Econ 441 Notes

Course Outline
Note: When an assignment is DUE, it means turned in to Canvas by 6 pm EST on that date.
1. 1/19: Introduction to the course

-
a. Why do countries trade?

b. Globalization: trade, ideas, culture, immigration
c. Distributional consequences of trade
d. The Great Divergence
e. Paths to development
f. Trade wars
g. ASSIGNED: Problem Set #1
2. 1/21: Constrained maximization/consumer choice
€
a. How to maximize a function subject to constraints
b. Maximize utility subject to budget constraint
3. 1/26: Trading in an exchange economy
a. How to find the equilibrium price vector of a competitive exchange economy
4. 1/28: Intro to the Ricardian model and comparative advantage
a. How comparative advantage determines the pattern of trade
5. 2/2: Full GE solution to Ricardian model
a. Find equilibrium price, production, consumption of Ricardian model
b. DUE: Problem Set #1
=
c. ASSIGNED: Problem Set #2
d. ASSIGNED: Group Response #1 (Krugman 1997)
6. 2/4: Full GE solution to Ricardian model
a. Examples and interpretation of Ricardian Model
7. 2/9: Evidence on Ricardo and Comparative Advantage
÷
a. READING: Bernhofen and Brown (2004), Journal of Political Economy
b. Exam #1 material up to here
8. 2/11: Ricardo with Immobile Labor
a. Introduction to issues of trade and distribution
c. DUE: Group Response #1
9. 2/16: Distributional Consequences of Trade
a. Evidence on the distributional consequences of trade for workers, firms and regions
b. OPTIONAL: Autor, Dorn, Hanson and Song (2014), Quarterly Journal of Economics
c. EXAM #1, 7:30 PM EST
10. 2/18: Heckscher-Ohlin model
a. Two factors of production (labor and “capital”)
b. Factor intensity and factor abundance
c. Autarky equilibrium
d. ASSIGNED: Problem Set #3
a. Open economy equilibrium
b. Pattern of trade (Heckscher-Ohlin Theorem)
c. ASSIGNED: Group Response #2
a. Distribution in the HO model (Stolper-Samuelson Theorem)
b. Application to U.S. wage inequality
13. 3/2: Immigration
a. Factor supply changes in the HO model
b. Causes and consequences of immigration
c. READING: Perri (2016), Journal of Economic Perspectives
14. 3/4: Heckscher-Ohlin model in the long run
a. What happens when capital can accumulate?
15. 3/9: External Economies of Scale
a. Logic of externalities
b. Application to long-run HO model with human capital externalities
c. DUE: Problem Set #3
d. DUE: Group Response #2
16. 3/11: History
a. READING: Williamson (2011), Chs. 1-4.
17. 3/16: History
a. EXAM #2 Material up to here
18. 3/18: Firms and Trade
a. Introduction
b. Basics of monopoly pricing
c. EXAM #2, 7:30 PM EST
d. ASSIGNED: Problem Set #4
_
19. 3/23: NO CLASS (well-being break)
a. Equilibrium with monopolistic competition in a closed economy
a. Equilibrium with monopolistic competition in the open economy
b. ASSIGNED: Group Response #3
a. Heterogeneous Firms
c. ASSIGNED: Problem Set #5
a. Empirical evidence on firms and trade
b. READING: Melitz and Trefler (2012), Journal of Economic Perspectives
c. OPTIONAL: Bernard et al. (2007), Journal of Economic Perspectives
a. Multinationals
b. Supply chains
c. DUE: Group Response #3
25. 4/13: Trade policy
a. Basic motivations for and effects of trade policies
26. 4/15: Trade Policy
a. The logic of retaliation and trade agreements
b. US-China trade war
c. DUE: Problem Set #5
d. EXAM #3 Material up to here
27. 4/20: NO CLASS
a. EXAM #3, 7:30 PM EST
28. 4/23: NO CLASS
a. DUE: FINAL ESSAY
Welcome!
Lecture 1: Introduction
Today we will cover the following topics:
Professor Dominick Bartelme
I Introduction to myself, Dominick Bartelme
I Course introduction
University of Michigan
I Course logistics
ECON 441
1 / 25 2 / 25
About me My research
I I study “clusters in space”

I International specialization = clustering of industries in
I Call me whatever you like (but don’t be rude) countries
I Assistant Professor of Economics I Cities=clustering of people within a country
I Other spatial clusters: industries within countries, plants
I Research in international trade, economic geography and within firms, ...
economic development
I Some clusters are easily explained (e.g. gold mines)
I Research website:
I Others have more subtle roots
https://sites.google.com/site/dbartelme
I Why software in Silicon Valley? Cars in Detroit? Textiles in
I Email: dbartelm@umich.edu Bangladesh?
I Clusters often due to (and generate!) externalities,
implying a role for policy
3 / 25 4 / 25
My research My research
The Textbook Case for Industrial Policy: Theory Meets Data Trade Costs and Economic Geography: Evidence from the U.S.
I Should countries favor (subsidize) some industries over I Why are some cities larger than others?
others? How much can they hope to gain from doing so? I One answer: they are close to other large cities, which
I Crucial how large national externalities (“increasing minimizes trade costs.
returns to scale”) are in each industry I My paper quantifies how important trade costs are to
I We estimate this using trade data explaining variation in population and income across U.S.
cities
I Although externalities are substantial, gains from
correcting them are relatively small I Even today, trade costs play a large role
I More open countries gain more I Trade costs may not be large
I Most countries not really that open (services) I Could be that outcomes are sensitive to small variations in
trade costs
5 / 25 6 / 25
More about me Course Introduction
I Married, three kids This course is about international trade.

I Partner is Lisa McLaughlin, CEO of Workit Health
I Why do countries trade?
I Children Aria, Orson, Holden
I Which products do they trade?
I Grew up in Ann Arbor
I Why do countries produce what they produce?
I Michigan undergraduate (math + econ)
I What are the consequences of trade for di↵erent types of
I Things I like:
firms, workers, countries?
I Art (esp. modernists)
I How can trade help (or hinder) economic development?
I Outdoors
I Games (chess, Zooba, Magic the Gathering, Monopoly) I How do government policies a↵ect trade and welfare?
I Sleeping I What are the motivations for and consequences of trade
policies?
END FIRST VIDEO
7 / 25 8 / 25
Two sets of “Big Questions” Course outline
I Review (maximization, general equilibrium)

I Trade and global welfare/growth
I How large are the global gains from trade?
I Classical theories
I How much does trade lift global growth? I Ricardo
I Heckscher-Ohlin
I Trade and distribution I Topics: comparative advantage (static and dynamic), trade
I Which countries gain most from trade? Which countries, if patterns, gains from trade, distributional consequences of
any, lose? How big are the gains/losses? trade, immigration and capital flows, economic history
I Which groups within countries gain most from trade? I Other issues in trade
Which groups (if any) lose? How big are the gains/losses? I Imperfect competition
I O↵shoring
I The answers to these questions will help us think through
I Firms in international trade
the causes/consequences of trade policies
I Trade policy
9 / 25 10 / 25
Should I take this course? Should I take this course?
I The course is indeed almost useless (practically)

I The material is indeed difficult
I I re-wrote the problem sets and added more review of basic
tools to the course
I I can tell you everything you “need to know” about
international trade in 30 minutes or less
I You won’t understand it well enough to explain it
I You won’t know why (or if) its true
I This course is for people who want to know the whys (and
ifs) of international trade
I Key to understanding the history and future of the world
11 / 25 12 / 25
Pre-requisites Methods
Simple mathematical models
I Explicit assumptions
I Econ 401
I Clarify economic logic of di↵erent forces
I We will make heavy use of these tools
I If you hated 401 you probably won’t like this either I Precise expression of complex ideas
I Calculus I Alternative is NOT “no model”

I Partial derivatives Model vs. Reality
I Maximization
I Model NEVER captures all of reality
I Statistics
I Helpful, not required
I Check data to see if model captures “enough” reality, and
one which dimension it fails
I Willingness to learn
I Some predictions are easy to check
I Some require ingenious statistical work
END SECOND VIDEO

13 / 25 14 / 25
Course Logistics Course Logistics
I The course is conducted entirely remotely

READ THE SYLLABUS CAREFULLY!!! I No official course time
I Canvas is the course website
I Communication, lecture videos and slides, assignments,
READ THE SYLLABUS CAREFULLY!!! readings, exams all done via Canvas
I Lecture topics, due dates, exam dates, etc. all listed in the
READ THE SYLLABUS CAREFULLY!!! syllabus
I Upsides: flexibility and ease for everyone
I Downside: less interaction
15 / 25 16 / 25
Course Structure Assignments and Grades
I Five problem sets (20%, lowest score dropped)

I Lectures + a few readings
I Three group discussions with group response (600-750
I Problem sets words, 15%)
I Group discussions and responses I Three exams (50%, lowest score dropped)
I Exams I Final essay (1250 words, 15%)
I Final essay I Some extra credit opportunities on problem sets and exams
I No curve (scale in syllabus)
17 / 25 18 / 25
Problem Sets Group Responses
I Groups assigned by me, di↵erent group each time

I Good practice for exams
I Group response to a prompt: question, reading, etc.
I Supposed to be challenging
I Meet synchronously to discuss, then write 400-600 word
I Encouraged to work in groups (hand in separately) response
I Graded on a scale 1-5 I Recommend Google Docs for collaborative writing
I Lowest score dropped I Graded 1-5, both writing and content
I Due at 6 pm EST on due date I Each response includes narrative of process used to create it
I NO LATE PROBLEM SETS! I Due at 6 pm EST on due date
I NO LATE GROUP RESPONSES!
19 / 25 20 / 25
Exams Exam Schedule
Three Midterm Exams Midterm # 1: Tuesday, February 16, 7:30-9:30 pm EST
I Conducted remotely (but synchronously) using Canvas Midterm # 2: Thursday, March 8, 7:30-9:30 pm EST
I Open book, but no communication with other people Midterm # 3: Tuesday, April 20 7:30-9:30 pm EST
I Multiple choice and short answer I Start exam between 7:30 and 8 p.m., lasts 80 min
I Questions on lectures, problem sets, readings I If you live in a time zone for which 7:30 pm EST falls
I Questions one at a time, in random order, multiple versions between 12 -6 a.m. and you want to talk about alternative
options, email me by Friday, January 22.
I Extra credit questions (compensate for inconvenient
I No other exceptions, unless provided for in the Econ Dept.
format)
policies and procedures
I Lowest score dropped
21 / 25 22 / 25
Final Essay My Office Hours

I will have extra office hours this semester:
Group Office Hours:
9:30-10:30 a.m, Mondays and Tuesdays
I 1250 word MAXIMUM essay
I Pick from a list of topics Individual Office Hours:
I Graded on a scale of 1-15 9-9:30 a.m Mondays and Tuesdays, by appointment

10:30-11 a.m Mondays and Tuesdays, by appointment
I Due Friday, April 23 at 6 pm EST
Schedule at https://calendly.com/dbartelme
I LATE ESSAYS LOSE 1 POINT PER 24 HOURS
Zoom links in syllabus.
LATE!
Appointments are short (15 min) so come prepared to be
efficient. Don’t sign up more than once every three weeks.
Please sign up between 24 hours and 1 week in advance.
I will typically NOT be available outside these times!
23 / 25 24 / 25
Conclusion
READ THE SYLLABUS CAREFULLY!!!
If you can’t find the answer there, please email me.
END THIRD VIDEO
25 / 25
Welcome!
Lecture 2: Maximization This set of lecture slides and videos will review maximization,
with consumer utility maximization as the main example
Professor Dominick Bartelme I Unconstrained maximization

I Constrained maximization
University of Michigan I Examples
Note this is a brief overview. There are many excellent online

ECON 441 resources on this topic (or go to your notes from Econ 401) if
you need a more in-depth review.
1 / 22 2 / 22
Unconstrained maximization Economic Examples of Unconstrained Max .

Pe buns
An unconstrained maximization problem is a problem of the

following form:
max F (x1 , x2 , ..., xn )

x1 ,x2 ,...,xn
I Firms maximizing profits by choosing quantity, taking

which means “choose the variables x1 , x2 , ...xn , so as to price as given (competitive market)
maximize the function F (x1 , x2 , ..., xn ). The x variables are
sometimes known as the control variables. I Monopolist choosing price (or quantity) to maximize profits
A solution to this problem is a set of values x⇤1 x⇤2 ,...,x⇤n and

F (x⇤1 , x⇤2 , ..., x⇤n ) such that F is maximized at x⇤1 x⇤2 ,...,x⇤n .
The value F (x⇤1 , x⇤2 , ..., x⇤n ) is known as the maximum.
The values x⇤1 x⇤2 ,...,x⇤n are known as the argmax, short for
argument of the maximum.
3 / 22 4 / 22
maximum
Partial Derivatives Critical Points Ready to use
function
call to characterize
looks like
You know the derivative of a single variable function,

The critical points of a function F (x1 , x2 , ..., xn ) are values x̃1 ,
dF
= F 0 (x). x̃2 , ...x̃n such that
dx
~
The partial derivative of a multi-variable function "

tide
@F
= 0 when xj = x̃j , 8j. & An op are
↳
@xj not
why, Wh ,
F (x1 , x2 , ..., xn ) with respect to a particular variable xj is the
but all
waxing
derivative of F with respect to xj , treating all other control are up
variables xi , j 6= i as constants. It is denoted by These equations are the first order conditions (FOC).
For di↵erentiable functions, the argmax is a critical point of F .
@F ↳
may be ang
The converse is not true in general. Wfp
-h
-
n
"
@xj saddle points
BUT, If a function is concave (shaped like a hill) then there is a
Example: single critical point, and it is the argmax.
@F @F This will be the “normal case” in this class.
F (x, y) = x2 y ) = 2xy, = x2
@x @y
#
'
x x 5 / 22 6 / 22
Geometric Intuition Geometric Intuition
oh -
,
wagon
7 / 22 8 / 22
class will
normal case in
be hills
Algebraic Examples
-1
First example (quadratic function):
l
.
F (x) = 3x x ,
dF
2
=3 2x,
3 2x
- -
- O
Constrained Maximization
A constrained maximization problem is a problem of the
A
following form:
dx I z
-
-
dF max F (x1 , x2 , ..., xn )

I = 0 ) x̃ = 3/2. x1 ,x2 ,...,xn
dx -
goes us maximum
s.t. g(x1 , x2 , ..., xn ) = 0
& Second example (bivariate standard normal distribution):

which means “choose the variables x1 , x2 , ...xn , so as to
1 1
(x2 +y 2 )
F (x, y) = e 2 , maximize the function F (x1 , x2 , ..., xn ), subject to the
2⇡
restriction that g(x1 , x2 , ..., xn ) = 0.”
j2⇡y e
7 .
how to solve ?
@F
= px
e
1
2
(x2 +y 2 )
,
@F
=
1
2
(x2 +y 2 )
, The condition g(x1 , x2 , ..., xn ) = 0 generally defines a set of
@x 2⇡ @y (multiple) values that x1 , x2 , ..., xn can take. This set is known
@F @F as the constraint.
= = 0 ) x̃ = 0.
@x @y
END FIRST VIDEO
9 / 22 10 / 22
Constrained Maximization Constrained Maximization

Our leading example of a constrained optimization problem is The consumer problem is to maximize utility subject to a
consumer utility maximization subject to a budget constraint. budget constraint:
Let x and y be two goods and let the utility function be
in here
U (x, y). The utility function has the following interpretation: if max U (x, y)
x, y and x0 , y 0 are two di↵erent bundles of goods, then x,y ✓
U (x, y) > U (x0 , y 0 ) means that the consumer would rather have s.t. px x + py y = I, x, y 0
x, y than x0 , y 0 , all else equal.
where px is the price of good x, py is the price of good y, and I
Generally we assume that more of each good is always strictly is income.
better, or @U/@x > 0 and @U/@y > 0 for all (positive) values of
x, y. We can see clearly that this implies that U has no critical The constraint set is called the budget line. We can write in the
points, and hence no unconstrained maximum. If we don’t give the following equivalent forms:
0I = 0 () y = p
the consumer some constraints (i.e. a budget), they will choose I px
to consume an infinite amount of each good (a.k.a. “no px x + py y = I () px x + py y x
y py
solution”). of
function g
11 / 22 12 / 22
First order conditions 7
Consumer Problem
<
The first order conditions for a (well-behaved) -7

-
constrained
maximization problem can be written as Let’s see how this works in our example of the consumer
problem
Entombs
@F @F @g @g
/ = / , 8j, i
@xj @xi @xj @xi max U (x, y)
Mio of x,y
derivates
constraint must also
g(x1 , x2 , ..., xn ) = 0 be satisfied the
param s.t. px x + py y I=0
- at
of constraint ① wax .
A set of values x1 , x2 ,...xn that solves these equations is a

critical point of F constrained by g. We have the following first order conditions:
These conditions capture the tradeo↵s induced by the
@U @U px ✓ pilato
constraint: the relative benefit to the objective (F ) of / = ,
increasing xj as opposed to xi must equal the relative “cost” in @x @y py
terms of the constraint. px x + py y = I
There are good Khan academy videos and other online resources ( constraint
budget
for more information on constrained optimization in general.
13 / 22 14 / 22
than
=
Indi↵erence curves Indi↵erence Curves
Equivalently: @U @U px
@U @U px / =
/ = @x @y py
@x @y py
@U @U This condition says that, at the optimal bundle x⇤ , y ⇤ , the slope

@x / @y
is called the marginal rate of substitution (MRS). It
of the indi↵erence curve is equal to the slope of the budget line.
captures how much y I am willing to give up for one more unit
Geometrically, this implies that the two lines are tanget to one
of x so as to be indi↵erent between the two bundles.
another.
The graph of all x, y combinations that yield the same utility
We can use this tangency condition plus the budget line to find
level Ū is called the indi↵erence curve. The M RS is the slope
the (typically unique) optimal consumption bundle where a) an
of the indi↵erence curve. Note that every bundle x, y is on a
indi↵erence curve and the budget line intersect, AND b) they
single indi↵erence curve.
are tangent.
The RHS is the slope of the budget line.
We will go over how to do this in the next video.
( hand side
right
-
"
PI
15 / 22 16 / 22
M
Geometric Intuition Examples of Consumer Optimization
Ine
: The first example takes Cobb-Douglas utility (0 < ↵ < 1):
max x↵ y 1 ↵
x,y
s.t. px x + py y = I
not
✓ fmri"Tened bnutnaffordabu
Then we have
??
(
✓ ◆↵
)
,
@U ⇣ y ⌘1 ↵ @U x
=↵ , = (1 ↵)
@x x @y y
which implies that our first order conditions are

if
p×T ,
then
y T
↵ y @px
= , p x x + py y = I
1 ↵x py
END SECOND VIDEO

17 / 22 18 / 22
Solving for Cobb-Douglas Demand Solving for Cobb-Douglas Demand
↵ y px
· = , p x x + py y = I
1 ↵ x py
We can solve the first equation for the optimal consumption of Now that we know x, we plug that into our equation for y to
y as a function of the price ratio and the optimal consumption get the complete solution:
of x:
1 ↵ px I I
y= · ·x x=↵· , y = (1 ↵) ·
↵ py px py
We can then plug this solution for y into the budget constraint: The optimal consumption of a good as a function of the prices
✓ ◆ and incomes is known as the demand function. These demand
1 ↵ px
p x x + py · ·x =I functions (for x and y) are the solution to the consumer
↵ py
problem.
Now we solve for the optimal consumption of x as a function of .
the price ratio and income:
o
.
I
x=↵·
px
19 / 22 20 / 22
Problem set
Question
CES Utility Function CES Utility Function
A second examples uses the constant elasticity of substitution The first equation can be solved for y in terms of x and the
(CES) utility function (0 < < 1), price ratio: ✓ ◆
1 ↵ px
⇣ 1 1
⌘ y= · ·x
U (x, y) = ↵x + (1 ↵)y
1
↵ py
Using the -
chain rule for di↵erentiation, we get We then plug this into the budget constraint and solve to get
✓ ◆1 ✓ ◆1 the demand function for x:
@U U @U U
=↵ , = (1 ↵)
@x x @y y I ↵ · px
pwg x= ⇣ ⌘ = ·I
and therefore our first order conditions are x
1 ↵ px ↵ · p1x + (1 ↵) · p1y
px + py ·
↵ ⇣y⌘1
↵ py
px
= , p x x + py y = I
1 ↵ x py and the analogous demand function for y: I
Note: is the (constant) elasticity of substitution because (1 ↵) · py

y= ·I
dx dy ↵ · p1x + (1 ↵) · p1y
/ =
dpx dpy
END THIRD VIDEO
21 / 22 22 / 22
① Find Foc
by Mrs price
-
ratio
-
demand function
unhurt
@ Use Foo and budget
and income
-
X and y with respect
to
prices
Welcome!
Lecture 3: Trading in an Exchange Economy

This set of lecture slides and videos will introduce the simplest
model of international trade, in which countries are simply
Professor Dominick Bartelme endowed with di↵erent goods and are allowed to trade.
I Setup and equilibrium

I Examples
I Comparative statics and the terms of trade
ECON 441
1 / 17 2 / 17
Motivation Motivation
I Trade is market exchange of goods (or services) across I This is a general equilibrium (GE) model
countries I A general equilibrium model is a complete, internally
I Simplest model: consistent representation of an entire economy
I Country A has something country B wants and doesn’t have I All agents follow specified behavioral rules (e.g. utility and
I Country B has something country A wants and doesn’t have profit maximization) C
spendingis another agent’s earning

I Each agent’s expenditure income
I Individuals exchange in a competitive market
no
prediction I All prices adjust to clear each market
I “Realistic” for some goods in his model met
,
I Everyone’s choices are consistent with one another -
either have
I Oil, diamonds, etc. deny nanny
anything
I Most of our topics will require developing and analyzing
a or
I In a deep (and subtle) way, paradigmatic for all trade

unexplained
GE models
3 / 17 4 / 17
Setup Competitive market
I Two countries, Home (H) and Foreign (F)

I Each country has a large number of people (L̄H and L̄F ) A competitive market is one in which buyers and sellers perceive
that they may buy and sell as much as they like at a fixed set of
I Each person in H is born with ā apples prices, without a↵ecting those prices.
I Each person in F is born with b̄ bananas Aggregate behavior, rather than individual behavior,
I Every person in both countries has the same utility determines prices.
function U (a, b) Both
Home and foreign people value both
I Each person can exchange goods in a competitive market
5 / 17 6 / 17
2 for
camp eg
requirements .
-
consumer optimization . .
.
Competitive Equilibrium Consumer Demand

The Home consumer problem is
A competitive equilibrium is a set of prices p1 , p2 ,..., pn and endowment
sell my
consumption choices such that max U (aH , bH ) y of Tn (apples)
aH ,bH
I Demand comes from consumer optimization given prices
and their income s.t. pa aH + pb bH = pa ā ① Income
I The supply of each good equals the demand for each good We can write the budget constraint in terms of the price ratio
(i.e. all markets clear). pb /pa ⌘ p
Walras Law: If there are n markets, and a set of prices clears? ? aH + pbH = ā
n 1 markets, then those prices also clear the last market.
Similarly the Foreign consumer problem is
Homogeneity of degree zero: if a set of prices p1 , p2 ,...,pn
He stunt
clear all markets, then the set of prices fun
p1 , p2 ,..., pn also max U (aF , bF )
aF ,bF
clears all markets, for any > 0. This means we can normalize
one price to an arbitrary value (like p1 = 1). s.t. aF + pbF = pb̄
7 / 17 8 / 17
Consumer Demand Market clearing
t An equilibrium relative price p is the price such that supply

Using the condition M RS = p and the budget constraints in equals demand in both markets:
.mg?n:meeetE-EYn
Home and Foreign, we can solve for the I
- -
demand of each type of not

agent for each good as a function of their endowments and p: E.
L̄H · ā = aH (pā)L̄H + aF (p, pb̄)L̄F ,
| {z } | {z }
"
"
od
-
Supply Demand
"
aH = aH (p, ā), bH = bH (p, ā) L̄F · b̄ = bH (p, ā)L̄H + bF (p, pb̄)L̄F
| {z } | {z }
Ici
aF = aF (p, pb̄), bF = bF (p, pb̄)
Keenan
Supply
: Demand
Henne
We can interpret ā as the income of Home consumers (given the By Walras’ law, if p clears one market then it must clear the
normalization pa = 1) and pb̄ as the income of Foreign other. We solve one of these equations to find the equilibrium
consumers.
I relative price, then plug it back into the demand functions to
find the equilibrium consumption levels.
paid I
=
9 / 17 10 / 17
graphical representation of Selves fer

general equilibrium for trig
✓ eguvibnwn
in this
economy
economy
Edgeworth Box ( Foreign) Example with Cobb-Douglas utility
consumer 2
Let
(
U (a, b) = a↵ b1 ↵
has
all bananas
,
We saw last lecture that the general demand functions are
warm
good •
satisfies a=↵·
I
pa
, b = (1
, # bananas consumed
↵) ·
I
pb
V Mps
-
p (
fer towers He apples consumed
L
Using our expressions for income (IH = pa ā, IF = pb b̄), we get
the following set of specific demand functions:
wdTpeTFt fraction
as
Pbt , consume
•
✓
yay -
own
apples 1
less bananas
(1 ↵)ā
aH = D
↵ā, bH =
Yoffe} appius
aF = ↵pb̄, bF = (1
p -
↵)b̄
because
Pfa and
pa
→
pb
END FIRST VIDEO

(
# 11 / 17
what is
p? 12 / 17
has all apples ,
no bananas
Example with Cobb-Douglas utility Trade
Setting supply equal to demand in the market for apples to
I Demand
solve for the equilibrium p: 1 ↵ LH ā
p=
- - - ↵ LF b̄
LH ā = LH ↵ā + LF ↵pb̄
-
LF b̄
)M
-
supply ) p = 1 ↵ LH ā -
tf supply
( La or Tr
,
aH = ↵ā, bH = ↵
LH
↵ LF b̄ then T LH ā
p
) aF = (1 ↵) , bF = (1 ↵)b̄
relative
# of
apples
LF
0£34:*
*
Back into the demand functions to get the consumption levels: F
①
wants
price of ,
barrenness Home exports LF aF = (1 ↵)LH ā apples to Foreign, and
LF b̄ goes Foreign exports LH bH = ↵LF b̄ bananas to home.
up
aH = ↵ā, bH = ↵ be more
LH apples Trade is balanced because the value of exports equals the value
LH ā of imports for both countries:
aF = (1 ↵) , bF = (1 ↵)b̄
LF ✓ ◆
GE 1 ↵ LH ā
model (1 ↵)LH ā = ↵LF b̄ = (1 ↵)LH ā
is
We get the same answer if we uses market clearing for bananas. ↵ LF b̄
13 / 17 14 / 17
Gains from Trade Terms of Trade
1 ↵ LH ā
p=
↵ LF b̄
I Autarky: countries cannot trade
LF b̄
aH = ↵ā, bH = ↵
I In autarky, Home can only consume apples and foreign LH
only bananas
I Each has utility of zero with Cobb-Douglas preferences A country’s terms of trade is the price of its exports divided by
the price of its imports.
I Implies infininte gains from trade - trashy anythingit
for sake of Home’s terms of trade is pa /pb = 1/p, while Foreign’s terms of
I Not a very realistic model to talk about gains from trade trade is pb /pa = p.
If
H T tof
then tot, F T
(next lectures)
Notice that Home’s terms of trade decline when the supply of
its export increases due to “productivity improvements” (ā ").
However, Home’s export earnings are still sufficient to buy the
same amount bH , because it exports higher quantity. Home also
has higher aH , and therefore is better o↵.
15 / 17 16 / 17
Immiserizing growth
I Can a country ever be worse o↵ from improving its

productivity (“immiserizing growth”)?
I Terms of trade decline is too big
I Not with Cobb-Douglas demand, but in general yes!
I Try an example with CES preferences with low elasticity of
substitution ( less than 1)
t
I A practical possibility for some commodities like oil, which
is one reason why OPEC restricts its supply
I More generally, a country’s trading partners tend to -
bc he wer
capture some of the value of productivity improvements prices
I
END SECOND VIDEO have
newsy
17 / 17
Welcome!
Lecture 4: The Ricardian Model

Today we will begin our coverage of the Ricardian model of
Professor Dominick Bartelme trade
I Motivation
University of Michigan I Setup and autarky equilibrium
I Principle of Comparative Advantage (CA)
ECON 441
1 / 20 2 / 20
Why do countries trade? Ricardo vs. Mercantilism
Ricardo was writing against the dominant economic orthodoxy

David Ricardo, On the Principles of Political Economy and of the time, known as Mercantilism
Taxation (1821) ✓
making money
I “Exports good, imports bad”
I Trade occurs and is beneficial because of technology or -
every good imported displacing workers that
I Positive trade balance ! accumulation of gold and silver could make it
productivity di↵erences across countries and industries

(assets) ! “national power”
I Countries gain from trade by specializing in what they do
I Maximize (net) exports using import tari↵s
relatively well
I Still a dominant policy and popular idea (e.g.
This is the principle of Comparative Advantage Trumponomics)
I (Second) simplest general equilibrium model of trade, yet I Can anyone spot the flaw?
rich in implications Ricardo showed that countries can gain from balanced trade
without tari↵s
3 / 20 4 / 20
Absolute vs. Comparative Advantage Setup
I Two countries (Home and Foreign), two goods (Wheat and

I Absolute advantage: productivity Cloth)
advantage I Foreign variables denoted with an ⇤
I Comparative advantage: relative I One factor of production, labor, that is mobile across
-
productivity advantage industries and immobile across countries

- -
I Comparative, not absolute advantage, I Perfect competition in input and output markets
governs trade patterns I Linear production functions productivity of /
wheat worker
= ✓
wok QW = 0
AW L W
next
hide
Q C = AC L C
END FIRST VIDEO I Labor market clearing L̄ = LW + LC
5 / 20 6 / 20
PPF General PPF
7 / 20 8 / 20
Marginal Product of Labor A specific example
Recall that the marginal product of labor is defined as

@Q
MPL = To be more concrete (and use graphs), lets work with a specific
@L
ummm numerical example
With linear production functions, M P LC = AC and
I Home variables: L̄ = 25, AC = 2, AW = 4
M P LW = AW .
I Foreign variables: L̄⇤ = 100, A⇤C = 1, A⇤W = 1
Also recall that the slope of the production possibilities frontier
is equal to (M P LC /M P LW ), which in this case becomes Notice that Home has an absolute productivity advantage in
both goods
M P LC AC
slope of P P F = =
M P LW AW
Interpretation: “opportunity cost” of wheat
H want to produce one more
unit of cloth , how
wnh whens the we
need
? MI 9 / 20 10 / 20
MPL w
Example PPF Autarky equilibrium
Suppose there is no trade between countries
I Autarky relative price of wheat MUST be
PWA
M P LC
=
PCA M P LW
if both goods are consumed

I Why? Think about PW A /P A > M P L /M P L . What
C C W
good would firms produce? wheat
I Both goods consumed if U has “sufficient curvature.”
11 / 20 12 / 20
Autarky equilibrium Arbitrage
PWA PWA⇤
1
= , =1
PCA 2 PCA⇤
Suppose YOU are the only one who can trade. What would you
do?
END SECOND VIDEO

13 / 20 14 / 20
Arbitrage Comparative Advantage

for
exploiting htt .
in
ponies
identical goods Under free trade,
A A⇤ I Home exports wheat and imports cloth
PW 1 PW
PCA
= ,
2 PCA⇤
=1 I Foreign does opposite
Suppose YOU are the only one who can trade. What would you Home has comparative advantage in wheat because it is
do? relatively better at producing wheat than foreign:
can make
can make 2
1
I Buy 2 units of wheat in home wheat for

- M P LW M P L⇤W /
wheat for
every
every 1
=2>1= 1 cloth
I Sell for 2 units of cloth in foreign cloth

M P LC M P L⇤C
I Come back home and exchange for 4 wheat Equivalently, Foreign is relatively better at producing cloth:
I Repeat can make make 2
for M P L⇤C 1 M P LC can
I This type of trade is known as arbitrage I cloth

=1> = born for every
every 2
M P L⇤W 2 M P LW z
wheat
wheat
14 / 20 15 / 20
Comparative Advantage and Autarky Prices Prices in Free Trade arbitrage permissible
ml
Comparative advantage can also be defined in terms of relative The free trade price PW /PC will be somewhere between the
autarky prices: Home has a higher autarky price of cloth: autarky prices 1/2 and 1 (why?)
M P LW PA P A⇤ M P L⇤W I Where exactly depends on the demand (marketO clearing)
= CA = 2 > 1 = CA⇤ = -
M P LC PW PW M P L⇤C I Assume that the equilibrium relative price is

-
( 1/2 < PW /PC < 1

autarky price
It turns out that this is actually the more general definition (we I Home completely specializes in wheat
I Foreign completely specializes in cloth
will see later) people move
I Known as complete specialization equilibrium where there is
Also notice that comparative advantage is symmetric: I Why? Linear PPF + mobile labor - better wages
If I Could have PW /PC = 1/2 or PW /PC =1

you have PCA P A⇤ PA P A⇤
high autarky > CA⇤ ) W < W I Can lead to incomplete specialization
cloth A A PCA⇤
price of , PW PW PC I In any case, each country exports good for which it has CA
will
you
have a hen
autarky pony
of rheas
16 / 20 17 / 20
Specialization Specialization
I Trade causes specialization and reallocation in production

I Sectors with CA expand
Free I Sectors without CA contract depends on
,
my I Changes in consumption ambiguous pure of good
I Reallocation is a source of gains in the long run
autarky I Experience tells us
I Reallocation can be painful in the short run
I The short run can last decades \
trade leads
less
to
job
NAFTA and mere in

farmer job loss
peer ,
poverty , migration
18 / 20 to us 19 / 20
Summary
Each country is exporting the good in which it has comparative

advantage
over
comparative
I First lesson of the Ricardian model - absolute
I Absolute advantage irrelevant for pattern of trade
I Very general “neoclassical” model: negative correlation
between autarky prices and net exports (Deardor↵ 1980)
Trade leads to production reallocation production

reallocation
,
I Second lesson of the Ricardian model
I Important for understanding distributional e↵ects
END THIRD VIDEO
20 / 20
Department of Economics Winter 2021
University of Michigan Economics 441
Problem Set 1
Solutions
DUE February 2, 2021 by 6 pm EST on Canvas
Question 1. Find the maximum and the argument of the maximum (argmax) of the following
functions:
A quadratic
/×=argmax=TY
tht 8-4=4
pug in
-
x z
-
-
✓ f-
'
(x ) -
- -
2x +4 -
2x = -
Y
Y
'
↳ fly foe )
-
y
1. 𝑓(𝑥) = 4𝑥 − 𝑥 2 tcu) , yay
-
-
(y wax y
-
-
= -
X =
2
-2×+4=0 #
316 6)
u
1 I ✓
'
÷÷=%ITExIt
I ly 5t¥ Fy
2 f- pwy
g-
2. 𝑓(𝑥) = 5 + ( ) 𝑥 − 𝑥 2x x
in
-
2x
-
= -
-
+ -
- z
L
" 2 '
' '
s site 's ' in
'
axrz at this
- -
o
- -
adnate
g-
Question 2 (firm’s profit maximization). Find the optimal ratio of capital per worker:
=4
per period
pfzik¥ ,
ummm- tenner nest
of pug,po¥
'm
you
output
-
yup
so
,
dk wage mental ,
p 1 4 r every
8 , Esp
1. 𝜋(𝐾, 𝐿) = 10𝑌(𝐾, 𝐿) − 𝑤𝐿 − 𝑟𝐾, where 𝑌(𝐾, 𝐿) = 2𝐿5 𝐾 5 , 𝑤 = 4, and 𝑟 = 8.

= hemetmy To
DIT IEE
¥k"rape 't k¥75 oof I
"
's
II o
k¥1 y
¥ K -
s
plus
-
of
-
- -
- -
.
-
Ok 4 1 10
p
unconstrained 𝜋(𝐾, 𝐿) = 10𝑌(𝐾, 𝐿) − 𝑤𝐿 − 𝑟𝐾, where 𝑌(𝐾, 𝐿) = 2𝐿 𝐾 , 𝑤 = 4, and 𝑟 = 6.
= 5 5
problem
¥i%Ep=y ;¥p
mere "
↳ necessary IT I pit -6--0

-
Ek¥pEs=6 k¥=p'÷ k=¥÷ fI=pfIi4Esy 4=0 its -
henchmen
Question 3 (consumer’s utility maximization). Find the optimal consumption bundles for the
=±¥÷÷¥ *÷i¥¥
following utility functions. Assume generic prices (𝑝𝑥 ,𝑝𝑦 ) and income (𝐼).
"
÷ 's ¥=H÷Y ÷H
'
±
'm 'm
'm 't:L
' *
.i÷÷
'
"
Common homothetic utility functions

a
.
y 7¥ iffy x
pxxtzxpx
I
'5.p
-
=
-
1 2
-
- -
'
I
1. Cobb-Douglas: 𝑈(𝑥, 𝑦) = 𝑥 3 𝑦 3 3pxX = I y

'
.
p×% + I
'
.
py
's
x*=Ig÷÷,,¥,!;÷÷¥ ÷
'
i n
" "
2
1 1
1 2
2. Constant Elasticity of Substitution (CES):𝑈(𝑥, 𝑦) = [( ) 𝑥 2 + ( ) 𝑦 2 ]
3 3
Li a) (IF
't
¥ att 0¥ HEY of
÷
of (3)( FK (F) II.
"
, - -
-
next Pss I
-
Foo -
-
fa÷ ÷
:
-
- - -
, - -
Non-homothetic utility function

D3. Quasilinear: 𝑈(𝑥, 𝑦) = 𝑥 + log(𝑦) "'
ft
'
¥ ITH !
"
Poe
' '
I
=L
'
my -
I -
×*e÷_pp÷,y¥pB@
hey , →
,
0¥ Ey 4 Ly Ppf tph pyx MCF ) -
¥÷i÷÷i÷ ÷÷÷ ¥÷÷ x÷¥¥i

I y
-
.
-
-
-
- -
- -
, -
D
1 3
4. EXTRA CREDIT (0.5 points) 𝑈(𝑥, 𝑦) = ( ) 𝑥 + ( ) 𝑦
1 1
p×(YpIy÷ ypsyy 's
÷!!i÷÷÷÷.÷÷
2 4
2 2
Question 4 (Comparative Advantage in a Ricardian world). Imagine a world in which the only
factor of production is labor. Each of the following situations compares the United States with a
different country and focus on a different pair of goods.
1. The following table shows how many units of cars and machines can American and Mexican
workers produce in a year:
'
.f÷÷ ::*.l÷ :S "
*
.
. . 1
Cars Machines
(mill. of units) (mill. of units)
US 10 20
Mexico 6 3
a. Which country has comparative advantage in cars?

✓
Mexico
b. Predict the pattern of trade (who sells what to who) ✓
Mex will
. sell cows te US , us will sell machines te Mex .
2. The following table shows how many units of machines and pharmaceuticals can American
¥; '÷o=Ih÷*
and European workers produce in a year:
n;÷=÷± .
-
-
Machines Pharmaceuticals
US 20 30
EU 40 60
a. Which country has comparative advantage in machines? ✓

neither ,
they
have the same
advantage in
making both goods

b. Predict the pattern of trade (who sells what to who)
✓
?
They will
probably not sell these
goods to each other .
They
will choose to consume domestically .
of trade based on it
No dear CA ,
cannot predict the
pattern
2
Welcome!
Lecture 5: The Ricardian Model

Today we continue our coverage of the Ricardian model of trade
I Gains from trade - graphical
I Calculating the gains from trade
University of Michigan I Determinants of the gains from trade
↳ charmer has
corny
ECON 441
1 / 25 2 / 25
Review setup Gains from trade
① @
I Home and Foreign, producing wheat and cloth
I Labor only factor of production (mobile), linear PPF
I Perfect competition
FT
✓
Recall our specific numerical example: y
.IE?EEeaae
I Home variables: L̄ = 25, AC = 2, AW = 4
I Foreign variables: L̄⇤ = 100, A⇤C = 1, A⇤W = 1 PPF
/
FETE own
gym
•
Howe oh
cheers
D environ
produces
pagf-agk.hn ✓
,
,
Recall that, if 1/2 < PW /PC < 1 then we have complete oh
foreign cloth
specialization. Graph assumes PW /PC = 2/3. produces
@
3 / 25 4 / 25
How does Home gain from trade? Foreign Gains from Trade
Trade is like an increase in M P LC , viewed as “roundabout

production”
I One unit of L produces 2 cloth Aw
.
Pp÷ =
y
.
} -
8g
I Instead, use that labor to produce 4 wheat ✓
I Trade wheat for cloth at PC /PW = 2/3 to get 8/3 cloth
I As if M P LC = 8/3 inhered of z p
I For foreign, get 3/2 wheat for each L instead of 1 as in
autarky of cheat fer its
-
Artur day UN
↳ 3 units L
can
get every budget
-
of cloth
5 / 25 6 / 25
Summary Quantifying gains from trade
Both countries gain from trade!

I Need a quantitative measure of the gains from trade
I Third lesson of Ricardian model I Compare autarky bundle to free trade bundle
I General result in a neoclassical model (Deardor↵ 1980) I How much better is the free trade bundle?
I In general, utility is not cardinal of bundle
How big are the gains? Which country gains most? Need some Utility
preferred
\
,
means tell
additional theory to tackle these questions. I Use the notion of “equivalent variation” from but
cheesing
much
how
microeconomics ENV 235 you
END FIRST VIDEO
7 / 25 8 / 25
Equivalent variation The gains from trade
The equivalent variation is the amount of income we would have

to give Home consumers in order to make them indi↵erent Let U F be the utility achieved at free trade and U A the utility
between the utility achieved with achieved in autarky. Then needed
titty A?
to
Whey is the income achieve f with
price
✓
I Free trade prices and income EV = £ A
e(p , U ) F
e(p , U ) A A
I Autarky prices (with the unknown income) ( expenditure fucken

income
where pAare the autarky prices and e(p, U ) is the expenditure

given that they optimally choose their consumption bundles (or income) needed to reach utility U given prices p.
each time. Define the gains from trade in percentages,
extra ,
7 I
Can think of the extra income as a balanced productivity -
income
EV e(pA , U F )
improvement, i.e. Home becomes more productive in both GT = = 1
e(pA , U A ) e(pA , U A )
-
goods (but stays in autarky).

-
man
uh
1h he
I How much productivity is free trade worth?

-
pneehrnnty improvement
9 / 25 10 / 25
Computing the gains from trade Gains from trade
For homothetic preferences (e.g. Cobb-Douglas, CES), we have
UF Graphically, we see that the di↵erence between the autarky

GT = 1 relative price and the free trade relative price is crucial for the
UA
magnitude of the gains from trade.
( expenditure function “cancel.” I

This is because, for homothetic preferences, the pA s in the
Letting PW /PC be Home’s terms of trade (TOT) and PC /PW
be Foreign’s TOT, we can restate this loosely as the change in
More generally this is NOT true. But we will use homothetic the TOT determines the gains from trade.
preferences when calculating the gains from trade in this class.
END SECOND VIDEO
11 / 25 12 / 25
Gains from trade How are relative prices determined?
I Market clearing condition: Home exports of wheat =

Foreign imports of wheat
I AKA Supply = Demand
I Walras Law: budget balance plus wheat market clearing
implies cloth market clearing
I Need to specify preferences to fully solve for prices using
-
demand functions
-
I Take a graphical approach in this lecture
13 / 25 14 / 25
Equilibrium in Wheat Market Export Supply Curve
Equilibrium: prices are such that supply = demand

I Home is supplier, Foreign importer (“demander”)
whlvx
)
Can be summarized by the intersection of two curves (autarky
Home willing
I Export supply curve: amount Home wants to export for to
50
expertbushels
-
too
at
of wheat
given relative prices iz

(
ratio
price
I Import demand curve: amount Foreign wants to import
for given relative prices
IMPORTANT: this is equivalent to setting total world supply

equal to total world demand.
⑥ Can hook up total demand and total apply

@ or expert demand I export supply 15 / 25 16 / 25
Export Supply Curve Import Demand Curve
17 / 25 18 / 25
Import Demand Curve Equilibrium
19 / 25 20 / 25
TOT and Gains from Trade Home Toti PFI Import demand shift
Foreign TOT
We have seen that the terms of trade (TOT) determine the
i.
Ipg income 9
gains from trade. How do country characteristics a↵ect the

TOT?
I Factors that shift the export supply or import demand
curves a↵ect the TOT
pure
I Export supply and import demand depend on domestic {
-
- -
-
- -
wuss
T
supply and demand factors, e.g. size and productivity bl
I Example: Foreign either increases in size OR increases in Foreign
want
productivity (both sectors) to demand
move &
Howl
will to
choose
apply
more
21 / 25 22 / 25
TOT and Gains from Trade An Extreme Case
F To -19
her
Improvements in Foreign’s overall productivity and/or
gowns a
population size lead to decreasing terms of trade! ( for Foreign)

-
✓
I Implication: large and/or productive countries tend to gain
less from trade
I Implication: small and/or less productive countries tned to It won't
from
c. gain more from trade gain

trade
I Mechanism: large and/or productive countries see smaller

changes in prices compared to autarky
1 indict
é
↳ look at extreme case .
Home
trading
b/w
+ pNdYTemself
23 / 25 24 / 25
doesnt
completely
vrhke
fever
pounds
Pov
- ten
Ricardo vs. Conventional Wisdom

news
Conventional Wisdom: centres
I “Competitiveness” is key to “win at trade” - pwdrunuty peer were term
gash rich
trade them
Ricardo: → says opposite
countries ,
I All countries gain from trade
I Countries gain from productivity improvements in other small centres
countries via more favorable terms of trade were

garh
I Exactly right with two countries: with more countries it fern large ,
depends on who becomes more productive
I Countries that compete with us for exports? more ambiguous
we want
-
I Countries that supply us with imports?

-
want to be more productive te
ferry n
END THIRD VIDEO improve
25 / 25
Welcome!
Lecture 6: General Equilibrium Analysis of the

Ricardian Model
Today we focus on solving for the general equilibrium of the
Ricardian model.
I Conceptual foundations
I Example (complete specialization)
University of Michigan I Example (incomplete specialization)
ECON 441
1 / 18 2 / 18
General Equilibrium in an Exchange Economy General Equilibrium in the Ricardian Model
Recall from Lecture 3 that a competitive equilibrium of the

endowment economy has two requirements: A competitive equilibrium of a Ricardian economy has three
requirements:
I Consumers maximize utility subject to their budget
constraints (demand) I Consumers maximize utility subject to their budget
I Market clearing (demand=supply) constraints (demand)
I Producers and workers make maximizing production
Supply in that case was given by the exogenous endowments. decisions, taking prices and wages as given (supply)
I Market clearing (demand=supply)
In the Ricardian model, we keep these requirements an add a
third: supply is generated by profit maximizing behavior of
firms (and wage-maximizing behavior of workers), given the These requirements hold in both autarky and in free trade; only
production technology and competitive input and output the outcomes are (potentially) di↵erent.
markets.
3 / 18 4 / 18
Supply in Autarky Supply in Free Trade

I Assume both goods will be consumed (utility has
Supply in free trade is basically similar, but now there is only
“sufficient curvature”) and hence produced
one world price price ratio but two PPFs.
I Wages in both sectors must be the same
I Profits in any active sector must be zero and negative for
I Profits in both sectors must be zero:
inactive sectors
Qty?
I E.g. either PW AW = w or PW Aw < w and Home does not
A
PW f-
· AW = w = PCA · AC
produce wheat
of
I If both sectors are active in a country, then we have
the
PWA M verse
AC -
shape of the pp F
) =
PCA AW O
ant .
price PW AC PA
ratio = = W
I Implies slope of budget line = slope of PPF PC AW PCA
I Implies indi↵erence between producing W and C ×
in FT
⇤
I Wages and prices adjust to make these equations true I Note: if AAC 6= AA⇤C then this cannot be true for both
W W
I E.g. if PW
A
· AW > w, wages rise countries \ different
I E.g. if PW slopes of PPF
are
A
· AW > PCA · AC , no cloth produced 2
rate cannot
,
price m te
both
be eep
DMM
5 / 18 at least
one
special led ,
6 / 18
tret
is completely that
is
has one
sector
not active
( if
diff )
Supply in Free Trade Fawkes
Ip¥IEiEyotw Computing Equilibria
!
autarchy
§
how of
w
Suppose we have pore In practice, use this procedure for computing equilibria:
MHM"
"
tnemveet-Z@aanp.n.a
art .
an
A
PW PW P A⇤ i) Solve for demand functions .
A
< C < W ii) Assume complete specialization according to CA
PC P PCA⇤
iii) Set supply=demand and compute market clearing price
I Then both countries must be completely specialized
ratio always find pure ruse lay
I Home specializes in W and Foreign in C
iv) If the result lies between (or equal to one of) the autarky
I We have w = PW AW > PC AC and w⇤ = PC A⇤C > PW A⇤W price ratios, we are done towel price rate then clears neuters
-
I Conclusions: v) If not, then we have incomplete specialization with the

I One or both countries completely specialize
=-D
appropriate autarky price ratio being the free trade price
I Incomplete specialization occurs when every price ratio -
ratio
strictly between the autarky price ratios leads to excess
demand (no market clearing) vi) In either case, plug equilibrium price ratio back into
( J
I In incomplete specialization, free trade price ratio equals the demand functions to solve for consumption in each country
autarky price ratio of the incompletely specialized country
END FIRST VIDEO
7 / 18 8 / 18
Example: Cobb-Douglas utility Example: Ricardian model in autarky
Let’s imagine the economy is in autarky. For Cobb-Douglas

-
Switch notation to goods a and b. utility we know that both goods are produced, so we have
price nano Enthymeme
good a
good y -
Let utility for both countries be given by ③ pa Ab
O= O
pa Aa = w p b Ab ) = Mamie Aof
-
pb Aa pneumatics
U (a, b) = a↵ b1 ↵
In
equilibrium
So we know what the price
arturefy
ratio is, and we know that at that
The demand functions are iruemg
price ratio producers are willing to produce any combination of
① a and b that is on the PPF.(Now we just need to know at what
✓
wage
w
O w -
a=↵· , b = (1 ↵) · point consumers wish to consume, given that price ratio.

J
alpha pa pb -
Plugging in our expressions for w and pa /pb into the demand

Here income will come from wages, which in turn depends on functions, we get
what is being produced.
⑥ a = ↵ · Aa , b = (1 ↵)Ab
9 / 18 10 / 18
Example: Ricardian Model in Free Trade Example: Ricardian Model in Free Trade
Step 2: Assume complete specialization according to CA
I Home produces a and Foreign produces b ✓ I =
✓
Let’s examine the case of free trade, with some specific numbers: I w = pa and w⇤ = 3pb Pa ( MP La )
w -
N w
A
2 I I Total supply of a is Aa · L̄ = 100
-
Aa
-
b
-
↵ = 1/2, L̄ == 100, L̄⇤ = 50

-
Mma 2. too @
AE
L
-
=
l
AE
.
l
-
-
-
Step 3: set supply equal to demand in the market for a and

-
Aa = Ab = 1, A⇤a = 1, A⇤b =3
of
LIMP L solve for the price ratio: Demand A heure + include Hr people
Xf
B
CAM
Step 1: the demand functions are
has
A
- y
→
1 1 pb
@ ·@
Home
100 = · 100 + 50 · 3
ON
forced 2 2 pa
1w 1w
a=
2 pa
, b=
2 pb
,
dee . .
,nwmt~
mene pb 2
-
FT price ratio
in
- y diff .
) =
1①w⇤ ⇤ 1 w⇤ pa 3
a⇤ =
2 pa
, b =
2 pb
.
Step 4: since /
AI
A's
YAY ~
pA pA⇤
✓
b 2 1
= 1 > > = bA⇤
pA
a 3 3 pa
an -
-
then we have a complete specialization equilibrium. Skip step 5.

11 / 18 12 / 18
tora
Ao
-
-
Equilibrium allocation Incomplete specialization?
Let’s keep most of the same example, but change Foreign’s
productivity in good a:
Step 6: plug the equilibrium price ratio (and incomes) into the '
demand functions to get the equilibrium allocation (per person): ✓ Trade 91
↵ = 1/2, L̄ == 100, L̄⇤ = 50
1 3
a= , b= ,
2 4
←
riff
-
-
ked Aa = Ab = 1, A⇤a = 2, A⇤b = 3
If we follow the same steps as before and assume complete

3
a⇤ = 1, b⇤ = . specialization, we get exactly the free trade price ratio:
2
Obi:÷F±÷m
pb 2
(
=
)
From here you can easily compute exports and imports. If you
pa 3 .
also solve for the autarky allocations, you can also compute the
gains from trade.
But now we have
END SECOND VIDEO
pA
b 2 2 pA⇤
= 1 > = = bA⇤
pA
a 3 3 pa
13 / 18 14 / 18
Incomplete specialization? Incomplete specialization?

Let’s change Foreign’s productivity in good a a bit more:
pA
b 2 2 pA⇤ ↵ = 1/2, L̄ == 100, L̄⇤ = 50
= 1 > = = bA⇤
pA 3 3 pa
a
Aa = Ab = 1, A⇤a = 5/2, A⇤b = 3
2k
WE STILL HAVE COMPLETE SPECIALIZATION! If we follow the same steps as before and assume complete
specialization, we get exactly the free trade price ratio:
All conditions for an equilibrium are satisfied, including that
producers in Home only want to produce a and producers in pb 2
=
foreign are happy producing only b (although they are pa 3
indi↵erent between producing a and b). And consumers are
happy to consume these amounts given the price ratio. But now we have
both will want to
But we are right on the edge of incomplete specialization... pA 2 5 pA⇤ paedrce A

b b
=1> < =
pA
a 3 6 pA⇤
a
15 / 18 16 / 18
Incomplete specialization Incomplete specialization

We know that the price ratio is pb /pa = 5/6 and that Foreign
pA
b 2 5 pA⇤ will incompletely specialize.
= 1 > < = bA⇤
pA
a 3 6 pa
To find the equilibrium consumption and production levels, we
This situation implies incomplete specialization.. plug pb /pa = 5/6, w = pa Aa , and w⇤ = pa A⇤a into our demand
The problem is that the price ratio needs to be 2/3 for functions to get the equilibrium allocation:
consumers to be happy consuming the complete specialization
1 3
bundle, but at that price ratio producers in both Home and a= , b= ,
Foreign only wish to produce good a. 2 5
There is excess demand for good b at a price ratio of 2/3. 5 3

a ⇤ = , b⇤ = .
4 2
On the other hand, there is excess demand for good a for every
complete specialization allocation with price ratio Total world consumption of a is 100 ⇤ 1/2 + 50 ⇤ 5/4 = 225/2.
5/6  pb /pa  1. Since Home produces 100 units of a, we know that Foreign must
produce 25/2.
Solution: need Foreign to produce both a and b. But producers
in foreign will only do so at price ratio pb /pa = 5/6. END THIRD VIDEO
17 / 18 18 / 18
Welcome!
back
step
theory
Lecture 7: Evaluating the Ricardian Model from
Today we will evaluate the Ricardian model’s ability to explain

Professor Dominick Bartelme the patterns of specialization and trade that we see in the world
I Many country, many goods extension (Deardor↵ 1980)
University of Michigan I Test of predictions (Bernhofen and Brown 2004)
I Problems with the Ricardian model
ECON 441
1 / 18 2 / 18
Predictions of the Ricardian Model Generalized Law of Comparative Advantage
In the two-country, two-good model we have that What if there are more than two commodities? More factors of
production? More countries?
I Countries export the good in which they have CA
I Trade causes specialization according to CA I Might export many goods
I There are gains from trade I Cannot sensibly define strict comparative advantage
I Alan Deardor↵ (1980) showed that a simple condition on
Some other “predictions” (e.g. complete specialization) are the negative correlation between autarky prices (CA) and
fairly unrealistic net exports in free trade still holds
I Testable version of the law of comparative advantage
Key Question: How do we translate these predictions to a
many-country, many good world? I Also provides proof of gains from trade
3 / 18 4 / 18
Correlation Weak Law of Comparative Advantage
Suppose there are N goods. Let pai be the autarky price of good
i, and let pfi be its free trade price. Let xfi cfi be production
Two variables x and y are positively correlated if high values of minus consumption at free trade, i.e. the quantity of net
x are usually observed together with high values of y, and low exports of good i. Assume competitive markets, maximizing
values of x tend be be observed with low values of y producers and consumers, and balanced trade, that is
P f f
I Negative correlation if x high when y low, etc i2N pi · (xi cfi ) = 0. Assume also that the production point
I Weak law can then be roughly stated as follows: countries is on the PPF.
Assumptions
are more likely to export goods in which they have low H
autarky prices
Weak Law of Comparative Advantage: Under free trade,
H
then put
Precise statement is slightly di↵erent, this is just for intuition X g-
,
.
t
pai · (xfi cfi ) < 0

-
i2N
tf high number
,
Epi must
be her number .
5 / 18 6 / 18
free trade price
§④
-
production good i
Proof Sketch about Aut .
prices
Testing the Weak Law
Need to show X X
pai · xfi < pai · cfi
i2N i2N fer looking at data
✓
exports imports I Weak law is great; all we need to know is autarky prices
I Economy could have produced autarky; the fact xfi under and exports to test the theory
that it didn’t means that
-
production -
I Exports are easy, recorded well in times past because of
has H X X customs duties (tari↵s) easiest to tox
be less
but
pai · xfi  pai · xai
why i2N i2N I The problem is autarky prices; very few societies with
row of revenue rev of autarchy records have everyg been in (even approximate) autarky
I At the autarky prices, consumers couldn’t a↵ord the free I Could also use “productivity” d
trade bundle, so I Difficult to measure \
X X
autarky prices come from productivity
Why ? pai · xai < pai · cfi
consumers prefer
FT
why in autarchy they
,
i2N i2N
didnt choose FT , must be
unaffordable
#
AN
tardy
.
END FIRST VIDEO

(
M hehe
not on PPF , only see budget 7 / 18 8 / 18
in one higher under trade
Autarky Japan Japan under free trade start 1859
But Bennett Brenn , -

t .
Japan is perhaps the only recent society to be well

approximated by the label “autarky”
I Policy of seclusion from 1639-1853
I Forced to end policy by the American navy in 1853
I Actual trade opened in 1859
I Actual trade increased rapidly
9 / 18 10 / 18
Japan under free trade Test
P
Test whether i2N pai (xfi cfi ) < 0
I Don’t actually see autarky prices that would have prevailed
after 1859
I Assume that those “counterfactual” autarky prices are on
-
average the same as those observed before 1859

I Assumes no adoption of western technology in comparative
disadvantage sectors during this time
I Collect price and export statistics; not that simple
11 / 18 12 / 18
Results Results
so we
expert
Trent turnt
products Cx)
have CA ,
pure n
importing
← CA disadvantage ,
exporting pied Lim)

→
→ inner negative
my
13 / 18 14 / 18
Summary Additional Evidence on Ricardo

mere broad arguments on
why CA is
import any in trade
I Fascinating, innovative paper I There is substantial empirical work comparative advantage

and trade carnations
I Pretty convincing on what was going on in late nineteenth -
I Regressions of relative exports on relative productivity

century Japan -
I Trade liberalization causes expansion of CA sectors -
commies at our
point in ar t .
I Not sure what it means about the world today expanded

I Fair summary: Ricardian comparative advantage has some
then
FT
I They have another paper on Japan’s gains from trade in explanatory power
this era, which they put at about 4-8% of autarky GDP I Plenty of variation that cannot be tied to (observable)
END SECOND VIDEO industry productivity di↵erences
15 / 18 16 / 18
Problems with the Ricardian Model Some things Ricardo doesn’t explain
adapt
courses
i) Where does comparative advantage come from? to
their
ii) Why does comparative advantage evolve over time? ✓ specializations

I Ricardian model very successful in some respects iii) Are there policies than can (and should they) change
not
but comparative advantage?
I Starting point for all thinking about trade-
end point
iv) What are the distributional consequences of trade within
I Idea of comparative advantage even more general than
↳ comparative crest differences countries? pieardrzm sees trade as identical btw counter ,
Ricardo but wes the case
)
v) Why do we see trade in similar goods between similar
I But there are some questions that Ricardo cannot answer I sunt on
countries? we can YusuinnndemIIT sanity
'
vi) How should we think about the role of large firms in trade?
/ vii) How should we think about international supply chains?

International END THIRD VIDEO
apply chains
U S
arent mended .
.
has
in prau trade very
become
17 / 18
political 18 / 18
Welcome!
Lecture 8: Ricardo with Immobile Labor

Today we begin our study of the within-country distributional
Professor Dominick Bartelme e↵ects of trade by modifying the Ricardian model to restrict
labor mobility across sectors
I Motivation and setup
University of Michigan I Distributional consequences of trade
I Gains from trade and redistribution
ECON 441
1 / 13 2 / 13
Motivation Setup in Autarky
I The Ricardian model is a “long run” model

I In the “short run,” workers are not completely mobile I Focus on Home
across industries I Two sectors, agriculture a and manufacturing m
I Plenty of evidence
I Mobility varies by time and place I Assume that autarky equilibrium has wa = wm = wA
→
I Extreme case: no mobility I Then standard autarky equilibrium has pA A
a /pm = Am /Aa
I How does this (or does it) change the conclusions from the I Assume pa /pm = 1/2 for concreteness
A A
“long run” Ricardian model?
I Does everyone in the economy still gain from trade?
3 / 13 4 / 13
Moving to Free Trade Free trade with mobility
I If trade opens up with complete mobility, then all workers

move to the agricultural sector
Autarchy price ratio is I I Manufacturing sector shuts down
I Assume the world or free trade price ratio is pa /pm = 2/3 I Real wages in terms of agriculture do not change:
I Assume workers cannot move from their current sector
I Wages will in general be di↵erent across sectors £
logical w wA
= Aa = A
I We use wa and wm for wage for workers in the agriculture pa pa
I
force
that
and manufacturing sectors I Real wages in terms of manufacturing go up:
coprolitesaeneg w pa pA
a wA
wages = Aa · > Aa · A = Am = A
seekers
is pm pm pm pm
tnhs
fact can
workersacross I Everyone gains from trade
move
sectors
5 / 13 6 / 13
Free trade with mobility
-
No mobility - the lucky ones
Manufacturing Assume workers are stuck in sector where they were employed
in autarky. Consider workers in agriculture sector:
I Intuitively, they cannot be a↵ected by immobility, because

they would not have wanted to move in the first place
I So their gains must be the same as those of any worker in
the standard case with mobility
I This reasoning uses a small open economy (SOE)
assumption
I Home is small in world markets
I World prices are the same no matter what Home produces
I Therefore, world prices are the same with and without
mobility in Home
-
I If Home is NOT small, they still gain (but gains can be

di↵erent than with free mobility)
Agriculture
END FIRST VIDEO simian
7 / 13 same is approximating 8 / 13
Herne is more similar

smaller ,
No mobility - the unlucky ones Generalizing

Now consider workers that were employed in manufacturing:
I With mobility, they would move to agriculture
I Workers stuck in sector of comparative advantage gain
I Now they cannot
from trade
I Real wages for workers in manufacturing sector in terms of
I Workers stuck in sector of comparative disadvantage lose
manufacturing don’t change: Qty
sane in
from trade Agriculture
/ I Their wage in terms of the good they produce stays constant
✓
wm wA
pm O
= Am = Am
pm
I Their wage in terms of good they don’t produce goes down
c -
I Key intuition: price of good in whichagriculture
>
country has
I Real wages in the manufacturing sector in terms of comparative advantage goes up, so if you don’t produce
agriculture fall: that good, you are worse o↵
wm w m pm pm pA w A pA wmA
END SECOND VIDEO
= = Am < Am m
A
= Am mA
= A
pa pm p a pa pa pm p a pa
I Conclusion: workers in manufacturing must be worse o↵
9 / 13 10 / 13
Gains from trade How about in practice?
I The country as a whole still gains from trade!

I Simple argument: I In practice, those harmed by trade are rarely if ever fully
I Country produces the autarky point under free trade compensated
I Implies that autarky consumption is still feasible (perhaps I Partial compensation is common
after some redistribution of income) I Unemployment insurance
I Can do even better by selling some agriculture and buying I Trade Adjustment Assistance (TAA)
manufacturing (since prices have changed) I Other safety net programs
I Another way to see it: equivalent to the endowment model,
where there are gains from trade I Other losers: owners of firms in the a↵ected industries,
I This implies that “winner” can in principle compensate owners of real estate in areas with plant shutdowns
the“losers” I It is difficult to calculate precise gains and losses for
I Standard argument for free trade: even if there are losers, individuals
in principle all could benefit
11 / 13 12 / 13
When does each model apply?
I The world is between perfect and zero mobility

I Regular Ricardian model applies to the “long run”
I No-mobility applies to the “short run.”
I More complex models have gradual adjustment from the
“short run” to the “long run”
I Next time we will see that adjustment can be slow
I Very useful for understanding current attitudes to
international trade in some parts of the world today
END THIRD VIDEO
13 / 13
exogenous as determined onside the model and imposed on model
endogenous → internal source
Problem Set 2
DUE February 11, 2021 by 6 pm EST on Canvas

I -
-
pywx
+
pywy
sewtien same as
previous prayers set → instead of I, income
depends on endowments ( w
y , Wy ) and puns ( Px .
Py )
Question 1 (Trade in an Endowment Economy). Consider an economy with two types of

consumers, which differ in their endowments: type-1 people own 10 units of good 𝑥 and none of
#
-
good 𝑦, while - type-2 people own none of good 𝑥 and 10 units of good 𝑦. Both types of consumers
like to consume both goods, with the same preferences over consumption bundles (i.e. the same
utility function). For each of the following utility functions, do the following:
a. Find the market equilibrium price ratio and optimal consumption bundles when there are
100 individuals of each type.
b. Find the market equilibrium price ratio and optimal consumption bundles assuming now
that there are 100 individuals of type-1, but only 50 of type-2.
Tip: You will need a numerical solver (such as Wolfram Alpha or MATLAB) to do the extra credit
question.
Common homothetic utility functions

1 2
1. Cobb-Douglas: 𝑈(𝑥, 𝑦) = 𝑥 3 𝑦 3
1 1 2
1 2
2. Constant Elasticity of Substitution (CES):𝑈(𝑥, 𝑦) = [( ) 𝑥 2 + ( ) 𝑦 2 ]
3 3
Non-homothetic utility function
3. Quasilinear: 𝑈(𝑥, 𝑦) = 𝑥 + log(𝑦)
1 3
1 1
4. EXTRA CREDIT: 𝑈(𝑥, 𝑦) = ( ) 𝑥 2 + ( ) 𝑦 4
2 2
Question 2 (Ricardian trade model with different utility functions). Imagine a world in which
the only factor of production is labor, where labor can move freely between industries, where there
is perfect competition in all markets, and where consumers have identical preferences in all
countries (that is, they all have the same utility function). The only two characteristics in which
countries differ is in (1) how productive their workers are in the production of different goods, and
(2) their population sizes.
Each of the following exercises focuses on a different utility function, compares the United States
with a different country, and focus on a different pair of industries/goods. For each one of them,
please respond the following questions:
a. Calculate the autarky equilibrium for each country, meaning the relative price, quantities
produced, and quantities consumed.
1
b. Calculate the free trade equilibrium, meaning the world relative price (same for both
countries), and quantities produced, and quantities consumed for each country when we
allow them to trade freely.
c. Calculate the gains from trade (GFT) of each country. Which country gains more? Why?
Tip: Re-use your work from Problem Set 1 and Question 1 of this problem set.
1. Cobb-Douglas
We focus on the United States and Mexico. Assume that the representative consumer in both
countries has the following Cobb-Douglas utility function:
1 2
𝑈(𝑥, 𝑦) = 𝑥 3 𝑦 3
where 𝑥 represents cars and 𝑦 represents machines. Moreover, assume that population (in
millions) in Mexico and the US is 𝐿𝑈𝑆 = 𝐿𝑀𝑋 = 1. The yearly productivity in car- and machine-
making of one worker in each country can be represented by the following table:
Cars (x) Machines (y)

US 10 20
Mexico 6 3
2. Constant Elasticity of Substitution (CES)

We focus on the United States and China. Assume that the representative consumer in both
countries has the following CES utility function:
1 1 2 1 2
𝑈(𝑥, 𝑦) = [( ) 𝑥 + ( ) 𝑦 2 ]
2
3 3
where 𝑥 represents airplanes and 𝑦 represents cellphones. Population (in millions) in China
is 𝐿𝐶𝑁 = 20 and in the US is 𝐿𝑈𝑆 = 1. The marginal products of labor are given below.
Airplanes (x) Cellphones (y)

US 1/2 1/4
China 1/4 1/2
3. Quasilinear
We focus on the United States and the European Union. Assume that the representative
consumer in both countries has the following non-homothetic utility function:
𝑈(𝑥, 𝑦) = 𝑥 + log(𝑦)
where 𝑥 represents machines and 𝑦 represents pharmaceuticals. Moreover, assume that

population (in millions) in the EU and the US is 𝐿𝑈𝑆 = 𝐿𝐸𝑈 = 1. Finally, assume that the yearly
2
productivity in machine- and pharmaceuticals-making of one worker in each country can be

represented by the following table:
Machines (x) Pharmaceuticals (y)

US 20 30
EU 40 60
4. EXTRA CREDIT (1 point)

Let us focus again on the United States and Mexico. This time assume that the representative
consumer in both countries has the following non-homothetic utility function:
1 1 1 3
𝑈(𝑥, 𝑦) = ( ) 𝑥 2 + ( ) 𝑦 4
2 2
where 𝑥 represents cars and 𝑦 represents machines. Moreover, assume that population (in
millions) in Mexico and the US is 𝐿𝑈𝑆 = 𝐿𝑀𝑋 = 1. The yearly productivity in car- and machine-
making of one worker in each country can be represented by the following table:
Cars (x) Machines (y)

US 10 20
Mexico 6 3
3
ECON 441 Problem set # 2
Karla Wong
,
goody goody
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Douglas Ulrey) -
-
x
y
2=4
specific demand
demand functions I 200
general
@ d.
Epb
tutor too
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a
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-
( I -
II)
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41=310
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puebbem Set 2 Answers
exogenous determined onside the model and model

as
imposed on
endogenous → internal source
I
pxwxtpywy
-
-
① sewtien same at previous problem set → instead of I ,

income
depends on endowments ( Wy ,
Wy ) and puns ( pre Py ) .
Agg Demand -
Agg Supply .
go
from individual Good x' ,wx' hwy
→
aggregate x
x D= v. x ! + Lux ? =L *
=
lol
,
(
'
( 10 ) tape Zs →
( } ;) ( O, )
'
) lo
u I
type Is w
→
w w = o
Yd Lif
,
x. y ,
Good Y E L, 49 t
y
'
hw
'
awry =
you
J
, ,
stock differ
may
[
Find equilibrium print ,
such that D
-
-
S in each nett
vid ! t Lili =
10L
,
v. 49 x
Lili =
lolz
One we have the

equilibrium prices ,
we can go
back to the mehri dual optimal bundles and calculate how much everyone will censure
way I pxwxtpyw ,
with
L Cobb 'T }
Douglas ✓ (x y)
prep
-
× y
.
, =
* * x*= (I )%YpHfI y* (3) PxwxmM4_

(E)Ip yep
.
Tremlett
problem set
-
:
y =
y =
,
,
demand and
we get showy agg .
the end "
ye =L
fqtzyoppng] (( 3) ioppy ) (F) thx)
'
( F)
+
, ↳ =
us + 's
from the
Yd ( ( 3) off] h(( E) off ) (F) (E) c. (3) y eonism meter

-4 =
-
+ +
Now
, equal AS
-
-
AD :
(E) 4. ( 5) (F) y
' -
104 (5) (F) he ¥ .

-
Ii
'
,
=
use , Main -
zu, Fiji .
-
2¥ →
p
! u(
1:(x7,y*n)=(F,E#
✓
*
I and [
⑨ if - too = 100
Type I # *
( Ffg)
z
Type '
p
If
=L
# a a :( xq.yqj.gg
relative pure p p ,
eqmwbnun
e-
Good 'T (E) to 'S ; (E) cop F) (÷)

.
=
x x
-
-
x -
- -
en : item : ⑥
÷:÷÷:Y÷÷⇐÷÷¥ : :÷÷÷÷÷i÷÷÷
ooo " ti
* -
÷:
' '
moment
-
- -
. .
eg er price
pet 4
,
.
=
.
UG -1 ) K 's)x 'T (E) YIJ

-
Z CEI
-
, +
from last pneblem set

x*= ( ypP÷y)PxuxptM
=
Plwxtpuyl definitions & warms
'
Lar
using
,
,
4 tp
Xd ( TIP) (Iff)
sewn
egret price by
ftp.kyxhep )
we :
get L,
(
* '
-
-
yp , +
↳
(yFpy ) P4%p;M
-
y (x)
=
Ytrxtpwy
,
of of markets
=
equilibrium one
pulp )
LOL
( Ifp ) ( 4th P ) ( Tff ) http
) '
D =
Tou
type 1 type 2 5 either Yu , Yp =L , p +
up
-
-
+
=
, ,
4¥ pot qf÷
'
'
47¥14
P
!
• 44 up
-
-
-
-
-
't
× -
¥q
Good x
x -
.
,
@
cxq.yetl-csb.stssadlxE.ykt-C63.to#p*--
#
y Emm ,
it - no
,
I
Goody it :
#
y
WE
-
⑧ cx9.im#.Erfaneecx:.yEI--(7FE FEI
F
"
Hi -
noo
, iotas ,
.
#
p qfz
=
3 .
Quasiuneen Vfx , -1 ) -
xthegly )
{ :-p
"
§ k¥9
Z
B
f TI
tpywyep Pnw >
{ k¥79
pxv fwm
+
wxtpwyc I
" wxtpwyc ,
y*
.
" , '
× = → A =
=
y* -
re mug =p .
-
i w
; I
we pw, z par . +
pay
-
pnw ,
-
+ .
spy ,
Wxtpwy I
pg
>
Px p
using
det and Walras law ,
we can
get eg.cl pure by .
sowing for the

egg .
of one
of truths ( in this case , good ) x
.
However ,
each centre → 2
possible demand → 4 sceneries
→ discard those inconsistent .
None ,
Type I aenhney never en Ist simarouba real income
( wxtpwy -
-
lo -
p O ) Tr
longer than I .
→
Type 2 consumers word donned
41 p units of
good y .
If
Type z
H be tht case
consumers were in
( not enough demand ) ,
word censure all endowment
,
barmy noting fer E te consume
↳ Wit eeorhbhm ,
heres only possible af .
wht be one
in which both
types of consumers
geste
censure both
goods :
Xd -
-
L
,
(9) +
↳ ( top 1) -
=
9L ,
-
↳ tulip
S -
D
gu ,
-
L
,
to lap -
w l
,
10 Lnp =L,
the p*= 4th Type I
Type 2
LOL ~
⑨ p*=¥ ( of -19) ,
-
( 9.5 ) and 69.19) -
( 5)i.
Good x x : -
a XI at
Lz
⑤ pet -
Yo ( -9,49 )
x z
( 9,3 's) and 69,47 ) Criss ) -
-
Goody 47 -
TIE y* .
-
1,7¥
m%#÷#
cars ( )
x
AFC ? )
#
=p
= ?
①
yen
Ricardian trade medium deterrent whwtytmctins
6
3
Borgias U Git ) } } @
a
MC
) per .
Cars Cx) machines ly)
Cobb )
y
1 US & Mexico →
y ( mill of units of )
-
( wit
-
x pure units
-
.
.
#
⑨ demand :
×*= (B) Ipx supply ,
n -
a
perf .
comp .
.
.
Px
-
IA py
=
Wf they Aff =
US Rs I xfs 33 you ist -
-
-
- s
,
-
,
, #
(3) ¥
*
Y =
↳
pug in demand functions .
MY
pm×=2 xdmx -
Z Y ! x
=
2
Is
*
x*__ Axl
y a
Zz Ay L
⑥ easiest way one long economy in autarky
from ( w) ,
saw rel .
price
of
machinery was { cars in the US and 2 cars in Mex .
→ opp .
cost of 1 machine in US =
Iz ,
while in Mex .
=L
cars be ) machines ( y)
would only
Supply → US
produce machines it
wrp ers verst I , while mere .
would
only nap in if the
up
is at least 2 ( mill .
Aunts)
( mill .
of units
)
Demery →
" "
Tqµywm
→ see it compute specialization is an
equilibrium
"
wuss Ayu spy way =p ×

Ax
xd ,
( wustpw.mx)
-
(5) (
At
"MtpYe) =
(f) Cupro) ,
gnawing.ie?ywD:6--LtsHwpxa smetnifnpgpmuh.info?mpnum-mnehemeanequirbmm
Y
"
) p
-
Z
US × Is -
4 YI,
-
-
134
-
Mex x dmx =
2 Yeux = 6 }
② Gains fern
-
Trade
is
Cpenertage)
'
EV
'
what the consumer would

equivalent and due to free trade
the percent change in income in
autarchy
that be to the mneme
price changes
'
,
"
in terms of its impact on

utility ?
¥i¥/E
Anarky Trade GET
Tor womotwtr utility functions → EV defined

by :
Ev (p d ,
ut
,
VA ) =
VIA -
2 US
-
• ' mate we
ecpm-j.vn#zeCPmx.u-hxk4tuEVwxr-
ar mes * um aus
pug opium maces +* ,
'
on mum hey 1237 .
mlymhr8wrgerGfT÷ be FT
price
runs hose te US
Marky pre
MN
and far from Mex 's !
( much lower absolute
productivity)
difference by dynamic and
hmm UA ?
Department of Economics Winter 2020 Department of Economics Winter 2020
University of Michigan Economics 441 University of Michigan Economics 441
9. When a country’s dynamic comparative advantage di↵ers from its static comparative advantage,
it may wish to delay opening to trade until its dynamic CA sector becomes productive enough. T
Econ 441: International Trade 10. Absolute advantage is irrelevant for explaining the pattern of trade, i.e. who exports what, in
Prof. Dominick Bartelme the Ricardian and H-O models. T
Winter 2020 2 Mulitiple Choice

Phantom
Midterm Exam sandy
model
nxersndy
-
Each question is worth 2 points. Some questions will come in sets of two or more questions that
refer to the same basic scenario. The questions within these sets are arranged in terms of order of
difficulty; if you can’t do the last question in a set then move on to the next questions.
February 21, 2020 Consider the two country, two good Ricardian model. For concreteness, lets think of the U.S.
and France, which can produce either agriculture (A) or manufacturing (M). We have M P LUAS = 3,
M P LUMS = 2, M P LFAR = 1, and M P LFMR = 2. Preferences in both countries are given by the utility
Please write your full name and umich id on your scantron. function U (A, M ) = A+ln M . The respective populations of each country are L̄U S = 1 and L̄F R = 1.
You may use scratch paper (provided) or the exam to work out your answers. Let’s assume that workers can split their time across industries, so it is perfectly possible for a country
You have 80 minutes to complete the exam. Please hand in both the scantron and your exam to allocate (for example) 1/2 units of labor to agriculture and 1/2 units to manufacturing.
paper. A
11. Which country has comparative advantage in agriculture? Which country has comparative
advantage in manufacturing? F
1 True/False where can , y
(a) France has comparative advantage in agriculture, the U.S. in manufacturing
Each question is worth 1 point. Mark a) for True and b) for False. ?? fmdtnisirfe ?
[
(b) It is impossible to tell
1. One explanation for why Prasad, Rajan and Subramanian find a negative correlation between
\ -
country growth and net capital inflows is that fast growing countries may have (on average)
e
(c) The U.S. has comparative advantage in agriculture, France in manufacturing
(d) The U.S. has comparative advantage in both agriculture and manufacturing
weak financial systems that limit domestic investment. FT
both hhnete be
countries
completely 12. Compute the autarky price ratio PA /PM for both the U.S. and France.
2. The two-country, two good Ricardian model predicts that at least one country will always speerblited
Yaeger
\ Wb fr
completely specialize in a free trade equilibrium.
XF
3. Paul Krugman argues that a country with a lot of sweatshops can improve worker welfare by
(a) PA /PM = 3 for the U.S. and PA /PM = 1 for France
Eg 2
= (b) PA /PM = 2/3 for the U.S. and PA /PM = 1/2 for France
legislation that mandates improved wages and working conditions.
TIF
@
(c) P A /PM = 2/3 for the U.S. and PA /PM = 2 for France
4. The Heckscher-Ohlin (H-O) model with capital and labor, and with identical technologies across
- (d) PA /PM = 3/2 for the U.S. and PA /PM = 1/2 for France
countries, is remarkably consistent with the data on the factor content of trade. F
5. In their article on Japan’s opening up to trade, Bernhofen and Brown found that Japan exported rain'TTmYorKe
\
Q
13. Compute the equilibrium world price ratio PA /PM under free trade.
-
every good with an autarky price lower than the world price, just as predicted by the law of should
comparative advantage. tf
price because
with X I
(a) 3/4 learn how
? be
te compute
's
€ I
(b) 1 MPL
6. In the static Ricardian and H-O models, it is impossible for a country as a whole to lose by eqmhbnm =3
going from autarky to free trade. That is, any losers can always be compensated by the winners
(c) 4/3 = I } world
to make everyone better o↵. T (d) 3/2 = l 'T MU Mpv 'm -
z
7. In the H-O model with capital and labor, domestic workers lose from the arrival of immigrants
in their country.
F II -
- t
%n= Im m
-
PAs mpun.mu .
2
8. Contrary to popular claims, the proportion of the population that are first-generation immi- pm
Pmma PAA I
2
grants has not significantly increased since the 1980s in most U.S. and European countries. f MPL
-
-
I
+
PAA - I
1
Patpn A.
- I
2 UCA ,
M ) I
Atlhm
PACHA ) - I
I
A=→m Etr
-
-
I
set S
-
- D
( A
us

sperrhlizeih Economics 441 University of Michigan Economics 441
✓
MM
aguwltme
US
14. Suppose now that U.S. productivity in agriculture increases by a factor of 10, to M P LA = 30. Consider a Heckscher-Ohlin model with two countries, the U.S. and China, and two industries,
What will the equilibrium pattern of specialization under free trade look like? manufacturing and services. Assume the normal HO assumptions, e.g. constant returns to scale
production, homothetic preferences, etc. There are two factors, college and non-college workers. The
ve
(a) The U.S. will completely specialize in agriculture and France will completely specialize in
manufacturing
U.S. is endowed with 200 college workers and 182 non-college workers, while China is endowed with
200 college workers and 1000 non-college workers. Manufacturing is intensive in non-college workers,
(b) The U.S. will completely specialize in manufacturing and France will completely specialize while services are intensive in college workers. It is physically possible to trade both goods costlessly,
in agriculture although policy might impose barriers on trade. The countries start in autarky, but they are both
contemplating moving to free trade.
I
(c) The U.S. will produce both agriculture and manufacturing, while France will completely
specialize in manufacturing 17. If the countries move to free trade, who will export what product?
(d) The U.S. will completely specialize in agriculture and France will produce both agriculture
and manufacturing e
(a) China will export manufacturing and the U.S. will export services
(b) The U.S. will export manufacturing and China will export services
15. Now lets go back to the original problem, with M P LUAS = 3, and imagine that in autarky we (c) There will actually be no trade because the autarky prices will be equal!
have the following labor allocations: LFM = 1, LFA = 0, LM
US
= 1/3, and LAUS
= 2/3. Now the (d) Both China and the U.S. will export both goods, because the curved PPF means that
two countries move to free trade, but workers are stuck in their autarky sectors. Pick the false complete specialization is not desirable.
www.inwoFfesipietn.eofifwd
statement about the resulting free trade equilibrium.
O
18. Continuing with the same example as the previous question, suppose the government in each
(a) In this equilibrium, P /P will[ be higher than in the case with free labor mobility across
✓
A M
country holds an independent vote to determine whether or not to move from autarky to free
sectors analyzed above in question 13
trade. Each person gets a single vote, regardless of college or non-college status. Each person
②
(b) The U.S. has higher gains from trade than in the case with free labor mobility, in the
sense that everyone could be made better o↵
cares only about their narrow economic interest when making their voting decision, and they
all took ECON 441. Moreover, the government has ruled out any transfers from one group to
(c) Both countries still gain from trade in the sense that winners could compensate losers and another, either in autarky or free trade. What will be the outcome of the vote?
still be better o↵ than they were in autarky
(a) China will vote for autarky and the U.S. will vote for free trade
(d)
\No one loses from trade in France
(b) China will vote for free trade and the U.S. for autarky
16. According to the Ricardian model with two industries, two time periods, and learning by doing (c) China will vote for autarky and the U.S. will vote for autarky
in the home country “infant industry,” the government should choose autarky instead of free
trade only if o
(d) China will vote for free trade and the U.S. will vote for free trade
19. There are two factors, labor and capital, and two goods. A labor-abundant country facing a
g
(a) The learning by doing e↵ect is strong enough that, in the second period, the infant industry wave of immigration should expect the wage-rental ratio to
is actually more productive than the other industry
(b) The revenue from specializing in the infant industry in both periods exceeds the revenue (a) Decline
from specializing in the other industry in both periods (b) Stay the same as long as factor prices are equalized around the world, otherwise decline
O
(c) The learning by doing e↵ect is strong enough and the gap in the initial sectoral producti-
vities is small enough
o
(c) Stay the same as long as the relative goods prices don’t change, otherwise decline
(d) Stay the same as long as the labor intensive industry expands, otherwise decline
(d) The gap between the initial productivities does not exceed the number of time periods, 2
3 Bonus Questions
Each question is worth 1 BONUS point. These points are added to your score AFTER the exam is
curved. They can only help your grade.
20. Consider a labor-abundant country (Mexico) in the 2 country, 2 good, 2 factor (capital and
labor) Heckscher-Ohlin framework. Maintain all the assumptions of that framework, except the
assumption of homothetic preferences. Instead, assume we have non-homothetic preferences of
some type. Pick the statement below that is definitely true of the standard Heckscher-Ohlin
model, but could be false in the model with non-homothetic preferences.
3 4
University of Michigan Economics 441 University of Michigan Economics 441
(a) In a free trade equilibrium, an increase in the number of workers will result in an expansion 4 Answers
of the labor-intensive industry in Mexico
D
(b) In a free trade equilibrium, Mexico will export the labor-intensive good 4.1 True/False
(c) In a free trade equilibrium, Mexico will export the good in which it has the lowest autarky 1. True
relative price
2. Falso
(d) In a free trade equilibrium, Mexico’s factor price ratio will equalize with that of its trading
partner 3. False
4. False
5. False
6. True
7. False
8. False
9. True
10. True
4.2 Multiple Choice

11. c
12. c
13. b
14. a
15. b
16. c
17. a
18. d
19. c
4.3 BONUS
20. b
5 6
penney
problem set 1 83
(( 3) x'EE )yt5
,
@CEfvCx.y)
-
Z
-
Ex
:
.i ÷x÷J%%
x
F- HEHE n'THE -
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is , -7
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¥ -
4's Iii) ( 354 =¥¥

isgytiffty
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)
= -
why would we saw
pxxtx.lu#I)--
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91%7 Not
8%87 ?
¥ they Aff
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-
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t -
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f-y 'T
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yzzlF-ix.PK
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-
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z
x
¥
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xtuegcyy ,
o÷:i÷ ¥¥¥= It:# i

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Riley)
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.
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4=17 yappy
,
, pxxxpx I
Pxdf=÷
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(ftp.yy
-
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FETE . . .am
Exam perren
Endowment Economy Example
too I apple per

tbh)
mere "
Ufa b) 't
.
=
(
IEpb÷T
n
Pg
too ,
that
can 2 bananas
per
Path)b
.
=
a .
Bbt -
-
I
step 2 :
find the Demand functions b (B +
Pa ( PPI ))
-
-
I
b
T
b÷ IE EIC;i÷I
a
Emei b'Yeti} IIIa

-3
Es Ca 's xzb , Fa by p.si I
-
.
- ma
-
.
-
. a
-
= -
Cains ⇐ b- y
'
some
baP#I(p÷ ra)
ter
"
( P (PET
'
l )
( Faya
Pa -
I
I a +
paa
-
p.
-
+ .
t÷a ¥p÷
know from two m h m is
problem sets
:
a =
I b
,
-
I
-
. Pa
step 2 : Find the inning

gendarmes of apple
- mu
for each
Income
person is
just evehenmeuy pure of that good Mex i
1 apple pa pa
-
× =
Carr :
2 bananas
.
Pb z
Zpb
step 3 : set 8 =D to find
eqnhbnwn pure
rate
( FILM I
from earlier
lo-FI
-
IIE For Comedians
,,P§-
of t
total supply 100
yoo
"
I
apples Mexican
=
Demand
④
:
from
fer apples
.
zpb soo
. .
.
.
=
=
"
He of apples
P
Pb
alL t
were rang
Pb
Income
i÷ 7÷÷ :# UE ftp.T F
in -
-
'
it ' -'
a
- -
-
. te trd 4 , apply the
. ✓ incomes ! ! ! !
Hep Y :
Fmd the consumption by each type of
person
"
YIU 2¥fu= TITE
TIE
al b
,÷
=
Fru
'
ante bmx
-
-
= =
functions
Pulpy of demand
,
Pws mu
-
me - back me the :
Bradman Example
at where
everything sane → MPL :
TEA -
-
I
,
TTA -
-2 7am
'
=L
,
Tom -
I
,
A- manky path
-
-
W "
Pb Tb ( bc labor
freely mobile +
food goods produced ) Ppg =
Tyla
we
already know equilibrium pm
're mine
→ demand truths and tmd allocating

ptg puree rope inte the
,tI÷
but
!÷a Ig pafpbe edge
"
am
The demand functions b Canada
pafpb al Ig Mep bmx
:
:
are a
- =
-
2 se -
=
I so =
w
-
,
,
, ,
,
can be
) or
(Fm
Pa mere ,
for
Zpb or Pb
pa
and must
be efral
Free Trade it specialization Total word B

complete supply neo
:
demand functions Total word

use
( supply A
same complete specialization apples) 100
:
assume can ,
→
bananas ,
mere →
set S =D to find equilibrium price rate

Pff
-
-
F ( same as endowment ) of E z
? yes ! Found rate
e
is e
eq pure
.
Free Trade w/ incomplete special intake
A- of cam :
too → tooo ?
Under Pet unprofitable for Comedian firms

happens when FT of B below Can
of
& d ar t
comp specialization Apple 100 Banana :
Lovo price bananas prize
'
.
: .
.
, of
pure bananas
100
2000-4-2
Cheek using
Ppf
market
charring condition for
Tj
apples :
too t
off in complete specialization ! ! !

=
=
> z
,
I +
Pp b
Carmela wuss produce apples and palps the Canadian

outages partie
be 22
. . .
pure rage must ,
↳ under
Find demand specialization
use same
autarchy logic
this
,
with incomes
given by complete
of Mex in apples and in uenrp
.
spec . in can .
Pa -
II
q
-
la
In MY ,
In Canada consumption must be the same as M

autarky ( since
prices and
autarchy) aw 4g
are as
but
incomes same
}
in
amy bmx }
,
}
,
=
, =
,
Total prediction
of
apples is
1100/3 ,
whereas total production of bananas is 4400/3
T T
( 34 ooo ) x Ihop ) ( ¥40007

'
+ FC IND
a
Welcome!
Midterm #1 Exam Review

Today is an exam review session. We will focus on solving
two-country, two-good models of trade.
Professor Dominick Bartelme I Conceptual foundations review
I Example (endowment economy)
I Example (autarky)
I Example (complete specialization)
I Example (incomplete specialization)
ECON 441
1 / 19 2 / 19
General Equilibrium in an Exchange Economy Endowment Economy Example

There are two goods, apples (a) and bananas (b), and two
countries, Canada and Mexico. There are 100 Mexicans who are
endowed with 1 apple apiece, and 100 Canadians who are
endowed with two bananas apiece.
Recall from Lecture 3 that a competitive equilibrium of the
endowment economy has two requirements: Everyone has CES preferences over apples and bananas,
I Consumers maximize utility subject to their budget ⇣ 1 ⌘
1 2
U (a, b) = a 2 + b 2
constraints (demand)
Steps to solve the problem:
Supply in this case is given by the exogenous endowments. i) Find the demand functions
ii) Find incomes
iii) Set supply equal to demand in one market to find
equilibrium price
iv) plug equilibrium prices back into demand functions to find
consumption of each good
3 / 19 4 / 19
Endowment Economy Example Endowment Economy Example

Step 3: Set supply equal to demand to find equilibrium price
⇣ 1 1
⌘2 ratio
U (a, b) = a + b 2 2
We will use apples (we could easily use bananas instead). The
total supply of apples is 100 · 1 = 100.
Step 1: Find the demand functions.
Total demand for apples from Mexicans is
We know from the problem sets that the answer is
1
1 1 pa 100
pa pb pa · pa · 100 =
a= pa · I, b= pb · I, 1+ pb 1 + ppab
1+ pb 1+ pa
Step 2: Find the incomes Total demand for apples from Canadians is
1 pb
Since Mexicans each have 1 apple, their income is pa . Since pa 200 · pa
Canadians each have 2 bananas, their income is 2pb . pa · 2pb · 100 = pa
1+ pb 1+ pb
5 / 19 6 / 19
Endowment Economy Example Endowment Economy Example
Step 3: Set supply equal to demand to find equilibrium price

ratio
Step 4: Find the consumption by each type of person
So we have total supply of apples equals total demand implies p
that Plug the price ratio pa /pb = 2 back into the demand functions:
100 200 · ppab p
100 = + 1 2 2
1 + ppab 1 + ppab aM X = p , bM X = = p ,
1+ 2 1 + p12 1+ 2
pa pb p p
) 1+ =1+2
pb pa 2 1 2 2
aCA = p , bCA = 2 = p ,
✓ ◆2 1+ 2 1 + p12 1+ 2
pa
) =2
pb
And we are done!
pa p
) = 2
pb
7 / 19 8 / 19
General Equilibrium in the Ricardian Model Ricardian Example
A competitive equilibrium of a Ricardian economy has three

There are two countries, Mexico and Canada, and two goods,
requirements:
apples a and bananas b, with utility function
I Consumers maximize utility subject to their budget ⇣ 1 ⌘
1 2
constraints (demand) U (a, b) = a 2 + b 2
I Producers and workers make maximizing production
decisions, taking prices and wages as given (supply) There are 100 Canadians and 100 Mexicans. The marginal
I Market clearing (demand=supply) products of labor are
TaCA = 1, TbCA = 2, TaM X = 1, TbM X = 1.

These requirements hold in both autarky and in free trade; only
the outcomes are (potentially) di↵erent.
9 / 19 10 / 19
Autarky Autarky
The demand functions are
I Recall that, in autarky when both goods are produced, we 1 1
must have (in each country separately) pa pb
a= pa · w, b= pb · w,
1+ pb 1+ pa
pa T a = w = p b T b
I This implies that, in autarky, In Canada, pa /pb = 2, so
pa Tb 1 4
= aCA = , bCA =
pb Ta 3 3
I This implies that we already know the equilibrium price In Mexico pa /pb = 1, so
ratio, based purely on supply side considerations
1
I So we can just plug this price ratio into the demand a M X = bM X =
2
functions and find the allocation
And we’re done!
11 / 19 12 / 19
Free Trade Free Trade with Complete Specialization
In practice, use this procedure for computing equilibria under
Now return to our example, and suppose that Canada and
free trade:
Mexico begin to trade freely. We already know the demand
i) Solve for demand functions functions (same ones).
ii) Assume complete specialization according to CA Now we assume complete specialization according to
iii) Set supply=demand and compute market clearing price comparative advantage. This implies that Canada specializes in
ratio bananas and Mexico specializes in apples.
iv) If the result lies between (or equal to one of) the autarky Note that this implies that the total world supply of bananas is
price ratios, we are done 200, and the total world supply of apples is 100. Note also that
v) If not, then we have incomplete specialization with the each Mexican’s income is pa while each Canadian’s income is
appropriate autarky price ratio being the free trade price 2pb , and there are 100 of each nationality.
ratio
Once we “know” that we have complete specialization, becomes
vi) In either case, plug equilibrium price ratio back into
identical to endowment economy model.
demand functions to solve for consumption in each country
13 / 19 14 / 19
Free Trade with Complete Specialization Free Trade with Incomplete Specialization
Set supply equal to demand to find equilibrium price ratio What happens if we increase the number of Canadians from 100
to 1000?
So we have total supply of apples equals total demand implies I Under complete specialization, there would be 10 times
that more bananas in the world (but no more apples).
100 200 · ppab
100 = pa + I Relative price of bananas would go down..
1 + pb 1 + ppab
I Potentially, down so far that it becomes unprofitable for
pa pb Canadian firms to produce bananas.
) 1+ =1+2
pb pa I That happens when the free trade price of bananas falls
✓ ◆2 below the autarky Canadian price of bananas.
pa
) =2
pb Let’s check using the market clearing condition for apples:
pa p
) = 2 100 2000 · ppab
pb 100 = +
1 + ppab 1 + ppab
p
Is 1  2  2? Yes! We have found the equilibrium price ratio! pa p
) = 20 > 2.
Same consumption as in endowment economy as well. pb
15 / 19 16 / 19
Free Trade with Incomplete Specialization Free Trade with Incomplete Specialization
This situation implies incomplete specialization This situation implies incomplete specialization
We know that Canada must also produce some apples, AND the We know that Canada must also produce some apples, AND the
price ratio must be pa /pb = 2, the Canadian autarky price ratio. price ratio must be pa /pb = 2, the Canadian autarky price ratio.
We find the demand for apples and bananas under this price We find the demand for apples and bananas under this price
ratio, with incomes given by complete specialization of Mexico ratio, with incomes given by complete specialization of Mexico
in apples and incomplete specialization for Canada. in apples and incomplete specialization for Canada.
17 / 19 18 / 19
Free Trade with Incomplete Specialization
The demand functions are
1 1
pa pb
a= pa · w, b= pb · w,
1+ pb 1+ pa
In Canada, consumption must be the same as in autarky (since

prices and incomes are the same as in autarky)
1 4
aCA = , bCA =
3 3
In Mexico we have
1 4
aM X = , bM X =
3 3
Total production of apples is 1100/3, whereas total production
of bananas is 4400/3.
19 / 19
Welcome!
Lecture 9: Empirical Evidence on

Distributional Consequences of Trade
Today we look in detail at some empirical evidence on the
distributional e↵ects of trade
I Worker-level evidence from the United States
I Consumption e↵ects along the income distribution
ECON 441
1 / 17 2 / 17
Worker-level evidence from the US Rise of China
I Autor, Dorn, Hanson and Song, ”Trade Adjustment:

Worker Level Evidence,” The Quarterly Journal of
Economics, vol. 129(4), pages 1799-1860.
I Evolution of wages and employment for US workers in
industries that compete most directly with China
I This is relevant in light of the huge expansion of China in
world trade.
3 / 17 4 / 17
are
Empirical Strategy Trade Exposure

gamp
I Measure worker’s ”trade exposure” by growth in US
imports from China over 1991 to 2007 that occurred in a
worker’s initial (1991) industry of affiliation
00
5 / 17 6 / 17
Empirical Strategy Results
I Worker level data from the U.S. Social Security

Administration
*
&:L import
:c::
surge
from China,
I Study e↵ects of “trade exposure” on cumulative earnings, had lower

county s
to
compared
employment, movement across sectors, and receipts of those who
competed .
Social Security benefits over the period 1992 to 2007

I Econometric strategy: instrument for the change in US
US
imports from China using import growth in other high
-
being
un
he wpetitioe
income countries for that industry
I Control for capital intensity, measures of computer and
high-tech equipment investments
7 / 17 8 / 17
Interpretation (column 9) Disability Insurance

I Compare manufacturing worker at the 75th percentile of
the change in trade exposure (7.30 percentage points) with
a manufacturing worker at the 25th percentile (0.62 I Trade exposure predicts a significant increase in years
percentage points). receiving SSDI as the primary income source.
I The implied di↵erential reduction in earnings over the I Comparing the 75th and 25th percentiles again, the more
16-year outcome period for the worker at the 75th trade-exposed worker spends an additional half month
percentile is roughly 46% (-6.86 * (7.30 - 0.62)) of initial receiving SSDI benefits as the primary income source
annual earnings. during the sixteen year outcome window.
I The negative e↵ect on reduced earnings works through I To place this magnitude in context, the average
both lower earnings when employed and less employment, manufacturing worker spends approximately five months
although lower earnings is the stronger channel. (0.43 years) over the same period with SSDI benefits as his
I Estimated that earnings are di↵erentially reduced by 2.6% or her main income source.
per year (-0.39 * (7.30 - 0.62)) for a worker initially
employed in an industry at the 75th percentile of exposure
to a worker at the 25th percentile of exposure.
9 / 17 10 / 17
Limitations Consumption e↵ects along the income distribution

I Trade can can have economy-wide e↵ects on workers wages,
which are not captured here
I What about later generations of workers?
I Could there be displacement from higher paying Fajgelbaum, Pablo D., and Amit K. Khandelwal. ”Measuring
manufacturing jobs to lower paying service sector jobs or the unequal gains from trade.” The Quarterly Journal of
non-employment? Economics 131.3 (2016): 1113-1180.
I On the other hand, new/better jobs could emerge for people
with those skills I Consumption baskets vary along the income distribution
I Also, all workers benefit from cheaper products from China I E.g. poor spend higher proportion of their income on food
I Should not be interpreted as an estimate of distribution of I Trade a↵ects the prices of di↵erent goods di↵erently
costs OR benefits of trade with China I Does trade lower consumer prices more for rich or poor?
I There are also geographic e↵ects: see Autor, Dorn and
Hanson (2013) in the American Economic Review
I Some evidence that the “China e↵ect” no longer operates
today
END FIRST VIDEO

11 / 17 12 / 17
Procedure Model
I F& K use a “quantitative” Ricardian model with many

goods
I Fajgelbaum and Khandelwal compute the equivalent
I The “same” good produced in di↵erent countries are cars
in
variation associated with trade (relative to autarky) for a imperfect substitutes for one another
✓ Germany
the same
not
large number of countries and income groups within I Allows many countries to produce the “same” good as cows in
us
countries
I Workers have di↵erent productivity levels, generating
I Ingredients:
di↵erent income levels
I Autarky prices, incomes, and utility levels
I Free trade prices, incomes and utility levels
I Di↵erent goods have di↵erent income and substitution
elasticities
I Only free trade prices and incomes are observable in I Substitution elasticity: by how much does a percentage
principle, although in practice they are not increase in a good’s price reduce its consumption? If PT consume
I Income elasticity: by how much does a percentage increase

,
I Need a model to infer these quantities less or
less ?
in income cause consumption to rise? HE
|
I Estimate parameters from aggregate trade data
issue :
we deny
ye tiny Wtsi luxury

u
13 / 17 14 / 17
autarchy pith ' / goods
snot elias Fury and
out .
> necessities
z
in
! we elasticity
< I
Findings Findings
from
poor yarn
trade were them
✓ rich
I Trade is “pro-poor” in every country

I On average, gains from trade are approximately twice as
large for poor (10th percentile) as for rich (90th percentile)
I Reasons
I Poor consume more heavily traded goods (e.g. food,
clothes, appliances) ✓ avg
.
I Rich consume more services, which are not as heavily traded

I Poor also consume more goods for which variety is
important
-
T
food
l
myth ,
I
different but doesnt
want no
wear
kinds of food guns ,
I 15 / 17 just 16 / 17
means
makes
germs reunion
of trade btfglr tempore
-
fer feed on these uke

as
2x
much
.
who value that variety
Summary and Limitations
-
trade is preparer ( consumption un
)
I Findings are confirmed by studies using micro data on
consumption choices (e.g. Cravino and Levchenko 2017),
although there is some evidence to the contrary (e.g.
as consumers
Borusyak and Jaravel 2018) people ,
earners of net
I Does not model whether or not poor are more likely to income
work in comparative-disadvantage sectors or jobs in some / to

due
countries (next series of topics) → are poor people nicely jobs te use
I Highlights that empirical work in international trade is trade ? Dees tag net . .
.
often model-specific only consumption =

-
END SECOND VIDEO
17 / 17
Welcome!
Lecture 10: Heckscher-Ohlin Model

Today we study the Heckscher-Ohlin model of trade with two
mobile factors of production
I Motivation and introduction
I Cobb-Douglas production and the PPF
University of Michigan I Factor intensity and factor abundance
I Autarky equilibrium
ECON 441
1 / 16 2 / 16
Review of Ricardo Limitations of Ricardo
I In Ricardo, comparative advantage itself has no

I Countries specialize according to comparative advantage explanation
I Aggregate gains from trade I Only one factor of production
I Factors trapped in comparative advantage sectors gain I One idea: comparative advantage comes from di↵erent
- from trade factor endowments (capital vs. labor, college workers vs.
workers I non-college workers)
Factors trapped in comparative disadvantage lose from
trade I Since di↵erent factors are useful for producing di↵erent
goods, di↵erent factor endowments give rise to comparative
advantage
3 / 16 4 / 16
Limitations of Ricardo with Immobile Labor Heckscher-Ohlin Model
I A “short run” model: factors are stuck

I In the “medium run,” most (all?) factors are mobile
/
yamamoto •
ahead
eulogies
of
capital
I Two countries, two goods (shoes and computers)
I Two mobile factors of production, K and L
I Traditionally K is capital, but we can reinterpret it as
“skilled labor” when necessary
I In the “long run,” many factor supplies are also I Factors are used in di↵erent proportions across sectors
-
-
endogenous (growth theory) memory I Equivalently, factor intensities di↵er across sectors
in ur
H-O model is a “medium-run” model: factor supplies are fixed, mat I Other assumptions:
but factors are mobile across sectors. Distributional e↵ects arise treed I Perfect competition ✓
it
you
double input inte
I be
I
will 2x
pwdrchen output
from di↵erent factor intensities across sectors. Constant returns to scale production ,
genome
more I Identical and homothetic preferences
END FIRST VIDEO capital
/ I
I
Identical technologies across countries
Di↵erent factor endowments across countries (factor
same
abundance)
production
functions \
will differ
5 / 16 6 / 16
Factor intensity The curves never intersect
this is
because
to the orgy of
✓ computers ,
We say that shoes are labor-intensive relative to computers if, @ so we knew

labor-intensive
shoes
compared
are
to
for all factor price ratios w/r,

O we have computers
- rental ( capital )
/ L
rate
wage S LC
>
( labor ) KS KC
means less
In general, as wage becomes bigger ,
That
,
workers wanted
fw L expensive be more
") # for all sectors

r K
The assumption is that, as w/r #, shoe production never
becomes more capital intensive than computer production
7 / 16 8 / 16
Cobb-Douglas Production Cobb-Douglas production
YS = L↵S KS1 ↵
Dividing each industry’s FOCs by each other, we get
YC = LC KC1 Shee computer
↵ KS w KC
Producers solve the following profit maximization problems: cost cess whoever
1
-
·
↵ LS
=
r
=
1 ① ·
LC
of labor of capital
bragger Inge ( rental
( )
mine
max PS L↵S KS1 ↵
wLS rKS hey replaying;mguml
implicitly exponent Producers face the same wage and rental rate, but make
defines how
much of good they produce
On l di↵erent choices because the production functions di↵er.
) If ↵ >
wary to
max PC LC KC1 wLC rKC will be

then LS /KS > LC /KC for all w/r ) shoes are labor
labor -
Taking first order conditions, we have intensive intensive and computers are capital intensive
#
pure 045
c) Ys Mpc
of labor - MPK reused Note, like in the Ricardian model, that producers are happy to
Tv, ✓ ◆1 OKs ✓ ◆↵
(
↵ I rare
KS LS
↵PS =O
w, (1 ↵)PS =Otaru
r produce any quantity of output as long as these conditions are
LS KS satisfied.
be ✓ ◆1 ✓ ◆
KC LC
unconstrained ? PC = w, (1 )PC =r
LC KC
9 / 16 10 / 16
The PPF with two factors The PPF with two factors
Recall that the PPF at a given level of computer production is

defined as the maximum amount of shoes that can be produced,
given that level of computer production.
✓ tfepIkI
'
autre
cloth then
Formally, we have sacrifice
In Ricardian , D- a of
net
wheat
P P F (YC ) = max L↵S KS1 ↵ it is
LS ,KS straight .
s.t. YC = (L̄ LS ) (K̄ KS ) 1
There is no closed form solution for this PPF, but in the

problem set you will be asked to show that it is concave
whenever ↵ 6= .
END SECOND VIDEO

11 / 16 12 / 16
ppf is
wired ,
because of tauter
intensity
Autarky Equilibrium Producer maximization and the PPF
Conceptually, the autarky equilibrium is exactly the same as in The first order conditions for producer maximization, plus a)
the Ricardian model. the assumption of competitive labor and capital markets, and b)
labor and capital market clearing, together imply the following:
I Consumers maximize utility subject to their budget not inside
constraints (demand) crave I Production takes place on the PPF
I Producers and workers make maximizing production different I If both goods are produced, the slope of the PPF at the
9 decisions, taking prices and wages as given (supply) point of production equals the price ratio
Note that this same logic also holds in the Ricardian model.
The first and the third are exactly the same as in Ricardo. The However, in the HO model the PPF is not linear, hence the
details of the second are di↵erent, but the ideas are the same. algebra can get a bit complicated.
13 / 16 14 / 16
Equilibrium Autarky Equilibrium
I Consumer maximization: consumption in on the budget

line, at the point where the slope of the indi↵erence curve
budget
equals (the negative of) the price ratio line um
ben tangency
eqrhb conditions
-
I Producer maximization: production takes place on the

, refinements
,
conditions
-
tangency a t same
PPF at a point where the slope of the PPF is equal to (the occur
negative of) the price ratio

I Market clearing: production equals consumption
y (uehtt .
Curve
point
,
These statements will also be true in free trade, except that
market clearing applies at the world level instead of the country
level.
END THIRD VIDEO

15 / 16 16 / 16
watch
maybe
try
one again
. .
.
Welcome!
Lecture 11: Heckscher-Ohlin Model

Today we continue our study of the Heckscher-Ohlin model.
I Internatial equilibrium and the pattern of trade
(Heckscher-Ohlin Theorem)
University of Michigan I The factor content of trade
I Confronting the data
ECON 441
1 / 18 2 / 18
Heckscher-Ohlin Model mobile Assume Home is Capital-Abundant

across
sectors
I Two countries, two goods (shoes and computers) but not
mobile
I Two mobile factors of production, K and L across
I Traditionally K is capital, but we can reinterpret it as countries
“skilled labor” when necessary
I Factors are used in di↵erent proportions across sectors
I Equivalently, factor intensities di↵er across sectors
I Other assumptions:
I Constant returns to scale production
I Identical and homothetic preferences
I Identical technologies across countries
I Di↵erent factor endowments across countries - differ in
of
ratio
tap
capital K
Review autarky equilibrium, followed by international " mm ① QE ,
> Q*s ,
, , -
mane
equilibrium.
hue
mud
price
of
computers, @ budget
Delative steeper
3 / 18 13 Lower because H 4 / 18
otc >
has won capital pure of s
price
more useful
y
terpene teeny
computers
Relative prices International Equilibrium
I Home is capital abundant: K/L > K ⇤ /L⇤

I This implies that, in autarky, the relative price of err
neg .
.
computers in Home is lower than in Foreign ✓ b. W ar t ml candidate

I We know from the Weak Law of Comparative Advantage pines
and
Jeff
Faget
mento
that Home will export computers and import shoes net
-
exp .
I Therefore, Home exports the good that is intense in its Fiume

so
nbq€se→
abundant factor /
Home
I This result is called the Heckscher-Ohlin theorem would
expgt
I We also have PC /PS < PCf ree /PSf ree < PC⇤ /PS⇤ we
1
will
Home Eiffel atyot
good
↳
rises computers
export exported
cover
with anarchy A :
anarchy prediction point
price
5 / 18 6 / 18
International Equilibrium International Equilibrium
Eqnwbirn
pure ratio
→ fecal I
uty T grim
graph
Rlanlian
in
d
As computers get cheaper ,
frat portions
quantity produced d, of import leap END FIRST VIDEO
demand
import T 7 / 18 8 / 18
A-O model
armed
→ PPF model is
. we set of IM Ix that H is
indifferent by
Summary and Discussion The factor content of trade
I Suppose there are many goods indexed by i and two

I H-O theorem can be seen as extending the Law of Ad
hemp
.
factors, K and L
.
Comparative Advantage back one step in the chain comes from

I Relative factor abundance determines autarky prices Relative factor I Define Ki1 to be the amount of capital used to produce 1
abundance
I Autarky prices determine the pattern of trade unit of good i (same for labor)
I H-O theorem requires stronger assumptions to make the I Define the relative factor content of trade as
first connection P 1 P 1
I Homotheticity K · exports K · imports
I Identical technologies F CTK,L = Pi 1i Pi 1i
i Li · exports i Li · imports
I No factor intensity reversals
I In a world of many commodities, predictions on trade in I The Heckscher-Ohlin-Vanek (HOV) theorem says that a
specific goods is impossible capital abundant country has F CTK,L > 0, i.e. it “exports
↳
similar to
- -
I However, a prediction on the factor content of trade

✓ capital” and “imports labor”
weak law
-
-
END SECOND VIDEO

In Ricardian , weak ler toys fer spent greedy AS
hard to * → weak hen
9 / 18 10 / 18
Testing the HOV Theorem Leontief’s paradox
I The HOV theorem has been subject to a lot of empirical Why do we have this “paradox?”
tests
I The first test was by Nobel-Prize winning economist
Wassily Leontief (1953) richest
/ ward
'
I Found that in 1947, the U.S. wascounty

in
a net importer of capital

took (relative to labor)
data
abort I This was puzzling because the U.S. seemed
vs
goods capital-abundant at the time
like cuber
are
capital Ins expense goods inane
on labor
11 / 18 12 / 18
Leontief’s paradox Paradox resolution?
made
Assumptions
M H -
O model ,
A key issue is di↵erent technology or productivities across
one job they countries
Why do we have this “paradox?” I E.g. U.S. and Bangladeshi production functions for
I Technology di↵erences across countries
-
AILS computers are

I Land is ignored not necessarily
I Labor should be divided by skills
true
YCU S = (AU S ↵ US
L · LC ) (AK · KC )
1 ↵
I There is not, in fact free trade YCBG = (ABG ↵ BG

L · LC ) (AK · KC )
1 ↵
I High tari↵s, transport costs

I The relevant quantity is now e↵ective factor supplies, e.g.
I All of these are valid concerns
AU S
L ·L
I Productivity di↵erences also naturally lead to di↵erent
factor prices
12 / 18 13 / 18
Factor Abundance E↵ective Factor Abundance

my
puffing
terms
14 / 18 15 / 18
abundant if you the extra

US is when rent
-
of us workers
predicting
US E↵ective Labor in 1947

- Summary
I Trefler (1995) finds that a single multiplicative productivity

di↵erence helps improve the fit of the HOV theory
-7
I “Improving fit” means that countries export their abundant
e↵ective factors more than half the time
I Other determinants of trade patterns also important
I Factor abundance important, but there are severe
measurement challenges
perfume
better
when we
lewd Smyre
capital alan
three
"
,
U.S , ,
multiplication
.
all faith 2X productivity

16 / 18 17 / 18
more productive n
them Bangladesh
Summary
I In the Heckscher-Ohlin model, comparative advantage

comes from relative factor abundance
I Countries export the goods which are intensive in their
abundant factor
I Overall gains from trade
END THIRD VIDEO Holger hnef,

till
greater
than
badger me a
18 / 18
Welcome!
Lecture 12: Factor Endowments, Trade and

Inequality
We continue our study of the Heckscher-Ohlin model by
studying the domestic and international distributional e↵ects of
Professor Dominick Bartelme trade.
I Trade and relative factor prices w/r
I Trade and real factor prices
I Trade and U.S. wage inequality
ECON 441
1 / 23 2 / 23
Review: Assumptions Review: Conclusions
I Two countries, two goods (shoes and computers)

I Two mobile factors of production, K and L
I Home abundant in K
I Factors are used in di↵erent proportions across sectors I Countries export the goods which are intensive in their
I Equivalently, factor intensities di↵er across sectors abundant factor
I Other assumptions: I Overall gains from trade
I Constant returns to scale production
I Identical and homothetic preferences
I Identical technologies across countries
I Di↵erent factor endowments across countries
3 / 23 4 / 23
Trade and Factor Prices Relative Supply and Demand
The relative supply and demand for labor can be written as

I What is the e↵ect of trade on real factor prices, after L̄ LC + LS L C KC L S KS
adjusting for changing good prices? = = · + ·
K̄ K̄ K C K̄ K K̄
I Can factor owners a↵ord the same consumption bundle as |{z} | {z S }
Supply Demand
in autarky? More? Less?
I What is the e↵ect on the factor price ratio w/r? Relative demand for labor is determined by
I Focus on the latter question first I Relative labor intensity in each sector
I Start by looking at relative factor demand I Industry shares in capital use
I These determined by producer optimality conditions that
marginal products equal factor prices
5 / 23 6 / 23
Relative Demand and Supply E↵ect of Trade we
When open to trade ,
✓
relative supply the capital price is
going
to use
, caring
Ppf te p and the scope
CET ; become
beeper .
7 / 23 8 / 23
Relative Supply and Demand
L̄ LC + LS LC KCT LS KS
d
@
= = · + ·
K̄ K̄ KC K̄ K K̄
|{z} | {z S }
Supply Demand
A price shift in favor of the computer industry leads to

I An expansion of the computer industry
I An increase in KC /K̄
•
I A decrease in KS /K̄
9 / 23 • 10 / 23
Summary An Example
At Home, opening to trade leads to

I An increase in the relative price of computers YS = L↵S KS1 ↵
I An expansion of the computer industry YC = LC KC1

I A decrease in the relative demand for labor
& Taking marginal products and setting their ratios equal to the
[
I A decrease in the w/r ratio
]
wage/rental ratio gives ratio of 's
met Mdm
men
I An increase in the labor intensity L/K in each industry
END FIRST VIDEO 1

↵
↵
· ①
KS
LS
=
w
r
=
1
·
KC
LC
T T
has te
factor pre
equal rain
Yume
mm
11 / 23 12 / 23
An Example Real factor rewards
Plug into the relative supply and demand equation to get
L̄ ⇣w⌘ 1 KC ↵ ⇣w⌘ 1 KS
= · + ·
K̄
|{z} 1 r K̄ 1 ↵ r K̄
| {z } We know that w/r falls for Home. But perhaps both rise in
Supply Demand
\ deep ends directly terms of purchasing power?
fairer I How does the real return of capital change?
Now solve for w/r: on
the
rate
✓ ◆ price I How does the real return of labor change?
w K̄ KC ↵ KS -
I
= · · + ·
r L̄ 1 K̄ 1 ↵ K̄
ruffslmao istrite of
capital / labor and
ytetue anent in
aeuouy
If KC " then KS # by the same amount because K̄ is fixed. of capful
just absolute,
are when not
Thus an expansion of the computer industry lowers w/r when between S &C seaters
< ↵.
-
by recurve to
change m
l ponies
be Ks goes to Kc
13 / 23 14 / 23
How much can

people buy
after FT ?
Real return to capital Real return to labor
In free Trade ,
Assume PC > PS . Since LC /KC goes up, M P KC goes up Similarly, we know that LS /KS goes up, which implies that
and M P LL goes down. That means M P LS goes down. Therefore, we have
r r w w
> = (M P KC ) > 0 < = (M P LS ) < 0
PS PC PC PS
Since r goes up by more than either price change, owners of Since w goes down by more than either price change, workers
capital are strictly better o↵ from trade no matter what their are strictly worse o↵ from trade no matter what their
preferences for di↵erent goods preferences for di↵erent goods
workers can
afford less
shoes and computers

them before
15 / 23 16 / 23
Stolper - Samuelson Theorem Implications
Implication 1: Trade inherently generates conflict in the H-O

model. There are always winners and losers.
Stolper-Samuelson Theorem: If the Home country opens to Implication 2: There are still policies that can make everyone
trade, the price of computers increases relative to shoes, and better o↵.
w PS PC r I Remember that we still have aggregate gains from trade
< < <
w PS PC r I Winners can compensate the losers fully and still be better
Full
Note that this is true regardless of what industry factors are Trade
o↵
employed in: factors are mobile between industries! wakes I Tends not to happen in practice
me I This result explains a lot of the political discourse around
bigger free trade
I
⑦
END SECOND VIDEO mom
something
realm
,
distributional
17 / 23 conflict 18 / 23
Trade and the Skill Premium The Skill Premium in the U.S.
We can re-interpret the factors in the H-O model as di↵erently

educated workers (“skilled” vs “unskilled”)
I In the U.S., usually understood as college vs. high-school
wage
T
graduates inequality
I In other contexts, other splits might make more sense
Study how trade a↵ects the skill premium
wS /wU
19 / 23 20 / 23
Comparative Statics Trade and the U.S. skill premium
Think of skill-abundant countries as rich countries and

unskill-abundant countries as poor. Then Stolper - Samuelson
implies that I The U.S. skill premium has been rising, and so has trade
I Skilled workers in rich countries gain from trade with poor I This is consistent with trade causing the increase in the
countries skill premium
I Unskilled workers in rich countries lose from trade with I There are some reasons to be skeptical:
poor countries I Rich-poor trade is still relatively small relative to U.S. GDP
I Skill premium is rising in many poor countries as well (more
I Skilled workers in poor countries lose from trade with rich
to follow)
countries
I Unskilled workers in poor countries gain from trade with
rich countries
21 / 23 22 / 23
Other Explanations?
I Skill-biased technical change (computers, internet,
robotics)
I Implies an increase in the demand for skill in all industries
prem.FI#nies
" I Trade and SBTC might interact: exporters use more
on
skill-biased technologies
I O↵-shoring might raise relative demand for skill in both
T countries Nail premium
be → both
met I Need skilled workers to manage supply chain in both rising
in
consistent
me
Th
countries
countries
I Low-skilled immigration in rich countries
ones is debatable
\
I No doubt a combination of factors, how much of which
us both skilled &
immigrants , unskilled
↳ many
I Note: assumption that gains from lower prices felt equally
by everyone probably not true (imports are “pro-poor.”)
END THIRD VIDEO

23 / 23
Problem Set 3
DUE March 9, 2021 by 6 pm EST on Canvas
Question 1 (Ricardian Model with Immobile Labor) There are two countries, Nigeria and India,
and two goods, oil and diamonds. There is one factor of production, labor, that is immobile across
sectors. Both countries have 100 (million) workers apiece. The amount of each good produced
by a single worker in each sector and country are given in the following table:
Nrgeramttitarc.la/- Friend
wages differ
A
Wo = w
D
=
W Oil Diamonds
Nigeria → CA in oil
PA Nigeria 𝐴𝑁
𝑂 =2 𝐴𝑁
𝐷 =1
÷ # ÷
-
India 𝐴𝐼𝑂 = 1 𝐴𝐼𝐷 = 1

.
Tundra → manuals
=
Preferences in both countries are given by the utility function
𝑈(𝑂, 𝐷) = 𝑂1/2 𝐷1/2
Initially both countries are in autarky. Each country allocates half of its labor to producing oil and
half to diamonds in autarky.
( India)
These in oil sector ( Nigeria) benefit .
These in diamond sector
𝑝𝑂
benefit .
1. Suppose the countries open up to trade. Compute the equilibrium price ratio 𝑝 = under
𝑝𝐷
free trade. ! '
it ¥7
p
-
I I
p -
-
p
-
D
-
2. Who gains from trade? Does anyone lose from trade?
Diamond workers in India & on workers in
Nigeria gain from trade
oil works in India & Drained workers in hyena here from trade
Question 2 (Autarky in the H-O with Cobb-Douglas production and preferences). Imagine
an economy with two sectors (𝑥 and 𝑦) and two factors of production (labor and capital). The
" 't
production functions of both sectors are: x ( ix. Kx) L kx ¥ Eui kit
-
-
'T
Y (ly Ky )
=
Ly KIT 2 1
𝑥= (𝐿𝑥 )3 (𝐾𝑥 )3
3k¥ % Shiki
,
3k¥
-
e-
Ye
-
54-3 k 'T =
,
𝑦=
1 2
(𝐿𝑦 )3 (𝐾𝑦 )3
'T 'T
ELIF to Xe
-
34 ki
-
Yu -
-
=
,
,
Moreover, assume labor and capital are on fixed supply (𝐿 = 3 and 𝐾 = 7) and can move freely
between sectors, there is perfect competition in all markets, and consumers have homothetic
preferences that can be represented by the following utility function:
3 1
𝑈 = 𝑥 4𝑦4
Please respond the following questions:

t
35¥
'T 73
( sit) 47 )
yds ) Ti
=
e
x ,
t
L I 3
3 3
xids.at 's ?¥ FIT, ¥15,

" 1
.
you ,
-
Econ 441 , problem set 3 Nigeria → CA in
oil Karla Wong
Que him
-
1 India → mangels
-
Supply
:÷.÷÷ ÷ "÷÷an*
NrgeramAtar
A
Wo I W =
W
: : no
.
.
50 .
I
Diamd L go
.
1
( India)
These in oil sector ( Nigeria) benefit .
These in diamond sector benefit .
① Aggregate Denard
-
Aggregate AM
) u ( o
, D) = Ok k
I
( O, D) MM (p pp )
Po O
.
pp
D=
PI
.
+
D=
→
PD
dyad
Fn¥ Eo E
:
--
h0±D÷ Po
¥=to÷D± Esa
D
w
;÷
o
*fE
-
ur
poor .ir#..-p.o+r.o=-e
On
demand
, so for )N+ go conf on -
t ( MITT ⇐ Afp ,
=
V
Po
dtmhnd Nt
I Dn -
AND Pg = PD
Diamond (D)
-
(D) 'zf%;?÷ )
go
= go D=
o
,
-
-
a' Po
o
-
Po
! PD
=
dem the A 'D
(÷
-
Oil
ftp.pg) Pyo )
-
go
+ so . =
for ,
t Pipo
= 150
t Popo
50
Lux
-
50 -
I t 50 -
+ go .
so Z
Po
-
- tr
ftp.igy
-
② Diamond workers in India & on workers in

Nigeria gain from traded
oil works in India & Drained workers in hyena here from trade
÷
Qoettoh
,÷ii
-
L
t tu
y
l Optimal capital
::*
:*
-
① .ie :*.se
' .
x. a .
40¥ .
- ftp.cf.EE
Y Y
i
i
- v
y 5447k¥ Yu
-
u
retune
capital
-
law
to
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used
¥
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, %
rape
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-
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)
-
meaux
:
,
th k
Ef ③r
&
444k¥ Vt: I
'
y why ray
-
-
- -
-
¥rxc¥k¥=
↳
¥ Er -
, kits -
r optimal
I 19
2¥ FYI
2¥ .
I Imho = -
ft 344-3143 w Lx tax
Ty if
④
-
-
-
i
optimal
"
' W
Emo
vk.ae#xllxikx7--hEkx'
try
@
Fa tf Z ftp.E
-
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-
's
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-
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,
d l
×
%.
-
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→ t÷
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-
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-
-
44145 2¥13
KO
LI Ky) -
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.
ly )
tiffs
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34¥
-
I
-
ate -
-
÷
,
9K KY
.
Ky 's
↳
it'ai¥
=
443
5144 3kg
y=fayYFy
-
284
4--3144--4447
-
,
284-444--34-+4494
I to
→
- eyes .sn,
284=314×5144
I .E slope Ky 282
,kyg ftiIII
-
-
of PPF 3+55
caber around
441.4¥
autos
- ✓ to premium of
good y
second
derivative ?
meat #
4m=Hi%¥¥ui4H%÷ .
③ f"u
'
Holland ;
x
;
-
-
=
RFD ( capital)=kx'
Eugene ftT/
-
Question
-
3
① ÷
where The
capital intensive x
; 6133¥ ( =
32.970
machine
-
@ 'T %
car : Laker - Intensive → yes
=
2( s ) (7) a 12.5901
⑤ US : has CA in and experts machines us M Xm

" b
I
" Z
MH tho : has CA in and experts cars

I> Ym
3 I
② Germany / consuming
@ Airplane
Machine
:
:
capital
Lazer -
-
intensive
intensive
inhibit
# 32
6
. 970 12.5931
and experts ?Ifz

=
airplanes
2-
I
-
⑧ us
.
.
has CA in =
, ,
CA in and machines
Germany : has
experts
:c) ÷
"
"
±
.
.
; i :S : :c's'¥i¥¥ : :÷ : .
>
÷ ,
x =
'T
z( D (2)
¥ 3 668
airplanes
=
y
-
IT 7.5685
4/1 )
=
Y =
(2)
airplane
CHIT
6
"
( Els) neither
-
3.66817568T
t
xui "
(E) ( H )
" 'T the -6606
( { (3)
=
t
12.5931
-
1649 yn 16
-
26
'T
.
Xc -
-
4 ( ¥11473 ( + ( htt >
48.6173
③ China
Yc "
16 ( Ifm )
't (H
"
]! not . 6919
Labor intensive
@ cellphone
: -
Airplane :
capital -
intensive
2. 8h57
Airplane
⑥
Us : has CA in and experts
airplanes ¥26.4742 the .
6606
✓
China :
has CA and cellphones
in
experts yay
Quesnoy
paedveteu Is in the labor-intensive sector and contracts in the capital - intensive sector .
Factor pills are e¥ed - ohne te factor pure insensitivity .
Consumption because pores of goods dont

would in as income increases change
.
Exports
would increase for labor -
intensive and decrease fer capital -
intensive
goods
factor
price
road
=
Wy
28e
(3+34743
'The up w%yCzGrsui%)
"
door as ,
-
-
-
q
-
43+3424312
'
fig-
fg a
-
'T
gg3(3+345728%4443+345
"
( 3734343
Aggregate
Demand -
Aggregate MN
) Uco D),
= Otp 't
I
( O, D) MM (p pp )
Poo
.
D=
pp
.
+
D= PI
FmdE
: →
pp
"
's III. E- ÷
'
¥=±o÷
'
. Eiko .
(E
p}
*
D=
Pn(¥) Poot Poo I
urI!÷
-
Poot I
-
D
D=①
sets -
general term) entree +
Demand the Welsh

Demand for
a
AV
"
India t ,
d Demand for
Nigeria .
ftp.T#)Bhmeuddhnemd=sop5i-soCDFe-.zpoo
07dam! 50 for )N+ go conf on -
;?÷ )
zfp.it#)oii=ICroj!t )
demand
oil
On conj ! conf
-
,
↳ ↳
Diamond dmmd=c (D) ILz(DE

d
"
I
t.zf.it:1 )
-
N LI
I N I
ordered .
↳
ftp.ro.org/ItzfaPop;ID-=iilro#o)xhlrEI )
Effie ! I w I
? ftp.ofohffnyroj?D--4HIfPoptoI).hLH( II )
"
Dsanmeedha
,
(
2
m) 150
e
sofltthfo ]tso( Epp 't -
1+3%0+78.4=3
so ( Pg;÷)
.
501%4%-1--150 ftp.F.at
:÷÷÷÷÷y¥ ÷÷=
-
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④ ez
.
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.
B
.
Foran : E
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so Litt # 7+501
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so ftp.tpr#+sofEfPop;IsJJ=zso
tI( dojo)tt( Porto)
5
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-
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tffo.tt#r3tPpIotPp-
2+4%-4%+1
a 5
¥a:
x. (↳ Fck .
p×↳5kf-w↳ y
-
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Py 44k¥ -
why -
rky
- If
Department of Economics 'T Winter 2021
484=4%435 off 3- pylytsk.it
↳
- r - -
r
University of Michigan Economics 441 '
ki z'¥ E
-
ex
¥
's
Efx v
ft Ip, w ,
- -
3- p, OT
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3%55 er
1. Set up the maximization problem that defines the production possibilities frontier (PPF) for
-
a given production level of good 𝑥. Find the optimal capital-labor ratio used to produce
He
good 𝑦@ relative to the capital-labor ratio used to produce good 𝑥.
?? ?
2¥ Y
7
-
2. Find an expression for the slope of the PPF in terms of the endowments of capital and I
3
labor, and the amount of labor allocated to the production of good 𝑦 (Hint: use the chain
-
rule). Show that the second derivative is negative (i.e. the PPF is concave).
3. Find the relative factor demands, given factor prices, for each sector.
Matin tauer demand ( t×;
Uber ) =
¥× KIT .
( )
Question 3 (Comparative advantage). Imagine a world with two sectors (𝑥 and 𝑦) and two
k
t
¥y KIT .
relative factor demand K =
factors of production (labor and capital). Each of the following exercises focuses on different
ty
Ke ly
endowments of capital and labor, compares the United States with a different country, and focus
on a different pair of industries/goods. For each one of them, please respond the following
questions: kxtkyy
↳
a. What industries are intensive in what factors.
b. Who has CA in what (and hence who exports what)?
1. United States and Mexico. Production functions of cars (𝑥) and machines (𝑦) are:
2 5 F-
𝑥 = 6(𝐿𝑥 )7 (𝐾𝑥 )7 x
= 6
(3) ( x) =
32.970
us
1 7 %
𝑦= 2(𝐿𝑦 )8 (𝐾𝑦 )8 yrs
=
21358 (7) a
12.5901
6
X me
Endowments in Mexico and the US are: =
2
Ym
capital intensive
-
labor
( US
cars
intensive
Labor Capital machines
\ Mexico 𝐿𝑈𝑆 = 3 𝐾𝑈𝑆 = 7 32 . 970 12.5931
𝐿𝑀𝑋 = 1 𝐾𝑀𝑋 = 1
6 2
@ machine
industry → capital -
Mahn
car
indrtty → cake -intensive 32-91 =
z
by
-
.
=
, ' 2-5931
⑤ Us →
CA ;in machines
-
cars ( exports CA)mere → cot in
2. United States and Germany. Production functions of machines (𝑥) and airplanes (𝑦) are:
'T
4S) (7) %
1 7
-5931
X.us l 't
-
𝑥 = 2(𝐿𝑥 )8 (𝐾𝑥 )8
a
2 23
y us
=
4/37 ( 75¥ = 26.1649
𝑦 = 4(𝐿𝑦 )25 (𝐾𝑦 )25
X G =
2
'T
( id (2)
¥ =
3 . 668
Endowments in Germany and the US are: IT 7.5685

(
=
Y 6
=
4 t ) (2)
intensive
@ capital
-
machine
industry is both capital N still
c
labor intense .
( Labor Capital M
⑧ Both have cash machines

US 𝐿𝑈𝑆 = 3 𝐾𝑈𝑆 = 7 iz .
5931 26 .
1649
so
they
Germany
,
will not trade with each other 𝐿𝐺𝐸 = 1 𝐾𝐺𝐸 = 2 3 .

668 7 .
5685
✓
labor intensive
3. United States and China. The production functions of airplanes (𝑥) and cellphones (𝑦) are:
2
'
( Hk )
2 1 23 1 2 "
( Els) 26.4ha
-
4
𝑥 = 4 [( ) (𝐿𝑥 )2 + ( ) (𝐾𝑥 )2 ] Xu , t
25 25 "
(E) ( H )
" 'T - the -6606
1 2 Yrs ( If 3) +
-
1 16
-
1 1
𝑦 = 16 [( ) (𝐿𝑦 ) + ( ) (𝐾𝑦 )2 ] Xc
2
2
2
-
-
4 ( ¥11473 ( + ( htt 'T >
48.6173
"
!
Yc "
16 ( Ifm )
't
( H ) not . 6919
Endowments in China and the US are:

@ KIELTY Tamer
yaTTEme
-
snot
Labor Capital e m i.
US 𝐿𝑈𝑆 = 3 𝐾𝑈𝑆 = 7 26.4742 76.6606
⑥ us → CA in cars
machines
China 𝐿𝐶𝑁 = 14 𝐾𝐶𝑁 = 12 48.6173 hot 6919
\
CA y eggs
.
China → in
-
.
raiser -
intensive
Question 4 (Comparative statics)

Imagine a small open economy in the Heckscher-Ohlin model with capital and labor that takes
world goods prices as given (i.e. the world prices are not affected by what goes on in this small
economy). Explain what would happen to production, consumption, exports and factor prices if
this economy experiences an influx of immigrants, holding the capital stock fixed.
Paedveten world M due to move labor for labor -

intensive seekers .
Fatter pills ane un affined - ohne te factor pure insensitivity .
added immigrants
Consumption would ya because of larger population with
.
Exports ( ?)
3
- noo
⑧ Introduction te party
Benefits 250
②
-
⑤ counterarguments
) To Economics 441
Concussion Winter 2021

⑨
Prof. Dominick Bartelme
Group Response #2, DUE March 9, 2021
Instructions: Meet synchronously with your assigned group to discuss the prompt below, then jointly
write a 600-750 word response using some collaborative software (e.g. Google Docs, Box, Dropbox, etc.)
Please also briefly document the process used to create the response: for example, tell me when work
started, when the group meeting took place and who was there, and what was accomplished in the
meeting vs. other times. Not every group meeting needs to be long; some groups may prefer to do
much of the work using collaborative software (e.g. Google Docs) and asynchronous communication.
Grading is on a scale of 1-5, with “5” being the highest. The response needs to be thoughtful, cogent
and well-written to get a “5.”
Prompt: We have seen the case for the aggregate gains from trade, and we’ve also seen theory and
evidence that, within countries, there are winners and losers from increased globalization. What sorts
of policies (if any) should governments be implementing to reap the rewards from globalization while
minimizing the costs?
jobs due to increased globalisation

were
people
line to be done about free trades hard to

put
taxes / tariffs bc of
of dead weighs loss is counter
-
unless cost
deadweight loss opp
.
balanced .
-
che wenn petry
new weakened was use
→
trade schools
my for joy
( → isolated erasing ?? not practical
+H then gobs but beauty mouecomp#2me

-
athenry them te keys

smaller increase GDP and Cp
though thinks
to
industries ↳
supporting competitors
-
invest in new technologies ,
it cant beat out labor -
intensity ,
work on
Merkle
capital
-
curate
trade Nba
bunny infrastructure
,
A investments
new
jobs
creamy
trade notes
normalizing
new
Welcome!
Lecture 13: Immigration

Today we shift gears to study another manifestation of
globalization, flows of labor across countries.
I Immigration in a one good model
I Factor price insensitivity
University of Michigan I Rybczynski Theorem
I Immigration
ECON 441
1 / 24 2 / 24
Migration A One Good Model
Suppose we have just one good, with constant

-
returns to scale
production function ? ?
-
Migration: movement of labor across countries Y = F (K, L)

If wages are equal to the M P L and
Suppose there is no trade. What would happen to wages if
Home experienced increased immigration? @M P L
<0
@L
drawn? then an increase in immigration lowers wages and an increase in
pine FDI raises them (in the short/medium run).
-
consumption!
-
footer prices I
3 / 24 4 / 24
better
production
technology
Welfare Welfare
I
Suppose we have Home and Foreign, with w > w⇤ . Are there Suppose we have Home and Foreign, with w > w⇤ . Are there
aggregate welfare gains from moving workers from Foreign to aggregate welfare gains from moving workers from Foreign to
home? home? loss
of
production
in Foreign
1
YES!
I The increase in Home production from immigration is

greater than L · w⇤ (for a small enough L)
-
I Therefore, immigrants could split the increase in their

wages with Home residents and make everyone in Home
better o↵
I Foreign workers gain too I
be immigrants
are
driving down Home w

ly
5 / 24 benefit to immigrants ,
5 / 24
w
who earn higher
>
loss to Home workers

Consensus
gains from immigrate
-
:
VERY LARGE ! ! !
Summary
=
Amt of labor
y mere
way
I Without trade, an increase in factor abundance tends to
T n
/
lower the return to that factor in the short/medium run
I There seem to be large aggregate wage
m m -
economic gains from

immigration
I Some reasons to question the size of these gains
I May be social, political, distributional and/or cultural
reasons to limit immigration people wiliness
✓
were
I In the long run, capital accumulation will raise wages in

65 trillion nv m
the home country to their previous levels
END FIRST VIDEO
6 / 24 7 / 24
Heckscher-Ohlin Factor prices
facet
In equilibrium wages and rental rates determined by prices
Let’s now consider the question in the H-O framework wage
rental - w word
decides
= f (p)
I Small economy open to trade it
- te
pref U were decent ,
rate r
of
pure
nature
t
-
alters world mum

when
I World price PC /PS ⌘ p FIXED with respect to Home

-
mph via the first order conditions for profit maximization in each
variables sector derivative of world pure
, with respect to # of workers in Home = 0
I Two goods, shoes (labor-intensive) and computers I If @p/@L = 0 then @(w/r)/@L = 0!

(capital-intensive) I only changes if word price changes
I This result in called factor price insensitivity
I Home is capital abundant
I Consider an increase in Home labor due to immigration I II Compare with one-good case
Implication: capital-labor ratios do not change in either
factor industry y
prices
are if
they
wet cost ten
sediment same ,
8 / 24 Hog teretemany then

will
9 / 24
in
ITI ng ed
Implications for output A Simple Example

Suppose we have L̄ = 100 = K̄, LC /KC = 1/3, LS /KS = 2, and
KC /K̄ = 60/100, KS /K̄ = 40/100
If capital-labor ratios do not change, how is the additional labor I We have the relative supply and demand equation
employed in the economy?
L̄ 100 1 60 40 L C KC L S KS
I Expansion of production in the labor-intensive sector = = · +2· = · + ·
K̄ 100 3 100 100 K C K̄ K K̄
I Consider the relative supply-demand equation |{z} | {z S }
Supply Demand
L̄ L C KC L S KS I Now consider an increase in L̄ of 50 units. In order to use

= · + ·
K̄ K K̄ K K̄ up the extra labor (with no change in LC /KC or LS /KS ),
|{z} | C {z S }
Supply Demand we have to expand the labor intensive industry and
contract the capital-intensive industry
L̄/K̄ " can be accommodated by increasing KS /K̄ and
decreasing KC /K̄ without changing LS /KS and LC /KC L̄ 150 1 30 70 L C KC L S KS
= = · +2· = · + ·
K̄ 100 3 100 100 K C K̄ K K̄
|{z} | {z S }
Supply Demand
10 / 24 11 / 24
Immigration in H-O Rybczinski Theorem
This result is known as the Rybczinski Theorem:
In the H-O model with two goods and two factors, an increase
- - -
in the supply of a factor leads to an expansion of the sector
| l
using that factor intensively and a contraction in the other
Imam
sector, holding prices fixed.
PPF l
I Re-allocation across industries “substitutes” for the factor

-
- l -1
, price changes that take place in the one-good model
"
←
be labor 9 Shee sector which is

,
12 / 24 13 / 24
labor-intensive will N and computers f
When are good prices unlikely to change? Summary
world oheehnt
good pure
change I Immigration causes wages of native workers to decline in a
one-good model (no trade, short-medium run)
I A country is small in world markets
I With two goods and trade, immigrants may be absorbed
I The amount of immigration/FDI is small through an expansion of the labor-intensive sector without
I If L " causes PC /PS " then Stolper-Samuelson says native wage changes (in medium run)
workers lose I Long run e↵ects in both models depend on capital
accumulation, long run returns to scale, etc.
END SECOND VIDEO
14 / 24 15 / 24
U.S. and European Immigration (Peri 2016) Some Facts RE Recent Immigration
E↵ect of immigration on U.S. and European wages and

economy is a hot topic these days
construction ,
I Low skill: immigrants from Mexico and Central America -
agriculture ,
depressing low-skill American wages? restaurants
I High skill: engineers and computer scientists from Asia
{ depressing American high-skill wages?

I Eastern Europeans/refugees/migrants depressing West
my
European wages/employment?forth African
-
in us,
firms I Hard to disentangle supply and demand, other factors
empty
and
Cs I
agree my maybe have
and
increased demand immigrants
↳ down fill
driving n
16 / 24 that 17 / 24
incentives for labor
Americans to go
inte thy
field
Some Facts RE Recent Immigration Some Facts RE Recent Immigration
B
-
from
Germany
18 / 24 19 / 24
Some Facts RE Recent Immigration Some Facts RE Recent Immigration
20 / 24 21 / 24
Summary of Recent Trends Immigration and Wages
Peri (2016) describes a number of economic mechanisms at

work, as well as types of empirical variation used to estimate
I Share of foreign-born in U.S. and Europe has significantly p impacts.
in recent decades
I Driven by immigration from poor countries
I Driven by immigration of both highly educated and less
educated groups
O O
I What has been the e↵ect on destination-country wages?
Fergie
-
with different educ when
revers
9-
/ complement
each
&
immigration other
is good
thing
new immigrate n affects

old be
immigrants competing
22 / 24 for same jobs 23 / 24
Conclusion
I E↵ects of immigration on native wages depend on many

factors
I Overall e↵ects likely modest for most groups
I Magnitudes matter: 10 million 6= 100 million
I Static Rybczinski logic + dynamic capital accumulation
and innovation argue against a simple negative e↵ect due
to supply-demand intuition
I For very high-skilled workers there are likely substantial
positive spillovers (Kerr et al 2016)
END THIRD VIDEO
24 / 24
Welcome!
Lecture 14: Heckscher-Ohlin Model in the

Long Run
Today we look at the the Heckscher-Ohlin model in the long
run, when capital can accumulate
I Motivation and closed economy
I The open economy
University of Michigan I Implications
ECON 441
1 / 16 2 / 16
Capital Accumulation Motivation
Over time, capital (physical, human, knowledge) accumulates

due to the purposeful investment decisions of agents (savers,
innovators, firms, governments)
In the static H-O model, we kept factor supplies fixed.
Arguably, the vast majority of economic growth over time is
due to this sort of purposeful investment. But we know that factor supplies are not fixed, and moreover
respond endogenously to economic conditions.
In equilibrium, savings must equal investment. For every
investment, someone (sometimes the same person) must save.
The economic theory of savings and investment is that they are
(broadly speaking) determined by the rate(s) of return on
savings and investment (the interest rate in a simple model).
3 / 16 4 / 16
Capital Accumulation in a Closed Economy Capital Accumulation in a Closed Economy
In a closed economy, there tend to be diminishing returns to

In the long run, capital accumulates until the marginal product
most types of capital accumulation, reflecting a mix of
of capital (the rate of return) equals the opportunity cost of
-2mm
production technology constraints and demand-side forces
investment (the value of consumption).
I E.g. need labor to operate machines Diminishing returns means that the marginal product of capital
I E.g. need a mix of engineers and production-line workers declines as it accumulates. If the marginal product of capital
I E.g. need a mix of land, labor and machines in agriculture declines faster than the opportunity cost of capital, then we
I Limited demand for any one set of products eventually reach a steady state.
??
I “Knowledge” accumulation a (partial) exception
Capital also depreciates: continued investment is needed simply

( ]
In the steady state, capital ceases to accumulate on net and
continued investment simply replaces depreciated capital.
END FIRST VIDEO
to keep the amount of capital at a steady level.
5 / 16 6 / 16
The Open Economy The Open Economy
Recall the following propositions from the H-O model:
Consider the open economy version of the Heckscher-Ohlin Rybczinski Theorem: In the H-O model with two goods and
model in the long run. two factors, an increase in the supply of a factor leads to an
For each individual sector (e.g. shoes), we have expansion of the sector using that factor intensively and a
contraction in the other sector, holding prices fixed.
YS = L↵S KS1 ↵
Factor Price Insensitivity: In a free trade equilibrium, if the
world price ratio p doesn’t change then neither does w/r.
The marginal product of capital is
✓ ◆↵ Implication: a country that accumulates capital will see a
@YS LS shift in production to capital-intensive sectors. If world goods
MPK ⌘ = (1 ↵)
@KS KS prices do not change (note: impossible in autarky), then this
accumulation will NOT drive down the MPK (equal to the
The MPK is declining in K, so there are diminishing returns at rental rate r)!
the sector level.
Corrollary: the limits to growth through accumulation in a
closed economy do not necessarily apply to open economies!
7 / 16 8 / 16
The Open Economy Asia’s miracle
This di↵erence depends crucially on the price of the

capital-intensive good(s) not declining when one country I In 1960s, Asian “tigers” (Singapore, Taiwan, S. Korea,
accumulates capital. When is this likely to happen? Malaysia) were not much (or any) richer than most
Sub-Saharan African countries
I The country is “small” in world markets I Sustained rapid growth rates over 5 decades
I The other countries “decumulate” capital in response I One explanation: focus on capital (physical, human)
I Global demand for capital-intensive goods is growing, and accumulation
other countries are not accumulating capital I What happened to the capital-intensity of exports?
We return to this point later, but first a small bit of evidence.
shift
goods
market Labor goods10 / 16 ,
additional
9 / 16
fromcapital
µ
centres
war absorbcapital
want
Rybczynski in Action Rybczynski in Action ( veal
eaten
be
gin
→
END SECOND VIDEO
as
hgwy
imports 11 / 16 12 / 16
tan
so mpk
fall
de Ehret
as much
When HE accumulate capital rather than
Mp Kd, were
eppes
,
capital gods who µ price

Capital in the World Economy Capital in the World Economy
Lesson 1: Small open economies can potentially experience What happens if this “poor” economy opens to trade with a
faster growth than closed economies through capital world where capital is relatively abundant?
accumulation.
H-O Theorem: poor country specializes/exports labor intensive
However, there is another side to this feature of the H-O model. -
goods.
Suppose we have an economy that is initially in autarky, with a Stolper-Samuelson Theorem: price of capital intensive goods
very low level of capital stock. fall, and so does the rental rate on capital!
- far from
newly state
Low capital stock ! high rates of return on investment ! fast
stock
This implies that investment (and hence capital accumulation)
growth (but decreasing over time) falls, lowering the poor country’s rate of growth.
What happens if this “poor” economy opens to trade with a Lesson 2: Opening to trade with a “rich” world can cause a
world where capital is relatively abundant? poor country’s growth rate to decline relative to autarky.
13 / 16 14 / 16
Capital in the World Economy Summary

Under some circumstances, the long run world capital stock
under free trade does not depend on which country the capital is I Many people (including economists and policymakers)
located in. think that free trade leads to higher growth rates in poor
countries
Implication: The long run equilibrium of the HO model is I The long run HO model shows that this is one possible
consistent with a range of distributions of the capital stock
outcome
across countries.
I However, the model is also consistent with long run
Total global production of each good is the same in each of divergence of welfare across countries
these distributions. I Evidence is mixed (the real world is complicated), and the
The distribution of income is di↵erent across distributions. model might apply more to some time periods than others
I We will examine some evidence from the nineteenth
I High-capital countries are richer century, where the “First Globalization” and the “Great
T
I Low-capital countries are poorer Divergence” coincided in time
-
Lesson 3: Free trade can lead to long run divergence in capital END THIRD VIDEO
stocks and economic welfare across countries. split into
huh &
15 / 16 16 / 16
poor
centres
Welcome!
Lecture 15: Externalities and Endogenous

Comparative Advantage Today we are building on our discussion of the dynamic H-O
model to think about the role of externalities in long-run
comparative advantage and the global distribution of income.
I Motivation and recap
I Learning by doing
University of Michigan I Dynamic vs. static comparative advantage
I Implications
ECON 441
1 / 13 2 / 13
Motivation Motivation
I In the long run HO model, there may be comparative
advantage
Where does comparative advantage come from? I Di↵erences in capital stocks per worker may persist in the
I In the static Ricardian model, it falls from the sky and long run, leading to both comparative advantage and
income di↵erences divergence
lasts forever relative level
✓ I Comparative advantage can evolve over time in
outcomes
I In reality, comparative advantage
I However, not all di↵erences in specialization can be
I Changes over time for some countries, is remarkably
can
't make explained di↵erences in factor supplies
inferences durable for others overall level of rich
about I Is correlated with absolute advantage , I There are productivity di↵erences across countries that
goods f I
Doesn’t seem all that @
“deep” for many goods
predicting carry
hrs
cannot (easily) be explained by di↵erences in factor
from CAN
curate gentle
I In the regular HO model, comparative advantage comes
" '
weather .
"
gear,
supplies dk where they comes them
-
. -
soil
from factor endowments I The way that CA evolves over time cannot always be
-
-
~
I But where do factor endowments come from? explained by the evolution of the capital stock
centres
Why do genremere capital ?
h ave
. .
I Introduce alternative/complementary theory for how

Ricardian comparative advantage changes over time
3 / 13 4 / 13
Learning by Doing Learning by Doing
Ricardian model with two sectors, Agriculture and

I Assume each sector is made up of a large number of firms
Manufacturing
I Each firm’s contribution to employment in that sector (in
*The manufacturing sector experiences learning by doing any time period) is tiny
I Basic idea is simple: you get better at doing something I Firms are aware of learning by doing, but...
with practice frem I They benefit from it even if they don’t contribute
I Applies to plants, firms and countries as well (to what hiring \
I A firm that produces agriculture in period 1 can still enjoy
their
the higher manufacturing productivity in period 2 if other
degree?) employees
looking at firms produced manufacturing in period 1
I Key assumption: learning by doing is external to agents in their pmdrctI, This generates an externality in manufacturing production
the economy ready their -
?? manuals
I ↳ generates
you can ,
productivity
deltas depend on "
benefit from "
but also
firm's productivity Karang by doing
'
of
went hot firm does but on
by-product
what other firms de .
but other firms can .
learning
5 / 13 6 / 13
Learning by Doing Equilibrium with Free Trade
I In period 1, Home productivity in manufacturing is Am I What does the equilibrium with free trade and learning by
I In period 2, Home productivity in manufacturing is doing look like (in both periods) when Home has initial CA
in agriculture?
Am 2 = Am 1 + L m 1 , >0 I In both periods, Home specializes in agriculture )
productivity is constant over time
I Home gets better productivity in manufacturing in period
I Just like the static economy
2, the more it produces manufacturing in period 1
I Intuition: each firm maximizes profits by producing in the
I For simplicity, productivity is constant in agriculture and
sector in which Home has static comparative advantage.
both foreign sectors
Firms would switch to manufacturing in period 2 if
I Assume that initially Home has comparative advantage in productivity in manufacturing had grown enough, but
agriculture, Aa1 /Am1 > A⇤a1 /A⇤m1 , and we have free trade because no firm produces in Home manufacturing in period
-
with complete specialization. Which sector does Home 1, productivity in Home manufacturing is unchanged in
=
specialize in for period 1? =
period 2
7 / 13 8 / 13
levels
educ when ,
higher of infrastructure
& levels
Example: South Korea Dynamic Comparative Advantage
N
I In the 1950s and 1960s, South Korea was about as poor as
Sub-Saharan Africa at the time, and largely agricultural
I Home has static comparative advantage in agriculture in
period 1, T
I World Bank recommended focusing on opening the megyn? Am 1 A⇤ 1
< m
A⇤a1
"
economy and specializing according to their comparative Puff Aa 1

advantage in agriculture and low-wage light manufacturing I Home has dynamic comparative advantage in
(e.g. textiles) T
manufacturing if
I S. Korea did some of that, but also invested in heavy
industries (e.g. steel, chemicals, shipbuilding) and high-tech offs Am 1+ L̄ A⇤ 2
> m
(e.g. automobiles, electronics), using govt. intervention Aa 2 A⇤a2
I Today South Korea is a wealthy country that specializes I Interpretation: Home has dynamic comparative advantage
precisely in high-tech electronics, automobiles, and in manufacturing if it can eventually gain static
shipbuilding comparative advantage in manufacturing by specializing in
I Story is complex and contested, but the indisputable fact is manufacturing in period 1
the S. Korea’s comparative advantage evolved in (almost) I Otherwise, we say home has dynamic comparative
exactly the way policymakers intended (see Westphal 1990) advantage in agriculture
9 / 13 10 / 13
Dynamic Comparative Advantage Autarky vs. Free Trade
I Home will be better o↵ under autarky if is large and the

initial di↵erence between Aa1 and Am1 is not too big
I The concept of dynamic comparative advantage raising a I Is Home having dynamic comparative advantage sufficient
number of crucial questions. For now we focus on the for it to be better o↵ under autarky?
following: YES i . .
I No, Home has to balance dynamic gains from learning by

✓
I Can countries lose from trade when their static comparative doing against losing the static gains from trade
advantage is di↵erent from their dynamic comparative I Are there even better policies that Home could pursue?
advantage? who learning by doing all countries gain them
, trade .
.
.
I Yes, Home would gain more by being in autarky during

I When should countries open to trade in order to gain the
most? ↳ period 1 and moving to free trade in period 2
I Reaps dynamic gains from autarky in period 1, and static
gains from trade in period 2
I More complex policies might do even better
I The size of is crucial, but there is not much evidence
11 / 13 12 / 13
Conclusions
I Free trade encourages specialization in sectors with static
-
CA, but may want to restrict trade (for some time) to

-
allow their dynamic CA to develop

I Similar flavor to dynamic HO model
I Can explain divergence in specialization and welfare across
ext ante similar countries
I Remain both tough theoretical and empirical issues that
are on the forefront of research in international trade, e.g.
I How big is ? Is it di↵erent across countries and sectors?
How can we tell?
I What policy tools (if any) should countries use to shape
their long-term CA?
I How are other countries a↵ected by the use of these tools?
What will be their response?
I Next, we look at the ability of these models to explain the
historical experience
13 / 13
Welcome!
Lecture 16: The Nineteenth Century and the

Great Divergence
Today we look at the big picture of the evolution of trade,
specialization and development over the nineteenth and early
Professor Dominick Bartelme twentieth centuries and how they do or do not accord with the
theories we’ve learned so far
I Understanding the Nineteenth Century
I The Great Divergence
ECON 441
1 / 19 2 / 19
Understanding the Nineteenth Century Historical Background

I Before nineteenth century, expensive international
bye 18003 transportation
The later nineteenth century witnessed I Only durable high value/weight ratio items traded
/I
I Explosion of trade (“First Globalization”) Based largely on specific geographic endowments of high
coney value agricultural products
I Increased specialization into manufacturing and primary µ
I Spices
products producers tbh te African Chinese te Mamma transport I Tea
relative
✓
I Massive immigration and capital flows to value I Sugar
I Gold and silver
I The “Great Divergence” in incomes between rich and poor
I “Exotic” textiles
countries I Weapons
Key Question: How can we understand this set of outcomes? I Partial exceptions: intra-European grain, wool, textile and
lumber trade, internal Chinese trade
I Large international price di↵erences, due to transport costs
and monopoly power in trade
3 / 19 4 / 19
taken
ceheui
of SE Anan
Commodity Price Gaps The First Globalization
D ✓
\
Dutch
In the later half of the nineteenth century, all this changed
east
India
I Innovation in transportation and communication
company I Steamships
monopoly I Railroads
I Refrigeration transportation G tht
I Telegraph
meets of I Industrial revolution in Britain, then Europe and US
d
↳
yboblixwtnen
I New tradable products
I Rapid increase in productivity
I Declining tari↵s
I Organizational improvements
I Lots of land in the “New World” to exploit
dishonor
1pmhosed 5 / 19 6 / 19
from
Declining Ocean Transport Costs Declining World Tari↵s
7 / 19 8 / 19
Commodity Price Convergence Growth of trade
END FIRST VIDEO
9 / 19 10 / 19
Patterns of specialization Patterns of specialization
I Western Europe (first Britain, then France, Germany,

jog'tmynp www.vh.im
l
Belgium, Netherlands,...) industrialize o
or a
I Land-abundant “New World” specializes in land-intensive d L
primary products
I Asia and Africa do less trade, but specialize in high-value
primary products
I The United States is an exception: high
productivity/exports in agriculture, also industrializes in
late nineteenth century
11 / 19 12 / 19
Patterns of Specialization Patterns of Specialization
Why hyper specialization

do we see
-
in these agricultural commodities ?

13 / 19 14 / 19
everytiny
Ricardian trendy pnedrcnyd yourself
→ can not
-
want ye specialize
-
can
Williamson, Jeffrey G.. Trade and Poverty : When the Third World Fell Behind. Cambridge, MA, USA: MIT Press, 2011. ProQuest ebrary. Web. 24 February 2016.
.
Copyright © 2011. MIT Press. All rights reserved.

,
Terms of Trade Capital and Labor Flows
I Massive immigration from Europe to the New World

I Forced migration (slavery) from Africa to New World
I Also migration within Asia and from Asia to Africa (i.e.
Indians in South Africa, Chinese in Malaysia)
I Generally from labor-abundant to labor-scarce locations
I Big capital flows from U.K. to the New World
I n
f
Williamson, Jeffrey G.. Trade and Poverty : When the Third World Fell Behind. Cambridge, MA, USA: MIT Press, 2011. ProQuest ebrary. Web. 24 February 2016.
Copyright © 2011. MIT Press. All rights reserved.
railroads ,
machinery
te
big
15 / 19 16 / 19
price of
- exports
th To T t
productivity , Mle of imports
homer pyres ,
Williamson, Jeffrey G.. Trade and Poverty : When the Third World Fell Behind. Cambridge, MA, USA: MIT Press, 2011. ProQuest
higher my hire
ebrary. Web. 24 February 2016.
Copyright © 2011. MIT Press. All rights reserved. •
Summary Williamson and Dynamic HO
Broadly, Williamson’s evidence (and story) is consistent with

Declining trade costs plus increasing manufacturing the dynamic HO theory (with some externalities in
productivity in Europe/US leads to manufacturing)
I Increase in primary products prices I Initial (approximate) equality of nations leaning
I Terms of trade boom for primary producers I Falling trade costs induce specialization ✓ by
I Specialization in manufacturing for Europe/US, primary I Nations specializing in sectors with increasing returns/scale doing
products elsewhere the divergence . -
economies/learning externalities do relatively better in the
long run
I Higher standards of living for everyone, but...
I Virtuous or self-reinforcing cycle
I ...faster growth in Europe/US \
I Increasing division into rich/industrialized vs.
gainsequal
not
I Poorer nations benefit from increasing terms of trade, but
not domestic productivity improvements
poor/primary producers I Gap in living standards grows, although they improve
everywhere
Antre
those with
ne
justP
ne but
not productivity
CA ,
m
17 / 19 18 / 19
Implications
Note the implication: globalization a key cause of divergence
I Suppose trade costs didn’t fall
I Europe/US may have partly industrialized, but
specialization limited by lack of export markets and lack of
access to primary imports
I Periphery nations cannot fully specialize either: must
maintain some industrial output
I Over time, European/US technology di↵uses to periphery
I World experiences balanced industrialization
I Some divergence in living standards across countries, but
more limited
I Likely slower global growth overall
END SECOND VIDEO
19 / 19
of trade
possibility → everyone
=
Welcome!
Lecture 17: The Global Economy in the

Twentieth Century This lecture examines twentieth century developments in the
global economy
Professor Dominick Bartelme I Review nineteenth century

I World wars and trade wars
I Postwar developments
University of Michigan I The “Second Globalization”
I Agenda: new issues in twentieth century trade
ECON 441
1 / 17 2 / 17
The Nineteenth Century World Wars and the Great Depression
Declining trade costs plus increasing manufacturing

productivity in Europe/US leads to
I Increase in primary products prices I Breakdown of all types of international economic relations,
I Terms of trade boom for primary producers including trade
I Specialization in manufacturing for Europe/US, primary I Rise of protectionism with World Wars and the Great trade
,
Depression wars
products elsewhere
I Higher standards of living for everyone, but... I Incredible economic damage to rich countries, poor
I ...faster growth in Europe/US countries didn’t do so well either (falling terms of trade)
I Increasing division into rich/industrialized vs. collapse in
global demand & trade
poor/primary producers
I Consistent with dynamic HO model
3 / 17 4 / 17
Collapse of trade Rise of protection
GD
WW1
WWII
l
l
int
e %^ " ?
5 / 17
|
trade wars 6 / 17
Smoot Hawley ? ?
Rich countries in Post-War Poor countries in Post-War
import '
Hail boom P hyper specialize
to exports
I Faced declining terms of trade for primary products and
Europe → economic physical I
r
exported
their goods
trade barriers in rich countries
I Rebuilding after war ! fast growth rates ,
I Responses
US -
imported
manufacturing I Slowly and gradually dismantle controls on imports, capital heavy I Latin America and some Asian and African countries (e.g.
iwdvrties
,
them mad
helps flows
domestic
Indonesia, India, Nigeria, etc.): industrialization through
I Successful state intervention to promote recovery and import substitution in medium/heavy industry
producers
I Japan, Taiwan, S. Korea, a few other East Asian countries:
,
make high
further development of industrial capacity prefix Industrialization through import tari↵s and export
\
}
,
I World trade begins to increase again be competitive promotion in light/medium industry, later moving to heavy
loans te big international
industry
ha:÷
END FIRST VIDEO companies etc
,
I Both strategies involved high protection through tari↵s for
.
strategic industries and heavy state intervention

I Low share of overall trade
.
7 / 17 8 / 17
t
encouraging Firms
smh try
'
Wb
they can become
competitive
globally
Failure of ISI and success of NIC The Second Globalization
I Initially (i.e. 1950-1975 or so) both strategies had some

success
[
I Post 1975, import substituting countries tended to face
economic crises
I I Between 1980 and 2010 the growth rate of world trade
increased again trade of intermediate goods off share
I Borrowed heavily abroad to fund investment in industry
-
I Lack of appropriate scale/human resources, plus corruption I New forms of production chains spanning countries off -
some
and lack of competition, meant most of these investments

were unprofitable → unproductive industries
I High trade growth in many poor countries
C T
I Driven by new technology (container shipping, internet,
I When world interest rates rose in the early 1980s these
countries faced huge debt crises
cheap flights) and declining tari↵s
I Both intellectual and economic pressure for these countries I Other aspects of this globalization as well (social, cultural)
to liberalize their economies
I Export-oriented countries tended to perform better, but
only a few really succeeded in transforming their economies
Tmaybe just
did A better,
unkmefey If 9 / 17 10 / 17
bulk of
trade today
New Issues in Twentieth Century Trade from ere womanly Intraindustry Trade
sunken
countries
The second globalization has some new features that we want to
understand
I Growth of intra-industry trade, e.g. manufactured goods
for manufactured goods
I
I The role of large firms
I O↵-shoring and supply chain fragmentation /
fax
't I Strategic and developmental use of trade policy /
gov
I Trade agreements: GATT and WTO, regional trade
agreements (TPP,TTIP)
I Industrialization of (some) poor countries, not others China
I Some convergence in income per capita, but not universal...
11 / 17 12 / 17
Rise of O↵-shoring Tari↵ reductions under GATT
13 / 17 14 / 17
Pattern of Protection Divergent outcomes
I Rich countries have lowered trade barriers on most goods, I In 1960, South Korea had about the same (very low)
besides protected agricultural sectors income per capita as Camaroon and Indonesia, and half
I Rich countries still subsidize many industries directly and that of Peru
indirectly I Today, South Korea’s per capita income is 12 times that of
I Poor countries tend to have higher tari↵s on manufactured Camaroon, 6 times greater than Indonesia’s and 3 times
goods greater than Peru
I Wide di↵erences in the pattern and motives for protection I South Korea has also been famously successful at exporting
(i.e. which industries are protected and why) I Is this causation or just correlation? What are the
I Growing industries underlying forces that determined the growth paths of
I Declining industries these countries?
sp bang open ht 'T truly

-
to
capensis
15 / 17 16 / 17
Summary and Agenda
I H-O (perhaps with endogenous factor accumulation)

appears to do a reasonable job of explaining the “First
Globalization” of the late nineteenth and early twentieth
century
I How do we understand intra-industry trade, o↵-shoring,
new industrializers, and other features?
I Need to understand trade policy
I Agenda
I New tools to tackle intra-industry trade
I Firms in international trade
I Analyze o↵-shoring
I Trade policy
I Trade and development
END SECOND VIDEO
17 / 17
Welcome!
Lecture 18: Imperfect Competition and Trade
Professor Dominick Bartelme Today we will start our unit on imperfect competition and trade
I Motivation
I Basics of imperfect competition (monopoly)
ECON 441
1 / 16 2 / 16
Review World Trade Flows

Why do countries export the products that they do?
I Technology di↵erences (Ricardo)
I Factor endowments (Heckscher-Ohlin)
I These are both sources of comparative advantage
A
e
I Works pretty well for broad sectors (e.g. autos, textiles,
-
agriculture) O
In these models, trade is based on di↵erences across countries
I Autarky prices equal in both countries ! no reason to
trade
I No reason to import and export the same category of goods
(e.g. textiles)
I In general, models predict less trade the more similar are
countries med trade the were different
aunties are US & Canada → annular trade T

3 / 16 4 / 16
US & hunter trade
Europe
→
in
smear trade in
Japan
→
US &
Modern trade facts Intra-industry trade, US
I Most trade is actually between similar (rich) countries

(“North-North”)
-
@ @ D - 812 is.mn
I A lot of trade is “intra-industry” trade, at whatever level of
aggregation
I Examples: golf clubs, fruit, whiskey, pharmaceuticals,
clothing, cars, cheese...
I Grubel-Lloyd index for some industry k and country i:
|Exportsi,k Importsi,k |
1
Exportsi,k + Importsi,k
It exports and imports are the game ,
then G L telex
-
-
I
trade
lots of intra -
industry ,
wet based on CA
5 / 16 6 / 16
tf Im & Ex diff then CA mutts
widely
are
,
Product Di↵erentiation An Example
I Even within narrow categories, products are di↵erentiated

I E.g. golf clubs are di↵erent
I Very few products by competing producers are
LITERALLY identical
I Instead, di↵erent brands produce somewhat di↵erentiated
products
I Companies invest in creating a brand that can be
di↵erentiated from its competitors
I One company has a monopoly on their brand, but
competes closely with similar (yet not identical) brands
Cheese
7 / 16 8 / 16
Brands and Trade “New” Trade Theory
Product di↵erentiation or brands provides the foundation for

trade in similar goods
I Similar countries have di↵erent brands Paul Krugman won the 2008 Nobel Prize for his contributions
to its development. The key ingredients are
I Consumers in both countries “love variety”
@
?
I At least some consumers will prefer the foreign brands (e.g. I (Costly) product di↵erentiation
cars) I Monopolistic Competition: firms set the price they charge,
I Consumers may want to consume all brands (e.g. wine,
FEE
cheese)
but have limited strategic interaction with competitors
I Increasing returns to scale: fixed cost of creating a new
[
I This will generate trade in the absence of comparative
advantage! 3 competition
brand generates falling average costs as output increases
I This seemingly innocuous observation will have major any mere
constant MC in
prediction
implications for understanding trade
p MC
-
not the 64
anyway
9 / 16 10 / 16
Roadmap Monopoly
brand
This lecture: of own
- I A monopoly is an industry with only one firm.
I Review of monopoly
- I In these industries, the marginal revenue generated from
Next lectures: selling more products is less than the uniform price charged
I Monopolistic competition for each product
I Introducing trade [I Tojustsellthemore, a firm must lower the price of all units, not
additional ones I ??
I Comparative statics I The marginal revenue function therefore lies below the
I Empirics demand function (which determines the price that
customers are willing to pay)
END FIRST VIDEO
11 / 16 12 / 16
Monopoly Monopoly
Suppose a monopolist faces the following inverse demand curve:
Suppose the monopolists faces a fixed cost F (independent of
P =A B·Q scale) and a variable cost c · Q. c is referred to as the marginal
cost and T C/Q is the average cost. The total cost is
where Q is quantity, P is price, and A and B are constants
¥
(with respect to the monopolists decision) TC = F + c · Q
The monopolist’s revenue function is then
The monopolist’s problem is
Revenue = P · Q = A · Q B · Q2
max Revenue TC = A · Q B · Q2 (F + c · Q)
Q
The marginal revenue function is the additional revenue that
the monopolist gains by o↵ering an additional unit on the The solution is to set marginal revenue equal to marginal cost:
MR MC
market (equivalently, decreasing its price):
=
@Revenue
=c
@Revenue @Q
MR = =A 2B · Q = P B·Q
@Q which comes out of the first order conditions for optimization
13 / 16 14 / 16
Get P m prom Q
q
Monopolist’s Production and Profits Example 20 2
P = 10 2Q, F = 2, c = 1 to
-
alla)
Z
Marginal revenue curve: 2
d
M R(Q) = (10 2Q) · Q = 10 4Q
dQ
Set marginal revenue equal to marginal cost:
@ 10 4Q = 1 ) Q = 9/4
, I
c
Markup of price over marginal cost:
812 3
Avg M arkup = P c = 11/2

= 1 =I
9/2,
Monopoly Profits:
*
¥ I
. v ' oh
⇡ =P ·Q F cQ = 99/8
= 2 9/4 = 65/8
a
9
END SECOND VIDEO f
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Welcome!
Professor Dominick Bartelme Today we continue our study of imperfect competition of trade
by developing the monopolistic competition model in autarky
I Monopolistic competition
ECON 441
1 / 17 2 / 17
Monopolistic Competition Monopolistic Competition
A monopolistically competitive firm can expect to sell

A simple model of imperfect competition I More when total sales for all firms increases
I More when its rivals increase prices
I Many producers, each with a monopoly on its own “brand”
I Less when its own price increases
I Brands are substitutes for one another
I Firms set their own prices but do not influence the market I Less as the total number of firms increases
price The following demand curve embodies these e↵ects
I Firms are “small” in the aggregate
I No strategic interaction: sweeps many real-world Q = S · 1/N 1/b · (P P̄ )
complications under the rug where S is total quantity sold by all firms, N is the number of
firms, P is the firm’s price and P̄ is the average of the other
firms prices. - ,
-
IT
Y hey so
'
3 / 17 4 / 17
Monopolistic Competition Solving for Equilibrium

Recall that monopolists should produce until M R = c. We have
Q = S · 1/N 1/b · (P P̄ ) b b
MR = P · Q ) P = c + · Q.
S S
The inverse demand curve is then
Assume all firms are symmetric, i.e. they have the same fixed
b b
P = P̄ + ·Q and marginal costs and face the same demand curve. Then they
N S
will all choose the same price
Notice that this curve is linear in Q. Then the marginal revenue
curve is
(pay by,o) Q P = P̄
? Remember P Q
: -
DP Q
f
-
won do
d
b and have equal share of the market
mm fM R = P )
' '
,
-
·Q
S
ft BQ
2¥ a Q = S/N
-
or, substituting in for P ,

→ I -
za ??
Then M R = c implies that (PP curve in the graph)
b 2b
M R = P̄ + ·Q right way ?
N S b
P =c+
N
5 / 17 6 / 17
Equilibrium in Monopolistic Competition Solving for Equilibrium
Again assuming that all firms are symmetric, average costs are
As n th,
F N ·F
& d AC =
Q
+c=
S
+c
This equation gives us a relationship between the average cost

and the number of firms in the industry (CC curve in graph)
7 / 17 8 / 17
Equilibrium in Monopolistic Competition Equilibrium
So far
I We have assumed firm optimization and identical firms
I We have derived prices, costs and quantities (and hence
implicitly profits) as a function of the number of firms
But what determines the number of firms?

END FIRST VIDEO
9 / 17 10 / 17
What determines Ho of
Free entry equilibrium firms in worries?
Equilibrium in Monopolistic Competition
Consider point n1 on the graph. There are a small number of
firms, price is higher than average cost, and hence firms make
positive profits
I Profits encourage entry, increasing competition and
lowering profits
p AC
-
Now consider point n3 . There are a large number of firms,

-
competition is fierce, average costs are higher than prices, and

firms are making losses
I Losses encourage exits, decreasing competition and
increasing profits → as long as they wake say to
At point n2 , there are no incentives for entry or exit. We will

call this point the free entry equilibrium. Although firms have
monopoly in their own brand, competition between brands and
free entry forces total profits including fixed costs down to zero
no incentive to
end or exit
11 / 17 12 / 17
# of firms made
Finding the equilibrium Example
Let S = 100, b = 2, F = 1, c = 1
i) Firms maximize
:
i) Write down the individual firm optimization problem 2 2
⇡ =P ·Q F + cQ = (P̄ + · Q) · Q 1 Q
ii) Find the marginal revenue function N 100
iii) Find the average cost function ii) Marginal Revenue curve:
iv) Invoke symmetry conditions to set P = P̄ and Q = S/N
@ 2 2 2 1
v) Set M R = c to get P P curve M R(Q, P̄ , N ) = (P̄ + · Q) · Q = P̄ + Q
@Q N 100 N 25
vi) Find intersection of P P curve and average cost (CC) curves
iii) Average Cost Function:
F 1
AC(Q) = +c= +1
Q Q
13 / 17 14 / 17
Example Example
Let S = 100, b = 2, F = 1, c = 1
iv) In equilibrium, we have Q = S/N = 100/N and P = P̄ :

therefore, we have
Let S = 100, b = 2, F = 1, c = 1
2 4 p
M R(Q, P̄ , N ) = M R(P, N ) = P + Once we know that N = 10 2, we can solve for the equilibrium
N N
P , Q, and anything else that we want. For example,
N
AC(Q) = AC(N ) = +1 2 1
100 P =1+ = 1 + p = AC,
N 5 2
v) Marginal Revenue = Marginal Cost:
100 10
2 4 2 Q= =p
P+ =1 )P =1+ N 2
N N N
vi) Set P = AC and solve for N
2 N p p
1+ = + 1 ) N = 200 = 10 2
N 100
15 / 17 16 / 17
Summary
I Monopolistic competition is a simple general equilibrium

model of imperfect competition
I Fixed cost of creating a new brand
I Firms have monopolies on own brands, but brands compete
with one another
I In the long run, free entry drives profits to zero
END SECOND VIDEO
17 / 17
Welcome!

Today we continue our study of imperfect competition by
Professor Dominick Bartelme introducing trade into the model
I Review
I Introducing trade
University of Michigan I E↵ect of trade on the number of firms, scale, prices, and
consumer welfare
ECON 441
1 / 12 2 / 12
Monopolistic Competition: Assumptions Monopolistic Competition: Results
g e-viubrim-x.mg
I Average costs are
I Many producers, each with a monopoly on its own D

-
“brand”
F
CC ⌘ AC =@+ c =
N ·F
+c
Q S
[ price →
III.
I Firms set their own prices but do not influence the market
aggregate
] ??
Relationship between the average cost and the number of
firms in the industry, holding total sales fixed
-
-
. ?
I Demand: I Using M R = c, we get
Q =eS · 1/N
* se "
00
e 1/b · (P P̄ ) b
PP ⌘ P = c +
I Cost: mixed @
N
TC = F + c · Q
Frost of all quantity
Relationship between prices
L (markups) and the number of
I Free entry - pay the fixed cost, create a new brand
-
firms
I Intersection of the curves where P = AC gives the free
entry equilibrium in which there are no incentives for entry
or exit
3 / 12 4 / 12
Equilibrium in Monopolistic Competition Adding Trade
In trade !
Autarchy → free
I Suppose we add another identical country, and allow free
trade
I Total industry sales S double to 2S
I Do the countries trade?
Ricardian and H Mody
Sohag
Fem O
-
-
trade
5 / 12 6 / 12
Adding Trade Equilibrium with Trade
We can think of the equilibrium with free trade is the same as

I Suppose we add another identical country, and allow free
the equilibrium in the closed economy with double the sales
trade
I The curve
I Total industry sales S double to 2S N ·F
AC = +c
I Do the countries trade? YES! Consumers want access to 2S
foreign brands as well has a lower slope F/S and the same intercept c
I Each country can produce any variety for the same cost,
I The curve
but increasing returns to scale (due to fixed costs) b
\ P =c+
encourage specialization and trade in absence
I Known as intra-industry trade of CA
N
doesn’t change
I What happens to the total number of firms? Prices?
I New long run, free entry equilibrium is again defined by
Consumer welfare?
the intersection of these two curves
6 / 12 7 / 12
Equilibrium with Trade Equilibrium with Trade
When the market size doubles (due to trade), we get

I An increase in the number of firms relative to each
country’s initial number of firms (from n1 to n2 )
I A decrease in price and average cost from P1 to P2
I Implies that consumers in each country
I Enjoy access to more brands
I Pay lower prices for each brand be 2 countries
I Consumer welfare increases y
I Initially, each country had n1 firms, for a total of0
2 · n1 .
After integration, there are n2 firms. Do some firms have
to exit, i.e. is n2 < 2 · n1 ?
# 8 / 12 9 / 12
in each END FIRST VIDEO
arty
Number of Firms
' EEEequations? Number of Firms and Scale
AC =
n1 · F
+c
y these
S The total number of firms in the two countries falls with trade
b integration, although the total number of brands that each
P =c+ country’s consumers have access to increases
n1
I Intuition: trade integration increases the degree of
Setting AC = P and solving for n1 , we get
competition, reducing prices and forcing some firms to exit
r
bS What happens to the scale of the surviving firms?
n1 =
F
gets bigger .
.
.
Recalling that trade integration involves doubling S, we can do

the same for n2 and find
r r
2bS bS
n2 = <2· = 2 · n1
F F
10 / 12 11 / 12
Number of Firms and Scale Summary
The total number of firms in the two countries falls with trade I Increasing returns to scale leads to specialization and trade
integration, although the total number of brands that each despite no comparative advantage
country’s consumers have access to increases I Trade integration has several empirically observable
I Intuition: trade integration increases the degree of predicted e↵ects
competition, reducing prices and forcing some firms to exit I Exit: Some producers exit after trade integration
I Scale: Surviving firms increase scale (and hence lower AC)
What happens to the scale of the surviving firms? I Variety: Total varieties available to consumers increases
I Scale increases since AC goes down I These e↵ects are more general than the simple model
I Surviving firms produce more output presented here
I Intuition: increased competition favors larger firms that I We will discuss evidence in a few lectures
can exploit economies of scale
END SECOND VIDEO
11 / 12 12 / 12
Lecture 18
Lecture 19
leave u
Problem Set 4
DUE April 1, 2021 by 6 pm EST on Canvas
Question 1 (Monopoly pricing and production). Let us focus on the market for one good, which
is supplied by only one firm. For each of the following demand 𝑄(𝑃) and total cost 𝐶(𝑄) functions,
please respond the following questions:
a. Find the marginal revenue (MR) curve.
b. Find the monopoly price and quantity.
c. Find the monopoly markup (𝜇) over marginal cost (MC) and total monopoly profits
② markup =
Tip 1: Solve the problems using algebraic variables and plug in values as the end. P MC
=
-
Ey -
¥i=F
1. Linear demand and constant MC. Monopoly profits
:
demand PCQ )
A P Q F Mc Q
𝑄(𝑃) = 12 − 𝑃 find
- - -
12
- -
Q
⑤
-
i =
get peg
-
inverse sea Mp -
me
.
TC -
F t MC -
p=¥
𝑄
'
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¥
=fg
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I. a =L
-
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'd
-
F
markup
-
= Tc mo
-
𝐶(𝑄) =
= =
-
-
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-
-
-
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-
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.
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-
④ p me t
-
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- - -
- -
.
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-
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"
T P a F m ' Q
④ monopoly
-
- - -
g.
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-
-
,
𝑃 z me =
= =
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-
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-
-
-
-
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-
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yes
-
Question 2 (Monopolistic Competition). Imagine a market with many producers where each
brand is not perfectly identical to the others. Moreover, imagine that any firm can create a brand
and enter the market if they pay a fixed cost 𝐹 = 10. For each of the following demand 𝑄(𝑃) and
total cost 𝐶(𝑄) functions, please respond the following questions:
① @ ③ ⑨
a. Find the equilibrium number of firms, prices, quantities,
-
and the markups of price over
- -
-
marginal cost.
1
b. Compute and interpret the change in the number of firms, prices, quantities, and markups
of price over marginal cost with respect to:
i. Size of the market (S)
CENT a) Q co I. Q
Size of the fixed cost (F) y@Ti-p.Q
F CQ
-
- - -
- -
-
ii.
loathe a) Q Intf VQ
'
QIN tf pit p={ I =Et¥ Etr

'
Pla) Mr
next o
-
[
- -
-
- -
- -
-
-
+
,
-
no
1. Linear demand and constant MC. Acca ) Fronto Ia th FT th lp=t7
- -
'
𝑆
̅
𝑄(𝑃) = − (𝑃 − 𝑃 ), 𝑤ℎ𝑒𝑟𝑒 𝑆 = 12 I Fat't
'
Iya
'
a Er 'T ye I
'
- -
mac -_
𝑁
𝑄 p My t
Ya; -7¥
'
mr=mc -
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-
+
mo
[
-
-
- -
-
-
-
2
meet IIF ⇐ 6¥
-fnI#
'
p=f p -
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𝑆
𝑄(𝑃) = − (𝑃 − 𝑃̅ ), 𝑤ℎ𝑒𝑟𝑒 𝑆 = 12 @ tf tf za Ith oinzaftztbn)
MR P Ac - -
-
-
-
-
-
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that ( Eatin
'
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𝑄 1
- +
𝐶(𝑄) = F − + 𝑄2 , 𝑤ℎ𝑒𝑟𝑒 𝐹 = 10
onset 'ztI) Sf I WE
↳ ' '
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'
§
-
-
-
M" ' T -
IN h¥u=CI7h n%H"
MN
spina
-
MC
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-
-
+ MR - me -
-
-
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3. Isoelastic demand and constant MC. tf
-
tent
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P=
-
-
𝑆 𝑃̅
2 p= -
E'In INE7
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𝑁 𝑃
→ Er " :-O
p
-
- -
It
'÷
-
E+¥¥y fz+WP
make 𝑄
𝐶(𝑄) = 𝐹 + , 𝑤ℎ𝑒𝑟𝑒 𝐹 = 10 ;
2
③ pee -
P -
Q
-
-
ftp.PJ.o ,
4
t Ext E trout
'
-
-
Tristan t
-
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# ( oipasnj )
'
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y
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atzpstn "
t )
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Q' f- =
't
=L
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MR -9
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z p N
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- -
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.
-
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5N Y
1N=¥T
-
a. f.
'
THE)yu-
Markup : P -
Mc
2
' '
t4m
ECON 441 PS # 4 Karla Wong
,
End inverse demand :

PCQ ) =
12
-
Q ② markup =
,
)
¥i=1¥
" P MC
=
@ revenue 42 a) 0--1210
-
: -
-
Q
E-
MR -
off =yu-za-_mP
Monopoly profits
:
a =
p Q F Me
Q
⑤
- -
.
-
set MR to P & Q
me
get
-
TC -
F Q
P=¥¥=bF¥
+ MC -
48
¥
ME
E. Q tz
F- Tc Q
= = me .
= =
-
k -
za
-
-
I n
-
z=zo,
+ =
÷ -1<1%1
19--47
2% -23g
0
f- = =
E- ca
1¥ ) il:)
-
F- -
- ✓
57,5-6 -2¥
,•"°=µ=5Y
=
tis
2.) @ PCQ ) - 12
-
Q "
:( a) 01--1201 Q
④
-
revenue Markup =
1hÉmRÑ
in -
Monopoly profits
:
p
-
me
OFF
-
MR =
=
a- =p
-
a - F -
ma -
Q
z -
fly +
to) F- To -
-
me -
¥
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E
I5=µ
"
Gcs,
= - +
⑧
.
me =
¥ -
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-
+
-
12
-
zq
= -
I IQ +
p= 12-5 =
fz=P me -1+5=1 ¥ ¥ -
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iz ÷ +2¥
.
IQ
-3¥
+
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Ey (2/5)
=
lo✓
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I
•
a-
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÷
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=
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lo
,
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'
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3.) @ ¥ ¥
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P PCH -
.
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o
,
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y
%
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I =
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:
IT =p @ F me
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. - -
me
-
= 0
¥ tz
16
F- me Q - .
Te
-
-
-
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tg Ti l 16
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o -
ta -
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'
"
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.
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=
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=
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'
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+
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=
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=
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-
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me
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of the
|¥o
mtm
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In I +
p =
sr÷ y + market
,
fun price increases
by NEM .
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S
,
M
¥ 8¥ 8- ¥ ¥
'
=
+ +
,
→
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F- iq÷=÷ ñ=s÷ v.
Ego I%sÉ
for every change in the size of the market ,
the number of firms increases
by ¥ .
a- % offs =E
-
a
-
-
Fer the of the market , the quantity increases by ¥, .
entry change
in size
munwp :p
-
me
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-
I stfu |¥=rf
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in the size of fur market
,
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É I F÷t¥ ¥ ¥ % WE
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-
=
me + =
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+ -
+ -
number of forms
1
in the fixed cost the
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,
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,
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l÷E
+
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±
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pure
increases by ¥ F- ,
where 7=10 .
f- 12M¥
in the fixed cost the
quantity 1-2=1-1
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Q
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-
Q = For
every change ,
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,
where
F -40 '
fixed the markup

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change
cost
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in
me ,
-
increases I
by where 7=10
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.
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MR "
In tf -
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p Ac
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fer
every change
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by TfL .
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'
of -
It Esp In =
'
of s÷
-
-
w
'
N -
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fro 194=47
-
for
every charge
in the site of the market , the number of firms marches
by to .
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-
I a
-
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every change
in the size of the market
,
the
granary increases
by FT .
markup :
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t i.
ZI
-
ft II ) + -
* +
zen + I -
zsa In Sff fsI=rEI

-
For every
change in the size of the market ,
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markup increases
by they .
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roti rI
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±
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the
pure in creates
by ¥2s ,
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=
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§ n
-
-
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For
why change in the size of the market , the
number of firms increases by Jo ,
a =
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=
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in mutates
the size , quantity .
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|%-=%
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-
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-
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= - =
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,
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by sZ ,
where s =
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P = 1
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{ Fife +
{ E¥
=
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¥
by
|¥=
decreases
every change in fixed number firms
For an cost the of
*
,
~
-
8 F- , where F = 10 .
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p=ysÑ % -1%3--5%-3=2
?
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every change
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nest
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decreases
by g- tfzfj ,
where F =
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if ¥ 11¥ f¥=
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= =
it
fixed
by
inverses
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,
the quantity 2 .
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-
me
=
join F- I NEW F- I m =
2¥= µ
=
us ,
Ter
every change in tin fixed cart
,
the markup decreases
±
by f¥_a-s{aÉ
-5+421=5 where
F- =
10 .
Welcome!
Lecture 21: Heterogeneous Firms monopolistic competition

model
✓
Today we continue our study of imperfect competition by
Professor Dominick Bartelme introducing di↵erences among firms
I Review
University of Michigan I Heterogeneous firms
ECON 441
1 / 23 2 / 23
Motivation Monopolistic Competition: Assumptions
I Many producers, each with a monopoly on its own “brand”

I In reality, firms are very heterogeneous in size
I Firms set their own prices but do not influence the market
I Large firms are systematically di↵erent than small firms price → toosmall
parameter
I Accounting for these facts introduces new mechanisms into I Demand: g. sensitivity
the model (Melitz 2003) Q = S · 1/N 1/b · (P P̄ )
I Workhorse model to analyze firm-level trade data
I Cost: of
variable
nest
TC = F + c · Q
Twang .me
doing heterogeneity
cost
into I Free entry - pay the fixed cost, create a new brand
new behavior based on

me
→
drftrbufnen of films
3 / 23 4 / 23
Before firms all

?
:
Model Demand four who
had same
crest / demands ?
who
Two new features: wow :
2 Back to the linear demand system

I Di↵erent firms have di↵erent marginal costs (same fixed Q = S · 1/N 1/b · (P P̄ )
Before :
free trade
costs)
I Higher marginal cost of exporting relative to domestic sales Fat bae bgQ~
-
-
Inverse demand given by -
Now :
→
b b b
Look at implications for P = P̄ + ·Q
cost of
and N S
I Quantities prodrug
shipping All firms face the same demand curve. Hence, they all face the
I Markups (price/cost margins) now higher same marginal revenue curve
I Profits than
pnedrciy
I Export participation for domestic @P · Q b
⌘ MR = P ·Q
@Q S
I Consequences of trade liberalization
5 / 23 6 / 23
Firm Optimization Marginal Cost and Revenue
OH :*
@P · Q b
⌘ MR = P ·Q
@Q S
I As before, each firm optimally sets M R = M C. produce
I Di↵erently than before, firms don’t all have the same
marginal cost
I More productive firms have lower M C, and hence choose to
set M R lower in equilibrium
I Since M R is decreasing in Q, this means that more
-1
productive firms sell more
§ because -
Iso ,
is
choose Pogo, negate 7 / 23 8 / 23
these larger than
less
prodrome
Marginal Cost and Revenue Markups
smaller
prefix
q
-
-
- -
b
go
.
I
higher
lower
me
pedrututy
,
a
↳ ✓
markup ,
compare
I
hunger prefix
\ Clanger
firm
I will be
I
were
← profitable
END FIRST VIDEO
9 / 23 10 / 23
Profits and Operating Profits Operating Profits
I Profits more
TR TC productive
!⑦/
P rof its = P · Q (c · Q + F )
= (P AC) · Q
I Operating Profits (after fixed costs)
I OP = P · Q c·Q ÷
= (P c) · Q
Theine
about moving
= markup · quantity f
forward ,
since (p -
MC
) .
pre fits
=
fixed vests is op .
in the past
11 / 23 12 / 23
Operating Profits and Costs Summary
I Less productive firms sell lower quantities, have lower

markups and make less profits
I Firms with negative operating profits will exit for sure
I In the long run firms with negative overall profits will also
exit (if fixed cost is somewhat renewable)
I In the long run, the highest-cost surviving producer
(“marginal producer”) earns zero profits; everyone else
f
earns some positive profits
f- me
,
wqpgf.gr I Next: e↵ect of trade I
✓
•
Fagen:*
compare
nm all
firms are
13 / 23 14 / 23
round
- ,
Operating petit as function of all

are
trams
marginal
margined crest producer
E↵ect of Trade Marginal Revenue and Trade
I Trade is like an increase in both the size of the market -
(more customers) and in competition (more firms)

-
I Assume trade does not a↵ect costs

I Operates only through the demand curve, or equivalently
through the marginal revenue curve
b b 2b
MR = P · Q =dP̄ + ·Q
S nN nS
I Both N and S increase following trade integration, and P̄

decreases
I Implies marginal revenue has both lower intercept and is
flatter
15 / 23 16 / 23
Marginal Revenue and Trade Heterogeneous e↵ects
B I High productivity firms expand

I Profits increase for productive firms
| O 1-5
#
em have
opening profits
pent
're
,
I Low-productivity firms have lower profits and some exit
-
I Surviving firms tend to have higher productivity

-
I Known as the selection e↵ect: industry productivity is

then
justus
,
believe ,
may increased through the exit of the “least fit” firms
choose
to
LR
I Absent from homogeneous firm models
tu M m m
exit in
•
END SECOND VIDEO
1 .
or
17 / 23 18 / 23
Trade costs and export participation Higher export costs
Some facts: sell only te

✓ many
I Not every firm exports U S .
.
consumers
I Exporters tend to be larger and more productive than
-4
non-exporters
I Firms tend to export less than they sell domestically
I Firms tend to earn lower profits (lower markups) on
exports
interesting ?
An interpretation
I Higher marginal cost to export (relative to serving
domestic market) for all firms
I Let’s see how it works...
19 / 23 20 / 23
Trade costs and export participation A tale of two firms

trade
nest
I Firms choose whether or not to export w.pne.ua

, µ,
\I
I Productive firms can earn positive profits on exporting .
, still makes petit ( just )

less
can still
make poetry
I Less productive firms may be productive enough to earn
D
f
profits on domestic sales, but not on foreign sales
I Hence only the most productive firms export -
mer ry
productive
{
firm
aspirates
thine will be firing Bc att S c
,
→
produces lower
qty
for the
foreign mkt them domestic Mkt

they exit and others
that AN
practice ,
but
21 / 23
cztt → we
pure firm can charge
22 / 23
that
cannot
Export A.) = or s me
sold
B.) t
qty
↳ met profitable
te sell
mkt he
foreign
,
on
doesnt
Summary
I Heterogeneous firm productivity helps understand the

selection e↵ect, by which trade
-
leads to higher average
previous
pill
productivity ↳ amount of
experts
a
I Heterogeneous productivity plus trade costs helps
understand why only most productive firms export
I Focused on partial equilibrium analysis, but the main
points survive a general equilibrium treatment
END THIRD VIDEO
23 / 23
Economics 441
Winter 2021
Group Response #3, DUE April 13, 2021
Instructions: Meet synchronously with your assigned group to discuss the prompt below, then jointly
write a 600-750 word response using some collaborative software (e.g. Google Docs, Box, Dropbox, etc.)
Please also briefly document the process used to create the response: for example, tell me when work
started, when the group meeting took place and who was there, and what was accomplished in the
meeting vs. other times. Not every group meeting needs to be long; some groups may prefer to do
much of the work using collaborative software (e.g. Google Docs) and asynchronous communication.
Grading is on a scale of 1-5, with “5” being the highest. The response needs to be thoughtful, cogent
and well-written to get a “5.”
Prompt: What has been and will be the effect of Covid-19 on firms engaged in international trade and
multinational production, bearing in mind heterogeneity in firm size and productivity? Have the effects
been worse for some types of firms than for others? Have some firms benefitted? How will it affect the
I
- m e
§
number, size and productivity of firms going forward? Your answer should not be comprehensive, but
focus on a few relevant dimensions of the question.
,,
guy
,
,y ?
mum , www.muw.ge µ, m,
gag, µ, , my way , mama, my

y ,a gang ,
be okay .
-
Zoom
chains
Grocery
-
less me
→ -
Medical
bragger firms → more
productive Man factory
↳ less damages
-
pharmaceuticals (?)
-
racemes
smaller businesses →
will offer the arrest
↳ move me I
will chase down
and then ?
- hand to reopen
Welcome!
Lecture 22: Imperfect Competition and Trade:

Evidence
Today we look at firms and trade from a more empirical point
of view
I Basic facts from BJRS (2007)
I Aside: selection vs. learning-by-exporting
I Gains from trade with heterogeneous firms (Melitz and
Trefler 2012)
(
trade
ECON 441
quantity 'm gains from
1 / 25 2 / 25
BJRS 2007 Exporting is Rare
I Use U.S. Census of Manufacturs data plus LFTTD (Linked

Longitudinal Firm Trade Transaction Database)
I O↵er a brief introduction to di↵erent “vintages” of trade
theories
I Establish some basic empirical patterns on firms and trade
(in manufacturing)
3 / 25 4 / 25
Exporters are Di↵erent Products and Destinations
Bulk of firms
smell
exporting
# of ephedrine
to small Hoof
destinations
off
exporting
ITEM
/
wherein
exporters and
5 / 25
9 6 / 25
exporters
-
men valve
of
exporters ,
few large
exporters fer
acceuzy
Hof
value small
all , make up
firms but value
, most
Products and Destinations Intensive and Extensive Margins
when destination
nicer,
county
more firms
export
g) @I
it firm
far away ,
only
§
/ large
firms
d d @p selling
a
""
export
*
rich
+
large
county
Y smaller firms
It
county
destination
reach out and
smh "
is rich , trade
export
amounts
with them 1 to 7- .
7 / 25 2 counties dragging 8 / 25
rich then other down export
per pnechrt
-
z zx value
→
export 2x
to
rich per firm
Summary and Discussion Selection vs. Learning-by-Exporting

different than non
Upon seeing exporters
a re
expenses
-
was
I Small number of firms export

I Those firms tend to be larger and more productive I Exporters are di↵erent
I Does this reflect
I Within exporters, smaller exporters export fewer products
I Di↵erential selection into exporting?
to less destinations I The e↵ect of exporting?
I Lowering trade costs (distance) increases I Both?
distance t I Number of exporting firms
I BJRS (2007) argue that it reflects selection
I Number of exported products -
I Decreases value per product per firm ? ? I Surely correct for the bulk of di↵erences
e -
I Are these patterns consistent with the theory from the last I However, there is some good evidence that, for some firms,
lecture? exporting itself raises performance
END FIRST VIDEO Instead m o re

productive trans export move
→
Exporting
wakes firms were
productive
9 / 25 10 / 25
Atkin, Khandelwal and Osman 2017 Atkin, Khandelwal and Osman 2017
but also
mostly domestic
y internationally
I Setting: rug manufacturers in Egypt
I With observational data, it is difficult to separate out I Randomize increased access to foreign buyers in
selection from learning by exporting high-income countries
I Also hard to figure out channels I Compare performance between treated firms and control
I Atkin, Khandelwal and Osman circumvent these difficulties firms
with a randomized controlled experiment
- I Note: ITT = “Intent to Treat” and TOT=“Treatment on
the Treated.” l t
imuehrcd actually
started
buyers bravest
te f my
ins
riders
lake
affect
11 / 25 12 / 25
583 standard
rugs
:
EXPORTING AND FIRM PERFORMANCE
defined
polity
576
TABLE VIII
IMPACT OF EXPORTING ON QUALITY LEVELS
Did forms tuna were moved cedte terry TABLE V n

(1) (2)
IMPACT OF EXPORTING ON FIRM PROFITS
more Control mean ITT TOT
Downloaded from https://academic.oup.com/qje/article-abstract/132/2/551/3002609 by guest on 22 October 2019

buyers
Log (reported Log (constructed
Panel A: Quality metrics
revenues − ?
Corners 2.98 1.11∗∗∗ 1.70∗∗∗
productive
\
Log direct revenues − Log hypothetical (0.12) (0.11)
QUARTERLY JOURNAL OF ECONOMICS

profits reported costs) constructed costs) Waviness
profits 2.99 1.10∗∗∗ 1.68∗∗∗
(0.12) (0.10)
Weight 3.08 1.07∗∗∗ 1.63∗∗∗
yes
(1) (2) (3) (4) (5) (6) (7) (8) (0.11) (0.11)
ITT TOT ITT TOT ITT TOT ITTTouch TOT 3.12 0.40∗∗∗ 0.66∗∗∗
(0.06) (0.07)
Packedness 3.11 0.89∗∗∗ 1.59∗∗∗
Panel A: Profits (in month prior to survey)
(0.11) (0.12)
Treatment 0.26∗∗∗ → 0.42∗∗∗ 0.21∗∗∗ 0.37∗∗∗ 0.19∗∗∗ 0.34∗∗∗ 0.37∗∗∗
Warp thread 0.68
∗∗∗
tightness 3.05 0.83∗∗∗ 1.49∗∗∗
(0.05) (0.08) (0.06) (0.10) (0.06) (0.10) (0.11) (0.19) (0.10) (0.12)
large
Firmness 2.98 0.87∗∗∗ 1.60∗∗∗
R-squared 0.21 0.22 0.16 0.18 0.16 0.18 0.19 0.19
:*
(0.11) (0.12)
Control mean (in levels) 929 929 931 931 951 951 541Design accuracy541 3.17 0.79∗∗∗ 1.41∗∗∗
Observations 573 573 644 644 685 685 687 687 (0.10) (0.12)
Warp thread packedness 3.05 1.07∗∗∗ 1.65∗∗∗ .
(0.11) (0.11)
Panel B: Profits per owner hour (in month prior to survey)
Inputs 3.07 0.89∗∗∗ 1.62∗∗∗
Treatment 0.20∗∗∗ 0.32∗∗∗ 0.17∗∗∗ 0.29∗∗∗ 0.16∗∗∗ 0.28∗∗∗ 0.25∗∗∗ 0.46∗∗∗ (0.10) (0.12)
(0.05) (0.08) (0.05) (0.09) (0.05) (0.09) (0.07)
Loom (0.12) 2.02 0.03 0.05 so -40709
(0.02) (0.04)
R-squared 0.14 0.14 0.12 0.13 0.13 0.13 0.19
R-squared
0.18 0.44 0.60 in
quality
Control mean (in levels) 3.53 3.53 3.54 3.54 3.55 3.55 5.56
Observations 5.56 6,885 6,885
hrgÉ
Observations 573 573 637 637 684 684 687
Panel B: Stacked 687
quality metrics
Stacked quality metrics 2.96 0.79∗∗∗ 1.35∗∗∗
Notes. Table reports treatment effects on different measures of real profits in the month prior to the date of the survey, all measured in logs. See text for descriptions of each (0.09) (0.08)
measure. Dependent variable in Panel A is profits. Dependent variable in Panel B is profits per owner hour. Owner hours include the hours of family member R-squared
production when 0.39 0.54
productivity ? variable, and include round and strata fixed effects. Control group means are reportedObservations
recorded. The regressions control for baseline values of the dependent in levels in Egyptian
pounds (LE) in Panel A and LE/hour in Panel B. The TOT regressions instrument takeup with treatment. Standard errors are clustered by firm. Significance: ∗ .10; ∗∗ .05; ∗∗∗ .01.
6,885 6,885
changed
Notes. Panel A stacks the quality metrics and interacts treatment (ITT) or takeup (TOT) with a quality-
or 13 / 25 metric indicator variable. The coefficients on the interactions provide the treatment effects separately for 14 / 25
each metric. The TOT instruments takeup interacted with quality metric with treatment interacted with to
quality metric. Each regression includes baseline values of the quality metric, strata and round fixed effects, learning
pores ? and each of these controls interacted with quality-metric. Panel B constrains the treatment effects to be equal
across quality metrics; these regressions include baseline values, strata and round fixed effects. Control group make better
means are reported in levels. Standard errors are clustered by firm. Significance: ∗ .10; ∗∗ .05; ∗∗∗ .01. 9
Quality
Wgs
→
effects. The resulting coefficients are identical to those! from

!! run-
ning separate regressions for each quality metric, but run thislearning
way
we can cluster standard errors by firm to account for any firm-level
m¥ by exporting
Downloaded from https://academic.oup.com/qje/article-abstract/132/2/551/3002609 by guest on 22 October 2019 correlations within quality metrics across time or across quality
metrics within a period.
EXPORTING AND FIRM PERFORMANCE 597
TABLE XI
QUALITY AND PRODUCTIVITY ON IDENTICAL-SPECIFICATION DOMESTIC RUGS (STEP 2)
Master artisan Professor
Downloaded from https://academic.oup.com/qje/article-abstract/132/2/551/3002609 by guest on 22 October 2019

Control (1) (2) Control (3) (4)
mean ITT TOT mean ITT TOT
Panel A: Quality metrics

Corners 3.23 0.72∗∗∗ 1.05∗∗∗ 3.31 0.29∗∗ 0.43∗∗
(0.14) (0.17) (0.13) (0.18)
Waviness 3.17 0.55∗∗∗ 0.80∗∗∗ 3.31 0.25∗∗ 0.36∗∗
(0.14) (0.18) (0.12) (0.16)
I Treated firms earn higher profits Weight 3.60 0.62∗∗∗ 0.91∗∗∗ 3.64 0.58∗∗∗ 0.86∗∗∗
(0.13) (0.16) (0.17) (0.25)
I Treated firms improve quality Packedness 3.30 0.77∗∗∗
(0.13)
1.14∗∗∗
(0.15)
3.28 0.28∗∗
(0.11)
0.42∗∗∗
(0.15)
Touch 3.29 0.52∗∗∗ 0.76∗∗∗ 3.27 0.36∗∗∗ 0.52∗∗∗
I Can we conclude that there is learning by exporting? (0.11) (0.14) (0.12) (0.16)
Warp thread tightness 3.00 0.51∗∗∗ 0.74∗∗∗ 3.30 0.25∗∗ 0.36∗∗
(0.09) (0.11) (0.12) (0.16)
Firmness 3.21 0.71∗∗∗ 1.04∗∗∗ 3.23 0.29∗∗ 0.43∗∗∗
(0.14) (0.17) (0.12) (0.16)
Design accuracy 3.65 0.53∗∗∗ 0.77∗∗∗ 3.45 0.27∗∗ 0.40∗∗∗
suggestive , but cheers man it .
.
-
why ? Warp thread packedness 3.05

(0.11)
0.87∗∗∗
(0.15)
1.28∗∗∗ 3.20
(0.11)
0.39∗∗∗
(0.15)
0.58∗∗∗
(0.14) (0.17) (0.12) (0.16)
make better ways , change higher pires R-squared
Observations
0.21
1,680
0.34
1,680
0.11
1,667
0.14
1,667
Panel B: Stacked quality metrics
Stacked quality metric 3.28 0.64∗∗∗ 0.94∗∗∗ 3.33 0.33∗∗∗ 0.48∗∗∗
(0.10) (0.12) (0.10) (0.13)
R-squared 0.19 0.32 0.09 0.13
Observations 1,680 1,680 1,667 1,667
Panel C: Objective metrics
Control (1) (2)
15 / 25 mean ITT TOT 16 / 25
Length accuracy −4.51 1.43∗∗∗ 2.09∗∗∗
treated pn
(0.51) (0.71)
Width accuracy −2.29 0.17 0.25
(0.29) (0.41)
Weight accuracy −221.0 89.1∗∗∗ 131.0∗∗∗
(20.3) (29.6)
598 QUARTERLY JOURNAL OF ECONOMICS
TABLE XI
(CONTINUED)
I Atkin, Khandelwal and Osman provide persuasive evidence
Control (1) (2) of learning by exporting
mean ITT TOT
Downloaded from https://academic.oup.com/qje/article-abstract
I One mechanism discussed in the paper is feedback from

Time (in minutes) 247.0 −5.67 −8.3
(6.6) (9.5)
buyers
R-squared 0.84 0.84 I Other recent studies suggest these types of e↵ects are
Observations 748 748
broadly based
Notes. Table reports ITT and TOT specifications using the nine quality metrics from the quality lab. Panel
A stacks the quality metrics and interacts treatment (ITT) or takeup (TOT) with a quality-metric indicator
variable. The coefficients on the interactions provide the treatment effects separately for each metric. The
timed
TOT instruments takeup (interacted with quality metric) with treatment (also interacted with quality metric).
Panel B constrains the treatment effects to be equal across quality metrics. Columns (1) and (2) report scores
END SECOND VIDEO 7
?
from the master artisan. Columns (3) and (4) report scores from the professor of Handicraft Science at
Domietta University. Panel C reports objective accuracy measures, which are calculated as the negative of the
meany improvement
absolute error for that specification, so that a higher value indicates that the manufactured rug was closer to
✓ a>
wedding
intended length (140 cm), width (70 cm), and weight (1,750 g). It also includes the time spent to produce the
rug in minutes. As in Panel A, these are run in a single regression by intereacting the objective measure with
treatment or takeup. All regressions include interactions of strata fixed effects with quality-metric indicators,
and standard errors are clustered by firm. Significance: ∗ .10; ∗∗ .05; ∗∗∗ .01.
17 / 25 18 / 25
expected since the loom size determines the width (and all firms
used the same loom).
Finally, we recorded the time taken to produce the rug. Since
the rug specifications, material inputs, and loom are identical for
Gains from Trade with Firms Melitz and Trefler 2012
I Identified 3 (additional) sources of gains from trade with

heterogeneous firms I Melitz and Trefler focus on the productivity gains from
I New varieties reallocation and the within-firm productivity gains
I Lower prices (higher scale, more competition)
I Reallocation from low to high-productivity firms
I Note: varieties difficult to measure empirically prices only
slightly less so
I There is a fourth: increases in within-firm efficiency
I Learning by exporting I Use the Canada-U.S. Free Trade Agreement (CUSFTA)
I Increased investment in innovation that preceeded NAFTA as a case study
I How large are these empirically?
19 / 25 20 / 25
Quantifying Gains across Firms

disappearing
r .
I Fall in U.S. tari↵s reallocated market shares to more

productive firms (exporters)
I Improved average productivity by 4.1%
I Fall in Canadian tari↵s increased competition, again
reallocating market share to more productive firms
I Improved average productivity by 4.3%
I Total productivity gains of 8.4%
I Is this a pure gain? No, results in exit of some varieties.
21 / 25 22 / 25
Quantifying Gains Within Firms Innovation Responses
I We saw that learning-by-exporting can raise firm

productivity
I Trade liberalization can also encourage firms to invest in
order to increase productivity
I New equipment
I R&D
I Theory: larger market increases the profitability of
investing to lower marginal cost
23 / 25 24 / 25
Productivity Gains
I Estimate an additional 4.9% increase in productivity due

to increased innovation
I Is this a pure gain? No, innovation has costs.
I Overall, conclude that CUSFTA increased Canadian
manufacturing productivity by about 14%
END THIRD VIDEO
25 / 25
Welcome!
Lecture 23: Foreign Investment, O↵shoring

and Outsourcing Today we switch gears a bit to talk about multinationals
(foreign investment), international supply chains (o↵-shoring).
Professor Dominick Bartelme I Foreign Investment
I O↵-shoring and outsourcing
I Definitions
University of Michigan I Empirical evidence and trends
I Informal theory and discussion
ECON 441
1 / 22 2 / 22
Foreign Direct Investment FDI Stocks
I Foreign Direct Investment (FDI) occurs when a firm from

one country owns and operates (in whole or part) a firm or
property in another country
I Example: Burger King owns Tim Horton’s (a Canadian
chain) O 00
I Example: Ford auto plants in Mexico •
I Example: Toyota assembly plants in the United States o
I Synonym for“multinational investment” @
I Many motivations
I Avoid tari↵s
O
①
→ Us plates
25% tariff on hushed
I Tax optimization products .
.
I Exploit cheaper local factors of production However,

I Operational synergies I
vuunionited
f.Ifs from
1 , Japan to
wages ✓ S the -
↳ her ,
One CEO , two
companies much newer
sharing synergies tariff 3 / 22 4 / 22

merge
rich → rich
but nah -7 poor
Some Examples Nationality can change
I Jeep made by Chrysler, now owned by Fiat

I Fiat changed its legal domicile to the Netherlands in 2014
5 / 22 6 / 22
Consequences of FDI What is O↵shoring?
The provision of a service or the production of various parts of

I If FDI involves simply changing ownership of existing a good in di↵erent countries that are then used or assembled
assets, it may not have big e↵ects into a final good in another location is called foreign sourcing
I FDI that involves new investment or, more simply, o↵shoring.
I Results in a flow of people, capital and technology across I Not to be confused with outsourcing, which is the
borders sourcing of inputs from outside the firm (either domestic or
I Raises labor demand in the host country
foreign)
I Ambiguous e↵ects on labor demand in the source country When Ford
boys
I Can result in big changes in comparative advantage and
I O↵shoring is trade in intermediate inputs pants hem near
-
Ford
specialization I Components plant either in
I Some finished goods where marketing and design are US or other

country
I FDI often generates political tensions outsourcing
,
both
important (e.g. Apple products)
it firmin
END FIRST VIDEO I Similar to immigration: Home firms can employ foreign Us just out
-
but
workers without them leaving their home countries sorry ,
it in
foreign ,
then both
outsource
&
offshoring
7 / 22 8 / 22
Some famous examples O↵-shoring indicators

O↵shoring is related to trade in intermediate goods. One
was indicator of the importance of intermediate goods trade is the
Value Added to Exports Ratio (VAX)
our H
combat Value Added in Exports
%
I iPhone & iPods & iPads V AX =
Total Exports
I Airbus/Boeing
I Barbie
I Value added is the domestic content of what is exported
I T-shirts
I Total exports include the value of other countries
intermediate goods
I Example: Boeing sells an airplane to China ! total value
of sale counted as U.S. export, BUT parts of the airplane
were build in Japan, Korea, France etc. Only the parts
built in the U.S. count as U.S. “value added exports”
9 / 22 10 / 22
VAX over time O↵-shoring indicators

✓ Ay T over time
I Another approach is to look at the foreign component of

domestic final output (not just exports)
I Example: how much of the value of the average German
car is produced by German factors vs. foreign factors?
I Can also di↵erentiate by factors of production, e.g. foregin
labor vs. foreign capital
I Doing this accounting = “slicing up the value chain”
(Timmer et al (2014)
11 / 22 12 / 22
* German Cars
review
again
13 / 22
\
( hvhh
does
Lot
, Fe 14 / 22
a
of incr mediate
trade
Foreign Value Added Shares over Time
15 / 22 16 / 22
Factor Shares in Manufacturing Over Time Factor Shares in Manufacturing Over Time
from a
M
source
a
expense
I
17 / 22 18 / 22
U.S. - China trade imbalance Summary
of
9
I O↵shoring has increased over time data
lots
offshoring
t
I Manufacturing tends to have a low ratio of value added to
when
total exports, while services tends to have the highest
I The U.S. runs a large trade deficit with China usher
I Services are “embodied” in non-service exports, e.g.
I At least part of the deficit is an artifact of how trade
statistics are collected → guess express
exports
iPhone te
( ? accounting is an input into car-making.
I The value of trade is measured each time a tangible good US
I Countries that specialize in manufacturing have especially
whole
,
crosses a border thug is low value added content of exports, i.e. they have lots of
I But with international supply chains, a single good can counted as intermediate trade
-
cross multiple borders, and intangible goods are not China 's expert I High-skilled labor is becoming more important in almost
typically measured at all all countries (in manufacturing)
west of the value I O↵shoring is important for understanding trade deficits
term China cheesy I And other things, see Johnson (2014)
-
heme fern China

END SECOND VIDEO
↳ Trade debut falls
there
, but
still
19 / 22 20 / 22
The Economics of O↵shoring The Economics of O↵shoring

Effects
I In H-O, the opposite factors in each country are winners
I O↵shoring allows firms to substitute cheaper foreign and losers
workers (or other factors) for more expensive domestic ones I E.g. Low-skill workers in rich countries and high-skill
on a task by task basis workers in poor countries lose
-
I Di↵erent 7
from trade in final goods3
in this respect I Opposites win
I This reduces domestic demand for workers who specialize I With o↵-shoring, can be that high-skill workers in both
in those tasks, which leads to falling wages (at least in the countries win
short run) I Intuition: o↵-shoring may raise skill content of tasks in
I Those workers will tend to be relatively worse o↵ both countries simultaneously
I Other workers/factors will be relatively better o↵ I We see relative wages of high-skill workers increasing
I Accessing cheaper inputs is like a “productivity boost” for
globally
managers, designers, engineers, marketing, etc.
I Not necessarily the case that lower-skill groups lose
I Can generate winners and losers in the short run, just like
I Combination of trade and technology transfer
the H-O model
END THIRD VIDEO
21 / 22 22 / 22
Econ 441: International Trade

Winter 2021
Problem Set 5
January 11, 2021
Due on April 15 at 6 pm EST

Please, write your full name and umich id on your problem set.
Please, pay attention to the organization of your answers. Always keep the order of the questions,
write legibly, and clearly indicate what you are doing.
1 US/Canada Free Trade Agreement

This question asks you to work throw the quantitative implications of integration between two
di↵erent-sized countries in the monopolistic competition model. The market sizes are S U S = 100 and
-
S CA = 10. Firms in each country can enter the market by paying a fixed cost 1 and produce with
a variable cost 1 for every unit q produced, so T C(q) = 1 + Q. As in lecture, firms in each country
face the demand curve Q = S · 1/N (P P̄ ) where - S is the market size, N is the number of
firms,
-
P is the price charged by the firm and P̄ is the average price charged by all firms. All firms
-
are identical. Note: don’t worry about “fractions” of firms in your answer. We will interpret these
quantities as millions (i.e. 2.5 firms equals 2.5 million firms), but just to keep the notation reasonable
we’ll use the lower numbers. E H CAPT )
-
- -
✓ 1. p -
f -
f -
se lp=f-¥
Find the marginal revenue curve for each country under autarky.
✓ Nt Foo tf Rus NE top /MRus=InxpT pea wt Qioxp Ron In # tap (mRcn¥t# -
-
Pus
- -
-
-
' -
-
2. Assume that, under autarky, free entry drives profits to zero. Derive the long run equilibrium
number of firms in each market, and compute the ratio of U.S. firms to Canadian firms.
✓ 3. Derive the scale of firms in each country, i.e. the quantity Q produced by each firm. Which
country has larger firms? How much larger are they (i.e. 2 times? 3 times?).
✓ 4. Derive theusmarkup of price over marginal cost µ = P/c 1 in each market. Which country has
larger markups? How much larger are they (i.e. 2 times? 3 times?).
✓ 5. Now lets assume that the two countries sign a free trade agreement. E↵ectively, firms in each
country now share the - same market. In the short run, i.e. no firms exits, compute the new
-
scale of each firm (now common across countries) and the new markups (also common across
↳ countries). Do they go up or down compared to their autarky values for each country?
?
Nus '
N'
Yours 1 F- I tint
✓ 6. Describe the two sources of gains from trade for consumers in each economy. Which country
do you think gains more from trade in the short run?
:
7. Compute the total profits per firm under free trade, in the short run. Explain the logic behind
your answer.
8. Compute the long-run equilibrium number of firms using the zero profit condition under free
trade. Is it larger or smaller than the short-run number of firms?
:
9. Compute the long-run scale Q and markup under free trade. Compare them to their short-run
values and provide intuition for the di↵erence.
2 US/Canada Free Trade, Heterogeneous Firms

Let’s stick with the same example, except now there are two types of firms. One type has marginal
cost equal to 1 and one type has marginal cost equal to 1/2. Assume that initially, under autarky,
half the firms in each country are of one type and half of the other. All other parameters are the
same.
1. For each country, find the price and quantity for each type of firm, given the average price P̄
and the number of firms N . Hint: first find the prices charged by low and high cost firms as a
function of the quantities sold by each type of firm using the condition M R = c. Then solve
for the quantities that each firm sells (given the average price) by plugging your solution to
M R = c into the demand curve.
÷
2. For each country, find the average firm price P̄ charged in each country for a given number of
high low
firms N under autarky. Hint: use P̄ = P 2+P .
3. For each country, find the total profits of each type of firm (i.e. including fixed costs) for a
given number of firms N under autarky. It’s fine not to simplify your answer too much.
4. Find the number of firms in each country under autarky, under the assumption that the high-
cost firms earn zero profits (and that they make up half of all firms). Compute the ratio
N U S /N CA . Hint: remember the quadratic formula, and pick the lower of the two solutions if
they are both positive. Explain why you should pick the lower solution.
? 5. EXTRA CREDIT (0.5 points) : Find the scale and markup of each type of firm in each country
under autarky.
=
6. EXTRA CREDIT (0.5 points): Now assume the countries sign a free trade agreement. In the
short run, i.e. no firms exits, compute the new scale and markups for each type of firm. Do
they go up or down compared to their autarky values for each country? Does anyone have
incentive to exit the market?
7. EXTRA CREDIT (0.5 points) Demonstrate whether or not the long run equilibrium (in which
firms are allowed to exit if the earn negative total profits but no new firms enter) will feature
positive numbers of high cost firms or only low cost firms.
2 I
ECON 441 Pueblem Set 5
Karla Wong 07448897
, ,
9-
p . P T p - p - = n t- Q - s - p - n - Q s - + P u s - N - 9 - o + p - R u s = Q n - Y I o + o P
=
IF -
t.MRus-1-w-E.pt#-pca--w--QToxp-Rca--Qn--Qo-i-QP µRcn¥+P#
Mhs =p
Yoo G- MRCA =P too
-
-
t①
(a) ¥+1 i
Ac MC
TC
(g)
=
It Q
a
=
Ntm -1 ¥
In Is +8=1
l
f- ¥ I -5+0--1
P
-
% f- In
+
P isnt
-
ip I
-
=\
-
a. p=
-
= -
-
I
'
to Foo N' 1W lNus_✓ P Ac 1+4 ¥+1 In Is NIS

Foxx
-
=
-
g-
=
-
-
-
p.pe
-
✗ + =
lNca=F
|RNteus#= ÷ = 3.15 ✗
true
a-
-
% aus
-
%
'
bQvs✓ a -
I 1Qca=¥ Fro ¥ to
.ir?E--nsr-s-÷
,
The U.S. larger forms by nsf

has or 2.2-36 times .
3. 15
µ
=
E- I Mus = ii. I -
I =
I µus=TY- 10%
yea
-
- " I -1 =
'ñ µ ¥-
Few 32%
=
Canada has
larger mashups by 1¥ or y . 472 tires .
¥ .
' °
=
¥
a-
SR
-
÷ µ:-*T µ
-
-
I -
i
1+1-1 b-
=|¥☒w =
8%
scale =
Q
Qua c Qsr< Gus
New scale of each firm ( Q) is

÷g which indicates that new
Qgp
13
greater than
Qua and less than Q us .
New mark p ( )
µ
is 1-
10+55
compared with t us
=
G- and
pea
-
tf ,
so new
markup went down compared with
autarchy
valves .
④ The consumers in each

county gain
from trade by having mere
access to a
greener number of firms .
Canady gains them trill

think number of firms that
move in the shor t have access to
I the is
run because they
us with 10+55 V5 =
10 firms compared with the V5 'S 10+55 he V5 firms
greater relative to the
- -
=
.
↳ 2.236 firms
Total profits Total Revenue -

total cost
110
% ¥ of -
-
a- Q
→
1!÷rs)(¥rs)
,
-
(61%51×-6) -
✗ +
¥rs -14 '¥rs ,
poet "eEym
% '¥rs ÷rs+¥rs l÷rI
a- -
:
÷m -
i÷rsit¥riI÷rs
subtracting fetal
total I card fetal profits I used of and number of of
By market size
nest term revenue 1W firms
get
a
.
Is firms find and

pwggiythwt.me equation Because the is
,1¥fs
since we answer
he + exit to out
my quantity my ,
.
of the whole market 111 (dollars ? ) divided by the number of firms 10 V5 to petits per firm
+
is
it means fur profits get .
? Total pucnwe Total

42 equilibrium cross
= -
=
o
zero profit condition total Revenue =

Total crest
site of the marks

= 110
p ¥0 R= % ¥ +
Ñ MR
Ln ¥ Ñ In -0¥ Ñ I
ins
Me
=
Ip MR
In
=
-
= -
1-
-
+
p
-
-
= -
f- -
% +3--1 =) -
f- + p -
-
l p -1+8
-
P -
-
Ac I +
to =
¥+1 =) I +
I =
You NI no
t.NET#-
The LR
equilibrium number of firms is 812 number of firms
smarter than the .
roughly
2.65 or he % of firms must exit in
LR=
?⃝
?⃝
/
p
Q =
£ = io.us 8 at
=
E- -
I
=
I +
I -
I ÷
up
QGR
=
§ ¥g I 8.989866
µsp=
12.236
The quantity for the

hey
Wu is
bigger than in the short run which makes sense since of firms
the number
is smaller than the shes would firm for the
nn
,
so
they produce more
per game market site .
For the markup LR markup is than short markup because there less firms in the
, the
bigger the run are
Long run
and
they would firms
g# and
compared to firms
more
meaning that have
gps as those
pz
in the short
competition autarchy
run
Nope markups are still have them on and former are remount
larger autarky
:
.
, them in .
④ high cost
"
MR
÷ ¥ f- %
!
¥
Mc t p-
=
p- a
-
+
=
I p =
1- + p
N
- +
us us
F-
% Q÷ñQ-
1-
N
-
÷→÷ •=±÷¥
pm NI
MR -
+
=
¥+8 /pEI=
1-
¥+8 Rca Mcca I IN ¥
-
P
=
= 1- +
-
f- -9=+0--1
,
p=t_ I -1¥ 1p¥=t¥
Demand awe : Q =
s .
( f- ( p -
-
pi ) ) ¥
-
Q¥= too .
(I -
(I -
In +
¥ _p- 1) 100nF -11¥ ¥ tp) 1¥ - too
Hot -20, + ioop Q= F- Too -29 + ioop
=) 39
=
2%-100 + ioop
|Q÷±(%--ioop
Q% =
too -
( wt (I - -
In +9-0-9)) too /£ -
I +
In ¥ F) -
+ ¥ -
50+1%0-24 IÑP + =) a =
If -
so -
zq + loot
foif-tf-F-soi-ioop-TQEI-io.nl
=) 39=2%-50 troop
( d- ¥
1-
+ -
F) ) ion -
I +
to -9=+5 ) % -10T¥ -29+1 of Q
=
¥ -10 -
ZQ + top
t.GL?--z-(I-i0+10P#QY-=io.(tn-(tz-tn+9-- p-)
3 Q =
¥ - lot top
10 ( tn I I ¥ F)
-
+ - +
%
'
-5 +
% -29 + wñ Q =
F- -
s -
za +
top 3Q= ¥ strop
-
IQYI-t.IF-s.io#-
④
÷=pmy÷pwn _'ñ+%+É%+¥_ i
÷-%j¥_
'
fpj-s-Z-n-i-g-I-canadf.it#=+---+g==p-=3--2-; -Y--
=
g =
→
1p÷-%+¥
④ p Q .
(F -
c G)
Total Pne fits = Total Revenue - Total crest
Profits
us
c
=
4- I ¥) Q + -
F +
a Q
-
8- +
÷
-
F + Q
µQ-¥+Q÷o-F=Pwtits¥=
Profits =
(I f- F) -
+ a -
Ft
-1 9-
-
g- +
Eo -
F +
¥ fq-Q-ni-QE-e-put.rs?#-
?⃝
"
Putin If a (i -
'
a'
-
Essa
-
r + of % a -
En +
QI -
F to /meh7sIF=za-ErgI#
#
pnehts YI e
f 's free) Q
-
-
Ft E E Ent QI
- -
F t
E → lpuetitsfa-Q-E.rs#
- half of
all firms
t
④
Petits
!! -
.
o -
-
up -
In +
Eg -
F 4%) la Esu -
- + -
FIN a
-
-
Ga tofu e)
- n
NII uafg
NI ! x 2 ttM-7T
Putin
IF =
o
=
za -
I QI + -
F
En -
za +
QI -
F
NII 20,1%7
n
: :X
-
¥¥÷ , t+'¥-¥=m
II. £¥÷
- mia
x=-b±F
¥y
Qvaann
:
I hate
50
-
F
g
- F) -
2±F¥F
-
2h
toy -
F - 2
F
= NI CA
N
Quadratic ?
Qais t( F- loot
1005
) ↳( mkata no + too
( as In ¥ ))
-
#
-
-
ioi! * we ¥7
→ HEH Ee
if .iq#a age us ¥
-
.
a
-
-
-
+
-
.
-
in:-. ¥
-
in E .
-
-
i H÷⇐ _
m.in#-iaQmYc--
¥ ÷ in ¥
.
,
.
-
.
.
Ha Iu%=z-Et -
E -
E)
-
I
-
T
CA
tan ¥) µI=t-EtT
-
M u
=
a .
- -
i
441-hnalExamtehewplaehiyimeh.t & Tretter ( her)
optimal → Bernard (want
Ho Mirando →
technology inferences
•
H o -
modes → fairer endowments

) ↳ " " oh" well 4 bread setter 8
b¥ trade based on differences
→ less trade with more simian counties
modern trade facts :
trade
- most
b. µ similar
( rich ) countries
intra industry trade

✓
-
golf miss -
Gruber -
Lloyd index for some

velvety
k and
county
i :
if and imports are the Shing then G -
L meth - I
pass
'
↳
✓
lusty ,
industry truly
cheese, I -
of not CA
→ hors intra -
cam
fruit
differentiated products competition widely wtf 9A
matters
,
then
→
if
-
Imp & Eep are .
'
trade of UA ! !
generates in absence
-
Paul Kingman ( never)

-
monopohbtir Competition have binned mthhetnen with

competitors
tnmg set the
pure tiny barge but strategic
•
:
,
brand nests as output mutates

www.y returns to of
generates falhy any
•
scale fixed
creating
:
easy new
.
a
.
→ constant MC m production
MR from
selling were
predicts uniform of all units
-
<
price
↳ lies below demand function ( ninth determines
pure)
14/16
"
* A Q BQ G- ) hide
maximizing monopoly my To Q -1
Revenue +
-
=
-
c.
-
→ set MR = MC 's OFF = '

① MR -
-
me → Q
@ markup = P - c
-
I
③ monopoly profits :
TY =
PQ -
F CQ
leuvuelqilmperfentcempetitrehandqndf.es
-
developing the monopolistic competition model in

arsirreky
"
"
Firms small tm
aggregate
-
in
No
sweeper many rent world
complicate us under tin
rug
-
interactions
strategy
-
:
.
sell
-
can expert to :
a
total sales for all fsrmf T
Demand
prints $1 T
(I b- ( P )
J)
•
anne Q :S -
:
.
I own A T
•
a total # fir -
g T
when forms
p sawing
for
equilibrium are
synmehrz
Slide 5/17 centres ? ?
( Mk )
-
fixed
marginal %
.
.
→
same nest and costs
p=p-
=
Assumed him optimitatnen and identical trans
penned prunes ,
cer ts , and
quantities ( and hence impurity profits ) as a function of the number of firms
[what determines # of firms ? ]

Free entry efvihbwm
:
" # of firms MR
=
?
S
profits
→
n ,
smh
,
pure Ac ,
positive
n
] → large # of forms
, price < Ac
,
losses
N§- =
(p 3)
-
¥
µ÷)% =p
4
Me
(NY t ( WI)
-
→
total 0 J
- exit true
entry equilibrium petits N fixed are
me
nests
means
twenty →
or
µ§
.
Mp
-
q -
I
stable i.
-
summary
-
:
Monopolistic competition
is
simple general efrhbvium model of importers competition
¥4 ÷¥p÷ -
¥g÷( In ) I - -1
-
Fixed west of creating brunet

-
a new
In LR , dunes
-
tree
entry profits to 0
.
I÷=¥n ¥g=¥%i No
?⃝
utrew:|npertentcompeh7nen&Tradeg
L
model ! !
→
imvedvciy trade me true
tin
All assumptions are game
-
and t i n
relationship b/w avg.com
→ Average
cer ts =
Ig + c
=
NJ + a ←
# of fir ms in the
industry welding tell ,
sales fixed
p , a e
fue entry equilibrium

ship exit
no
entry or
-
% b/w pure ( markup 8)

,
and tin
# of firms
→ ←
p c + recurve
-
=
AddnyTrI
5 double to 2s
Total velvety gulls
? Prices ? Consumer welfare ?

trade ?
Firms
Do they
-
picante & to say we
yest
-
consumers want foreign brands the .
↳ Each county for the

can
produce any variety same cost
,
but immensely returns to sente ( due to fixed costs ) encourage specialization
and trade
¥7 trade
.
intra
-
N÷
-
¥
+
AC = C
P =
c +
LR,
( game , new tie
entry epuubr.vn P
-
=
AC
shor t - run ?
peewit :
9 # of firms relative to
eyh county 's initial # of firms
d in P and AC
i.
consumers in each
country
Empey
to
brands
-
access more
pay lower
prices for each brand =Ñ¥ 2T¥ <
2ns
yn
=
consumer welfare 9
-
had total integration /trade nz firms 2ns ?

•
Initially ,
each
herby my forms ,
for a
of 2
nz . After ,
there are .
Is
nz
>
↳ total # of firms in 2 countries I

, although consumers have access to
moire brands
•
trade integration T degree of competition ,

redeem prices and feÉÉ .
firms bigger
Surviving
•
- more
output
Increased
-
competitor favors firms exploit euemennes of scale

larger they can
LeyvlN:HethogenvsFnmS_
→ differences
among firms
( v03 ) facts ( difference 8) into drug model

-
Acuevnty for mechanisms

:
Mentz new into
implications
-
:
model ? ↳ Quantities ?
workhorse
-
site dnstnyutnenoffi.ms
margins )
?
Markups ( pre / cost
-
Assumptions a re
sang with monopolistic forms
putts ?
* Model → Eypas participation ?
① toff firms .
have diff .
MC
( same freed nests ) consequences of trade
wyerahitaton
?
② Higher MC of relative te domestic sales
exporting hope negative
-
An firms have
↳
same
Mc is
demand
different →
awe &
change
MR Ware
MR for
eprhbnvm
SMU
18 Y
since lower me = more productive
→ MR 15 d in Q, mere firms sell

predictive move
↳
choosing P or Q that's than less
larger firms were profitable . larger predictive
operating profits smile 11

/ V3
↳ profits function of
operating as MC
compared v4
firm is sane
every ,
summary :
all firms are marginal
producer
-
Less
productive ( High MC ) firms sell lower
quantities have lower markups and less
profits
,
just enough to
cover fixed cost

Firms firms
Y y
-
mtn negative operating profits will

exit In LR_ ng thrall
-
profits will also exit .
,
.
LI.my#t ( marginal producer )

-
In else
"
0
surviving producer profits
"
ear ns
cost earns ; everyone some
positive profits
MR = p -
by Q =
dip tqbn Ff Q
-
MR has have mercept and is flatter .
mere forms , more customers ,

henner prizes
Expert parting muon?
firm experts
hideh/
→
not think about
envy usually . .
.
productive
→
them
Exporters target + more won
exporters
-
→
export less than held
domestically
→ hover
profits ( newer markups) on
experts
→
Higher MC te export ( relative to
serving dam .
mkt
) for all firms
Only firms expert

'
most
productive .
↳ be trade nests visually hideous

summery
:
selection effects
Focused partial equilibrium analysis but the main

general equilibrium treatment
-
on , pants survive on a
↳Lp?g;agnP•fhtGuhtenandTrade-Euid
B) 125 2007
empirical patens on firms on trade (manufacturing ) →

→
Exporting is rare
→
Exporters ??
Different Gide6/→
are
visually
→
predict, and
y
Destroyers
terms to # of destinations
Bulk of
exposing small # of products small
-
-
Value of few for all valve small # of firms but make Value
exporters ,
large exporters accounting ,
, up most
→
summary :
•
Small # of firms
export
↳
longer + more predictive
↳
smaller experts expert fewer products to less destinations
towering Cdr stance) increases

•
trade nests
A- of forms exposed products

-
ex
poetry +
t
/product /firm consistent w/ theory from last ? Yet ?
-
valve leave
* selection ✓ s .
Learning By Exposing
DJRS ( root) argues tiny it reflects selection
→ come uttermost
→ evidence ten the letter .
. .
Atlan Khandelwal and Osman Lot 7

,
whither
-
Hard to tell 4 observational data
RCT
•
↳
Egypt Ng mowtaetrverz
exam-pve-f.ms trent were introduced to
foreign buyers were productive ?
-
learning te make better

rugs
-
Quality T
→
learning by exporting
( heterogenous)
www..mg#
Gains from Trade v1 Firms
New varieties
using
-
-
R&D
prices CVSFTA
-
lower
New Equipment
-
to measure effor ts
Reallocation fan high
-
how te
productivity times of trade
Exposing
-
Lemmy by avg . 4. 3%
↳ increased investment in innovation /
C " S FTA T Canadian
4- 9% T
→ manufacturing productivity
Me "tZ Tretter
& zeiz →
learning my expert can raise
pnednynny
about
1470
of
Terry pmetitnbmty investing tower MC
:
increases te varieties
-
mkt
pure gmn ?
larger No ,
some exit .
÷:÷÷:÷÷:÷÷÷m÷=
'
FMRI
rich → rich
FDI : oeuvres when a fir m from one

county owns and operates ( whole / par t ) a firm
/ property in another
country only huh → poor
→
Bk owns TH
tariffs
-
Avoid
Tax optimization
-
Exploit cheap local of production

-
foyers
operational synergies
Nationality
→
binge Jeep
'
can -
offs pennon of or
production of them
henry
: service various
good in diff one
a
par ts of a .
countries not
used good
/ assembled into + red in another be cation is called offshoring (foreign nanny )
→
trade in intermediate inputs
Outsourcing
:
sourcing of inputs from outside the firm ( either domestic or

foreign)
when Ford
buys
pants tension -
Ford
in
plant either
Offshoring Meli centers vs or other

county
outsourcing
,
born
indicator of importance of intermediate goods trade is the Value Added te

( ✓ Ax)
Experts
-
Ratu :
If firmin
domestic content us just out
µ
-
but
exposed sorry ,
VAX d over time

\ more
gwbalitaien VAX
=
it
ten
in Foreign
born
,
in cwdl outsource q
← memory 's
Trade
other valve
offshoring
US China Imbalance
goods
-
of it .
.
→
Trade deficit I consider most value doesnt come from Curwen
summary
:
-
offs why T over time
name total
have led of
manufacturing tends exports
value to
te services highest
-
/
,
styled labor is
becoming more in
( in manufacturing)
-
hots of High
-
important almost all countries
mtkrwedierpl
trade
just like Ho
→ Generates winners + losers in
sR_ ,
dome saz ,
expensive workers
worsertf ,
other domestic workers better-off -
can substitute F
workers workers with ☐ workers

•
foreign , cheaper betlerotf

basis
on
Esk _by # .
✓
different from trade in + mere goods
Welcome!
Midterm #3 Exam Review

Today is an exam review session for midterm 3
Professor Dominick Bartelme I Exam Basics
I Monopolistic competition
I Trade and monopolistic competition
I Your questions
ECON 441
1 / 12 2 / 12
Exam Basics Monopolistic competition
I Alternative, non-comparative advantage basis for trade

I Tuesday,4/20 at 7:30 pm EST
I Instead, based on
I Covers lectures 18-23 I Economies of scale in production
I Mostly multiple choice and true/false I Product di↵erentiation
I A few short answer questions worth 2 points each (like last I Many producers (the “competition” part)
I Free entry
exam)
I Many producers, each a monopolist in their own brand
3 / 12 4 / 12
Conceptual Framework Example with linear demand and increasing marginal

cost
The theory of monopolistic competition (with our without
trade) is based on three fundamental building blocks.
i) Marginal revenue =marginal cost. This tells us the price Let the demand curve facing a given firm be
that each firm charges, given the size of the market, the ✓ ◆
1
number of other active firms and the prices they charge. Q = 100 · 1/N (P P̄ )
2
ii) The average cost of each firm (total cost divided by
quantity) as a function of the size of the market, the where 100 is total quantity sold by all firms, N is the number of
number of other active firms and the prices they charge. firms, P is the firm’s price and P̄ is the average of the other
iii) Equilibrium with free entry and zero profits: price equals firms prices. All firms are identical.
average cost. This tells us the total number of firms in the Each firm must pay a fixed cost of 1 to enter the market, and
market. Once we know that, we can go back and compute has marginal cost c(Q) = Q.
any other quantity of interest.
5 / 12 6 / 12
Marginal revenue equal to marginal cost Marginal revenue equal to marginal cost
The inverse demand curve is

Setting marginal revenue equal to marginal cost, we get
2 2
P = P̄ + ·Q
N 100 2 102
P Q=Q ) P = Q
The revenue function is 100 100
✓ ◆ Once we have this equation, and not before, we recognize that
2 2
P ·Q= P̄ + ·Q ·Q all firms charge the same price and hence have the same
N 100
quantities sold, Q = 100/N . Plugging this in, we get
The marginal revenue function is
102
✓ ◆ P =
@P · Q 2 2 2 2 N
= P̄ + ·Q Q=P Q
@Q N 100 100 100
Yp
g-
-
7 / 12 8 / 12
-
Ex -
Q +
Too Q 2
HE Q
ago
Average Cost Price equals average cost
The total cost of a firm that produces quantity Q is What determines the number of firms? Since there is free entry
1 for anyone willing to pay the fixed cost, firms must earn zero
T C = F + C(Q) = 1 + Q2 profits in equilibrium (after covering their fixed costs).
2
Therefore, in equilibrium price equals average cost, or
so that marginal cost (the derivative of variable cost with
respect to Q) equals Q. Average cost is then 102 N 50
= +
N 100 N
TC 1 1
AC = = + Q Solving this equation for N gives the equilibrium number of
Q Q 2
firms. Once we have that, we can solve for whatever else we
Again, recognizing that all firms are identical and therefore need (price, average cost, etc.)
Q = 100/N , we have We can rearrange this equation as
N 50 p
AC = + N 2 = 52 · 100 ) N = 10 · 52 ⇡ 72
100 N
9 / 12 10 / 12
Introducing trade Practical tips

Going from autarky to free trade is equavalent to merging the
two markets (increasing market size). Suppose that we have
I These same steps work for any demand curves and cost
two identical economies in autarky, each with N ⇡ 72 firms.
When we merge the two together, S = 200 instead of S = 100. curves. Only the algebra is di↵erent. The economics are
We can re-solve for the new equilibrium number of firms using the same.
the same steps but plugging in 200 instead of 100. We get I Study Problem Set 4 and the first half of problem set 5.
I There will not be *full problems* with heterogeneous firms
101 202 N 100
P = Q= , AC = + on the exam (i.e. no questions like PS 5, #2). However,
100 N 200 N
there will be conceptual questions on the ideas that we
and hence covered in lecture.
p I Make sure you review the Meltiz and Trefler reading, and
N 2 = 102 · 200 ) N = 10 · 202 ⇡ 142 the facts about firms and trade that we discussed in
Lecture 22. You may with to review the optional Bernard
We see that the equilibrium number of firms in the integrated
et al (2007) reading in this connection.
economy is (slightly) lower than double the number of firms in
the two autarky economies. Compare to the case with constant
marginal cost that we did in lecture.
11 / 12 12 / 12

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Course Outline

1. 1/19: Introduction to the course

a. Why do countries trade?

I I study “clusters in space”

I Married, three kids This course is about international trade.

Two sets of “Big Questions” Course outline

I Review (maximization, general equilibrium)

Should I take this course? Should I take this course?

I The course is indeed almost useless (practically)

I Calculus I Alternative is NOT “no model”

END SECOND VIDEO

Course Logistics Course Logistics

I The course is conducted entirely remotely

Course Structure Assignments and Grades

I Five problem sets (20%, lowest score dropped)

I Groups assigned by me, di↵erent group each time

Exams Exam Schedule

Three Midterm Exams Midterm # 1: Tuesday, February 16, 7:30-9:30 pm EST

Final Essay My Office Hours

I Graded on a scale of 1-15 9-9:30 a.m Mondays and Tuesdays, by appointment

READ THE SYLLABUS CAREFULLY!!!

If you can’t find the answer there, please email me.

END THIRD VIDEO

Professor Dominick Bartelme I Unconstrained maximization

Note this is a brief overview. There are many excellent online

Unconstrained maximization Economic Examples of Unconstrained Max .

An unconstrained maximization problem is a problem of the

max F (x1 , x2 , ..., xn )

I Firms maximizing profits by choosing quantity, taking

A solution to this problem is a set of values x⇤1 x⇤2 ,...,x⇤n and

Partial Derivatives Critical Points Ready to use

You know the derivative of a single variable function,

The partial derivative of a multi-variable function "

A constrained maximization problem is a problem of the

dF max F (x1 , x2 , ..., xn )

& Second example (bivariate standard normal distribution):

Constrained Maximization Constrained Maximization

The first order conditions for a (well-behaved) -7

A set of values x1 , x2 ,...xn that solves these equations is a

Indi↵erence curves Indi↵erence Curves

@U @U This condition says that, at the optimal bundle x⇤ , y ⇤ , the slope

Geometric Intuition Examples of Consumer Optimization

which implies that our first order conditions are

END SECOND VIDEO

the price ratio and income:

Note: is the (constant) elasticity of substitution because (1 ↵) · py

Lecture 3: Trading in an Exchange Economy

I Setup and equilibrium

spendingis another agent’s earning

I In a deep (and subtle) way, paradigmatic for all trade

Setup Competitive market

I Two countries, Home (H) and Foreign (F)

Competitive Equilibrium Consumer Demand

Consumer Demand Market clearing

t An equilibrium relative price p is the price such that supply

demand of each type of not

graphical representation of Selves fer

END FIRST VIDEO

We get the same answer if we uses market clearing for bananas. ↵ LF b̄