1. LECTURE 6: Gains from Trade in Neoclassical Theory
INTERNATIONAL TRADE
LECTURE 6:
Gains from Trade in Neoclassical Theory

2. Contents To illustrate the equilibrium point under autarky
To introduce the international trade and to see its influence to autarky economy
To research the minimum conditions for trade
To explain some important assumptions in the analysis

3. Introduction The effects of restrictions on international trade
Example: U.S. to non-NAFTA countries in 1999
Conclusion: sizable welfare losses in general can occur because of interferences with free trade
This chapter focus on participating the trade to avoid welfare cost
An updating of the Ricardian analysis
Loose some assumptions
Increasing opportunity cost
Factors more than labor
Explicit demand considerations

4. Autarky Equilibrium
Autarky: total absence of participation in international trade
Basic assumptions
Consumers seek to maximize satisfaction
Suppliers of factor services and firms seek to maximize their return from productive activity
There is mobility of factors within the country but not internationally (same factor return)
There are no transportation costs or policy barriers to trade (simple)
Perfect competition exists (simple)

5. Autarky Equilibrium
In autarky, production takes place on the PPF, and the equilibrium is at point E
Px/Py=MRT=MCx/MCy
Px/MCx = Py/MCy
Point A situation and B
具体位置取决于PPF和预算线切点，预算线位置取决于产品价格比。若位于A，则有Px/Py>MCx/MCy，即Px/MCx>Py/MCy，会增加X的生产。例如3/1>2/1。所以A移向E，反之亦然。

6. Autarky Equilibrium
Bring consumers into the picture and autarky equilibrium is at point E
Px/Py=MRS=MUx/MUy
Px/MUx = Py/MUy
CI1是社会无差异曲线。三线相切。全社会生产和消费相等，达到均衡，都是OX1和OY1。

7. Autarky Equilibrium Conclusion
In autarky equilibrium, the following condition should be satisfied
MRT = MCx/MCy = Px/Py = MUx/MUy = MRS
In autarky equilibrium, production of each good in a country must equal the consumption of that good (OX1 Vs OY1)
What happened when export or import exist?

8. Contents To illustrate the equilibrium point under autarky
MCx/MCy = Px/Py = MUx/MUy
production equal consumption
To introduce the international trade and to see its influence to autarky economy
To research the minimum conditions for trade
To explain some important assumptions in the analysis

9. Introduction of International Trade
The trade triangle
The opening of a country to international trade means exposing the country to a new set of relative prices
Result: the producers and consumers will adjust to them by reallocating their production and consumption patterns and thus lead to gains from trade
The ultimate source of gain from international trade is the difference in relative prices in autarky between countries

10. Introduction of International Trade
Prices in autarky is (Px/Py)1
International prices is (Px/Py)2
What does the difference mean?
The change of equilibrium point for producer
The change of equilibrium point for consumer
Note: C’ is beyond the PPF
国际比国内斜率大，陡峭，意味X国际市场较贵，即本国具有比较优势。原有均衡点E，向E‘移动

11. Introduction of International Trade
Trade triangle FC’E’
The base of this right triangle FE’ represents the exports of the country
The height or vertical side of the triangle FC’ represents the imports of the country
The hypotenuse C’E’ represents the trading line, and its slope indicates the world price ratio or terms of trade

12. Introduction of International Trade
The consumption and Production Gains from trade
The total gains from trade will be divided into two parts: the consumption gain and the production gain, or we say, the gains from exchange and the gains from specialization

13. Introduction of International Trade
Initial equilibrium point E
Consumption gain: When faced with trade price ratio, even without changes in production, E C
Production gain: with the new relative prices, there is an incentive to producers CC’
The total gains from trade is composed by CI1CI1’ and CI1’CI2
消费者利得：不改变生产模式；随后由于X产品的比较优势，增加X生产

14. Introduction of International Trade
Trade in the partner country
Assume a two-country world
Analysis for the partner is analogous to that employed for the home country while trade pattern is reversed

15. Introduction of International Trade
For partner, the international relative prices is less than autarky prices
Export? Import? Trade triangle?
对于伙伴国，相对价格线不是更加陡峭，而是更加平缓。意味着其Y产品具有比较优势

16. Introduction of International Trade
Note:
The partner country also gains from trade
The two trade triangle must be the same
Again, the ultimate source of gain from international trade is the difference in relative prices in autarky between countries
Concept Check P95

17. Contents
To illustrate the equilibrium point under autarky
To introduce the international trade and to see its influence to autarky economy
Both country gain and the source of gain from international trade is the difference in relative prices in autarky between countries
To research the minimum conditions for trade
To explain some important assumptions in the analysis

18. Minimum Conditions for Trade
Introduction
Relative price differences will present potential gains from trade
Two principal sources of relative price variation between two countries
Differences in supply conditions
Differences in demand conditions

19. Minimum Conditions for Trade
Trade between countries with identical PPFs
In the Classical Ricardian analysis, there is no incentive for trade because the pretrade price ratios in the two countries would be the same
In Neoclassical theory, two countries with identical production conditions can benefit from trade because of different demand conditions in the two countries and the presence of increasing opportunity costs

20. Minimum Conditions for Trade
Two countries have different autarky ratio
Country I good at produce X and Country II good at produce Y
The equilibrium point will stand between E and e
Both countries will attain higher indifference curves
Note: with constant opportunity cost PPF, relative prices in the two countries would not differ

21. Minimum Conditions for Trade
Trade between countries with identical demand conditions
Production conditions may differ because different technologies are employed with the same relative amounts of the two factors
Assume: country I is more efficient in producing good X and country II is more efficient in producing good Y
两国生产技术不同导致不同PPF。假定两国资源相对数量相同，1国技术能更有效生产X，2国Y

22. Minimum Conditions for Trade
Identical community indifference map and different PPF exist and thus different domestic price ratio
The equilibrium point will stand between E and e
Both countries will attain higher indifference curves

23. Minimum Conditions for Trade
Conclusion
Relative prices in autarky reflect underlying supply and demand conditions which include the relative amounts and quality of available resources, the characteristics of the production technologies employed, and the nature of demand in a country
The underlying basis for trade can change as technology changes, as factors grow within countries, as factors move between countries, and as individual country demand patterns change in response to economic development and the increased exposure to different products and cultures.

24. Some Important Assumptions
Costless factor mobility
Factors of production can shift readily and without cost along the PPF as relative prices change and trade opportunities present themselves
This is impossible in the ‘real world’ and the factors will not slide easily along the PPF but moves inside it—equipment, labor, etc.
Thus, some type of government assistance is required
分析现实世界情况时尤需注意

25. Some Important Assumptions
Full employment of factors of production
All of a country’s factors of production are fully employed
It means that the country is operating on the PPF
The real world does not always reach full employment
This assumption is to separate conceptually the problem of efficiency and welfare from that of idle capacity

26. Some Important Assumptions
The indifference curve map can show welfare changes
We know that when income distribution changed, the community indifference curves may intersect
Assumptions used here is to construct nonintersecting community indifference curves
Individuals within the economy have reasonably similar tastes
The opening of the economy to trade does not radically alter the distribution of income
Much moreCompensation principle: potential gains from trade exist in the sense that, within the country, the people who gain from trade can compensate the losers and still be better off
Thus, trade would still be preferred to autarky
Concept check on P101

27. Summary To illustrate the equilibrium point under autarky
To introduce the international trade and to see its influence to autarky economy
To research the minimum conditions for trade
To explain some important assumptions in the analysis