Professional Documents
Culture Documents
MIT14 581S13 Classnotes1 PDF
MIT14 581S13 Classnotes1 PDF
581 International
Class notes on 2/6/2013
Trade 1
1 The notes are based on lecture slides with inclusion of important insights emphasized
1
2 Standard Assumptions of Neoclassical Trade
Neoclassic trade models are characterized by three key assumptions:
1. Perfect competition
2. Constant returns to scale (CRS)
3. No distortions
Note that we could allow for decreasing returns to scale (DRS) by introducing
hidden factors in xed supply. Increasing returns to scale (IRS) is a much
more severe issue addressed by "New" trade theory. (Krugman, 1979, 1980)
yn (y1n ; :::; yG
n
) Output vector in country n
cnh (cnh nh
1 ; :::; cG ) Consumption vector of household h in country n
pn (pn1 ; :::; pnG ) Good price vector in country n
2
Revenue function summarizes all relevant properties of technology
Under perfect competition, y n maximizes the value of output in country
n:
rn (pn ; v n ) = pn y n (1)
The expenditure function
We denote by unh the utility function of household h in country n
Expenditure function for household h in country n is dened as
enh (p; u) = min pcjunh (c) u
c
3
Pa
Figure 1: Fig 1
4
(full exibility) and then consider less informationally intensive instruments.
We now reintroduce the index h explicitly and denote by:
uah and uh the utility levels of household h under autarky and free trade
h h
the lump-sum transfer from the government to household h ( 0,
lump-sum tax and h 0 , lump-sum subsidy)
The intuition here is that, after opening up trade, household should still be
able to purchase the same consumption vector in autarky. Budget constraint
under autarky implies pa cah wa v h . Therefore
pcah wv h + h
Thus cah is still in the budget set of household h under free trade
Step 2: By denition, governments revenue is given by
P h P P
= (pa p) cah (wa w) v h : denition of h
= (pa p) y a (wa w)v : mc autarky
= py a + wv : zp autarky
r (p; v) + wv : denition r (p; v)
= (py wv) = 0 : eq. (1) + zp free trade
Comments:
5
3.1.3 Multiple households per country (II): commodity and factor
taxation
With this last comment in mind, we now restrict the set of instruments to
commodity and factor taxes/subsidies. More specically, suppose that the gov-
ernment can aect the prices faced by all households under free trade by setting
good
and factor
phousehold = p+ go o d
whousehold = w+ factor
6
Why? If two countries have the same autarky prices, then after opening
up to trade, the autarky prices remain equilibrium prices. So there will be no
trade....
The law of comparative advantage (in words):
Countries tend to export goods in which they have a CA, i.e. lower relative
autarky prices compPared to other countries
P nh
Let tn y1n cnh ; :::; yG
n
c denote net exports in country n
Let uan and un denote the utility level of the representative household in
country n under autarky and free trade
Let pan denote the vector of autarky prices in country n
Without loss of generality, normalize prices such that:
P P
pg = pang = 1,
Notations:
cov (x; y)
cor (x; y) p =
var (x) var (y)
Pn
cov (x; y) = i=1 (xi x) (yi y)
1 Pn
x = xi
n i=1
Proposition 4 In a neoclassical trade model, if there is a representative
household in country n, then cor (p pa ; tn ) 0
Proof: Since (y n ; v n ) 2 n , the denition of r implies
pa y n r (pa ; v n )
pa cn e (pa ; un )
ptn = 0
7
Hence
(p pa ) tn 0
By denition,
P n
cov (p pa ; t n ) = g pg pag p + pa tgn t ,
cov (p pa ; tn ) = (p p a ) tn 0
Comments:
With 2 goods, each country exports the good in which it has a CA, but
with more goods, this is just a correlation
Core of the proof is the observation that pa tn 0
It directly derives from the fact that there are gains from trade. Since free
trade is better than autarky, the vector of consumptions must be at most
barely attainable under autarky (pa y n pa cn )
For empirical purposes, problem is that we rarely observe autarky...
In future lectures, we will look at models which relate pa to (observable)
primitives of the model: technology and factor endowments
8
MIT OpenCourseWare
http://ocw.mit.edu
For information about citing these materials or our Terms of Use, visit: http://ocw.mit.edu/terms.