Quiz 4 Today: Result of Quiz 4 4. International trade theories Review for the midterm exam Next class (Thursday, March 6): Midterm exam, 10:55am – 12:20pm Reading: Chapter 4: International trade theories Important date: Midterm exam, Thursday, March 6

Result of Quiz 4 N = 37 Range = 6 – 10Average = Name three government interventions in a market. 2. A ceiling price below the equilibrium price hurts all producers 3. A floor price above the equilibrium price hurts all consumers 4. A price subsidy increases CS, PS and (CS+PS) but decreases the total welfare (CS+PS-Sub. Cost) 5. A sales tax decreases both CS and PS, increase tax revenue, and decreases the total welfare (CS+PS+Tax Rev.) 6. Supply and demand (a) Graph the supply and demand functions (b) P* =Q* = (c) PS = 9 when a ceiling price of $4 is imposed

Take-home exercise (Thursday, Feb. 21) Suppose a market has the following supply and demand functions Demand: Q d = P Supply: Qs = P (a) What are the equilibrium quantity (Q*) & price (P*)? (b) What are the CS and PS at the equilibrium? (c) If a price subsidy of $0.8 per unit is imposed, what will be the changes in CS, PS and total welfare (CS + PS - sub. cost)?

4. International trade theories 4.1. Simple examples: two-person cases 4.2. Absolute and comparative advantages 4.3. Trade between two countries 4.4. The sources of comparative advantage 4.5. Other explanations for international trade 4.6. Trade between two nations 4.7. Measurement of the gains from trade 4.8. Exchange rate and its determination

4.2. Absolute and comparative advantages: Theory of comparative advantage -- Absolute advantage is neither the “necessary” nor “sufficient” condition for trade -- Comparative advantage is the “necessary” and “sufficient” conditions for trade. -- Two-person examples in Section 4.1

4.2. Absolute and comparative advantages: David Ricardo ( ): -- A businessman, economist, policymaker, and one of the fathers of modern economics -- Major publication: Principles of Political Economy and Taxation, Major contribution: theory of comparative advantage -- History: -- In the early 19 th century, British Parliament was controlled by landlords  “Corn Laws” limit grain imports and help exports  high price -- Industrial Revolution  needs to reduce grain prices -- Corn Laws were replaced in 1848 (25 yrs after Ricardo’s death)

4.3. Trade between two countries Wheat and cotton production in Australia and New Zealand (Table 16.2 on p. 3-4) New ZealandAustralia Wheat 6 bu./acre 2 bu./acre Cotton 2 bales/acre6 bales/acre Absolute advantage Australia: Cotton production New Zealand: Wheat production Production with no trade ( Table 16.3 in reading ) -- How to interpret Figure 16.1? -- Production possibility frontier (PPF)

4.3. Trade between two countries Gains from specialization and trade ( Table 16.4 ) When both countries have absolute advantages, specialization and trade can benefit both nations A strong assumption here: 1 bushel of wheat can be exchanged for 1 bale of cotton How to interpret Figure 16.2?

4.3. Trade between two countries Suppose the wheat and cotton productivity in Australia and New Zealand has changed to: New ZealandAustralia Wheat 6 bu./acre 1 bu./acre Cotton 6 bales/acre3 bales/acre New Zealand has the absolute advantage in both wheat and cotton production (Australia does not have any absolute advantage) but Australia has the comparative advantage in cotton production (what comparative advantage does New Zealand have?) Production with no trade (Table 16.6)

4.3. Trade between two countries Gains from specialization and trade ( Table 16.7 ) Although Australia does not any absolute advantage, specialization and trade can benefit both nations because both nations have comparative advantages Data on production costs: Country ACountry B Wheat $3/bu.$2/bu. Cotton $6/bale$8/bale Country A has an absolute advantage in __ production and a comparative advantage in __ production. Country B has an absolute advantage in __ production and a comparative advantage in __ production.

Class exercise (Thursday, Feb. 28) Data on production costs: Country C Country D Wheat $3/bu.$2/bu. Cotton $6/bale$5/bale Which country has the absolute advantage in wheat production? Which country has the absolute advantage in cotton production? Which country has the comparative advantage in wheat production? Which country has the comparative advantage in cotton production? Can specialization and trade benefit both countries? If yes, which country is likely to export wheat?

Midterm exam 1. What will be covered in the exam? 2. What will be the format? 3. What are the study materials and practice problems? 4. What do you need to bring to the exam? 5. Suggestions

Midterm exam 1. What will be covered in the exam? -- Chapters 1, 2, 3 and part of Chapter 4 -- Approximate distribution: Chapter % Chapter % Chapter % Chapter 4 ( ) %

Midterm exam 2. What will be the format? -- Multiple-choice questions (about points) (e.g., impacts of a price subsidy) -- Short-answer questions (about points) (e.g., what does PPP mean) -- Problems (about points) (e.g., calculate GNP, GDP, PS and CS) -- Graphical analysis (about points) (e.g., draw a graph and explain the impacts of a floor price)

Midterm exam 3. What are the study materials and practice problems? Quiz 1 to Quiz 4 Class exercises Take-home exercises Class examples Lecture notes (class class 14) Problem sets 1 and 2 (pick up your problem set 2 Monday, March 3) Reading for chapters 1, 2, 3 and 4

Midterm exam 4. What do you need to bring to the exam? -- Your calculator -- A ruler will be helpful -- No formula sheet is needed

Midterm exam 5. Suggestions a. Go over each quiz and make sure you understand and know how to answer each question in each quiz b. Go over each class exercise and take-home exercise and make sure you understand and know how to answer every question c. Go over the lecture notes, especially for the classes you missed d. Go over your problem sets and Chapters 1-4 readings e. Study hard and feel confident!