1. A Comparative Advantage Model in a Neoclassical World

2. A Two-Input Economy: A Neoclassical Model A production function with two inputs: capital and labor Capital and labor are imperfectly substitutable: an increasing cost production function Isoquants Isocosts How does each firm decides on the mix of inputs: the profit maximizing rule

3. A production function: Q = f (K, L); given K, as L increases Q will increase; given L, as K increases Q will increase Capital, K, and Labor, L, are to some extent substitutable Both K and L are subject to decreasing returns. Special cases: Fixed-proportions production functions Perfectly substitutable inputs

4. An Isoquant: a graphical representation of a production function Qx 0 Qx 1 K L 0 Qx = f (K, L)

5. The Isoquant: A Definition An isoquant is a curve drawn in a two-dimensional space representing all the combinations of two inputs (K and L), measured along the two axes, that can produce a given level of output. An isoquant map is a group of isoquants each representing a certain level of output for a given production function Isoquants farther from the origin represent higher levels of output Isoquants cannot cross

6. An Isoquant Map Qx 0 =10 Qx 1 K L 0 Qx = f (K, L) Qx 2 Qx 3 Qx 4 Qx 5 =100

7. The slope of an isoquant: the marginal rate of technical substitution (MRTS) Qx 0 K L 0 Qx = f (K, L) A B Slope = ΔK/ΔL = MRTS

8. Production Costs: Isocost Given Q = f ( K, L ) Cost = C = r K + w L where r = price of K; w= price of L K L o C/r C/w - w/r

9. Equilibrium Qx 0 =10 Qx 1 K L 0 Qx = f (K, L) C = rK + wL Qx 2 Qx 3 Qx 4 Qx 5 =100 a b c MRTS = w/r C/w C/r

10. Equilibrium Qx 0 =10 Qx 1 K L 0 Qx = f (K, L) C = rK + wL Qx 2 Qx 3 Qx 4 Qx 5 =100 a b c MRTS = w/r C/w C/r Expansion Path

11. A Two-Industry Economy K L o Computers Rugs (K/L)c (K/L) R W/r Kc KRKR LcLRLR

12. 0 0 K L K L X Y D

13. A production possibilities curve for an Economy with two imperfectly substitutable resources producing two goods: o Computers Rugs Uo U1U1 MRS = MRT

14. Two Countries C R R C oo UMUM UAUA Mexico U.S.

15. A two-Country Model C R R C oo p C’ P’ f c F’ Mexico U.S.

16. Can these two countries gain from trade? Y Y XX 0 0 Country A Country B Ua Ub

17. Two Countries C R R C oo UAUA UBUB Mexico U.S. Can these two countries gain from trade?