What Determines a Country

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What Determines a Countrys Comparative Advantage?

• Exogenous factors are the most obvious

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Climate (long growing season)
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Natural Resources (petroleum reserves)
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But there are also endogenous factors education,
skills, capital,...

• Implies that comparative advantage can change
  over time
• electronic goods to pharmaceutical goods to
  internet software to .

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Lets take a closer look at how capital (K) and
labor (L)affect comparative advantage

• Definitions
• capital abundant country has high K/L
• labor abundant country has low K/L
• capital intensive production uses high K/L
• labor intensive production uses low K/L
• Capital abundant countries comparative advantage
  in capital intensive production
• Labor abundant countries comparative advantage
  in labor intensive production

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Factor Price Equalization

• Factor prices
• wage rate for labor
• rental rate for capital
• Factor price equalization even if factors are
  not mobile, factor prices will tend to equalize
  with trade

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What causes factor price equalization?

• suppose U.S. has high K/L
• suppose Mexico has low K/L
• then opening up trade will shift
• U.S. production toward capital intensive goods
• thus demand for capital rises in U.S
• M. production toward labor intensive goods
• thus demand for labor rises in Mexico
• U.S. wages fall and Mexican wages rise
• that is a move toward factor price equalization
• assumes ceteris paribus, productivity would rise

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Gains from Expanded Markets

• Theory combines two features of production
• economies of scale (declining ATC over the
  relevant range of production)
• product differentiation leads to monopolistic
  competition
• Focuses on intraindustry trade (same industry)
• comparative advantage focuses on interindustry
  trade (different industries)

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Getting a sense of the gains from expanded markets
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Now lets develop a model to show the gains from
expanded markets

• First derive a relationship between
• the number of firms,
• the size of the market
• costs per unit (ATC)
• Second, derive a relationship between the number
  of firms and the price
• Third, combine the two relationships

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Now, summarize the results using a new curve
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Recall results from monopolistic competition model

• Product differentiation
• Firms face downward sloping demand curve
• With more firms in the industry, the demand curve
  shifts
• and gets flatter (a point we did not emphasize
  earlier), so the price falls
• sketch this by hand

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Now, summarize the result that more firms lead to
a lower price in another new curve
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Put the two new curves in the same diagram look
at the long run equilibrium
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Finally, open up the economy curve shifts
showing effect of a larger market
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End of Lecture
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