Trade: Pure Exchange

1
Trade Pure Exchange
2
Flashback to Savings
Period 2
y1(1r) y2
? (y1, y2)
grasshoppers
Period 1
y1 y2/(1r)
amount saved
3
Trade with 2 Goods
Corn
Initial endowment of corn and tractors
? (c, t)
Tractors
4
Autarky
Autarky is when you cant trade. I.E. must
consume what you have.
Corn
? (c, t)
Tractors
5
Autarky
Autarky is when you cant trade. I.E. must
consume what you have. You must be on
indifference curve A
Corn
? (c, t)
A
Tractors
6
Autarky
If you are on indifference curve A, your budget
constraint must be tangent to A at your
consumption point.
Corn
? (c, t)
A
Tractors
7
Autarky
If you are on indifference curve A, your budget
constraint must be tangent to A at your
consumption point
Corn
? (c, t)
A
Tractors
8
Autarky
If you are on indifference curve A, your budget
constraint must be tangent to A at your
consumption point. The slope of the budget
constraint is the ratio of prices.
Corn
? (c, t)
A
slope pT/pc
Tractors
9
Trade
Suppose you open up to world trade and the
relative prices are different than under autarky.
Corn
? (c, t)
A
slope pT/pc
Tractors
10
Trade
Suppose you open up to world trade and the
relative prices are different than under autarky.
Corn
? (c, t)
A
slope ptw/pcw
Tractors
11
Trade
Suppose you open up to world trade and the
relative prices are different than under
autarky. Here, the relative price of tractors is
higher in the world market.
Corn
? (c, t)
A
slope ptw/pcw
Tractors
12
Trade
Why does the budget constraint under trade
include the endowment?
Corn
? (c, t)
A
slope ptw/pcw
Tractors
13
Trade
Why does the budget constraint under trade
include the endowment? Because, if you sold all
your tractors and all your corn in the world
market, you would have enough income to purchase
the same number of tractors and the same amount
of corn.
Corn
? (c, t)
A
slope ptw/pcw
Tractors
14
Trade
In the new equilibrium, you consumer more corn
and fewer tractors.
Corn
? (cw, tw)
? (c, t)
A
slope ptw/pcw
Tractors
15
Trade
In the new equilibrium, you consumer more corn
and fewer tractors. Your utility is higher, so
trade makes you better off.
Corn
? (cw, tw)
? (c, t)
A
slope ptw/pcw
Tractors
16
The Trade Triangle
Possible to find the size of imports and exports.
Corn
? (cw, tw)
? (c, t)
Tractors
17
The Trade Triangle
Possible to find the size of imports and exports.
Corn
? (cw, tw)
? (c, t)
Export of tractors
Tractors
18
The Trade Triangle
Possible to find the size of imports and exports.
Corn
Import of corn
? (cw, tw)
? (c, t)
Export of tractors
Tractors
19
The Trade Triangle
Possible to find the size of imports and exports.
Corn
? (cw, tw)
Import of corn
? (c, t)
Export of tractors
Tractors
20
Trade
Intuition Tractors have a greater value
relative to corn in the rest of the world than at
home. So, you sell some of your tractors, which
other people find relatively more valuable. In
return you get corn, which you find relatively
more valuable than the rest of world.
Corn
? (cw, tw)
? (c, t)
A
slope ptw/pcw
Tractors
21
Trade
Suppose you open up to world trade and the
relative prices are different than under autarky.
Corn
? (c, t)
A
slope pT/pc
Tractors
22
Trade
Now corn is relatively more valuable than
tractors in the rest of the world.
Corn
? (c, t)
A
slope ptw/pcw
Tractors
23
Trade
Now corn is relatively more valuable than
tractors in the rest of the world. Based on the
previous example, what do you expect to happen
when the country opens to trade? Why?
Corn
? (c, t)
A
slope ptw/pcw
Tractors
24
Trade
Now corn is relatively more valuable than
tractors in the rest of the world.
Corn
? (c, t)
? (cw, tw)
A
slope ptw/pcw
Tractors
25
Trade Triangle
Corn
? (c, t)
Exports of corn
? (cw, tw)
Imports of tractors
Tractors
26
Trade Triangle
Corn
Intuition Corn has a greater value relative to
tractors in the rest of the world than at home.
So, you sell some of your corn, which other
people find relatively more valuable. In return
you get tractors, which you find relatively more
valuable than the rest of world.
? (c, t)
Exports of corn
? (cw, tw)
Imports of tractors
Tractors
27
The Model

• Flexible
• Could describe individuals within a town, county,
  state or country.
• Could describe entire towns, counties, states or
  countries trading with one another.

28
Trade within a country
Suppose we were looking at individuals trading
within a country.
Corn
? (c, t)
? (c1, t1)
Tractors
29
Trade within a country
Suppose we were looking at individuals trading
within a country.
Corn
Initial endowment
? (c, t)
? (c1, t1)
Tractors
30
Trade within a country
Suppose we were looking at individuals trading
within a country.
Corn
Initial endowment
? (c, t)
? (c1, t1)
Slope of the budget constraint with trade is the
price of tractors relative to corn
Tractors
31
Trade within a country
Suppose we were looking at individuals trading
within a country.
Corn
Initial endowment
Corn is relatively more valuable to others, so
you trade your corn for tractors.
? (c, t)
? (c1, t1)
Slope of the budget constraint with trade is the
price of tractors relative to corn
Tractors
32
Trade between countries
Suppose we were looking at individuals trading
within a country. Now, suppose this country was
going to trade with the rest of the world.
Corn
? (c, t)
? (c1, t1)
Tractors
33
Trade between countries
Suppose we were looking at individuals trading
within a country. Now, suppose this country was
going to trade with the rest of the world. In
this example, the relative price of corn fell, so
the corn you were trading isnt worth as much.
Corn
? (c, t)
? (c1, t1)
Tractors
34
Trade between countries
Suppose we were looking at individuals trading
within a country. Now, suppose this country was
going to trade with the rest of the world. In
this example, the relative price of corn fell, so
the corn you were trading isnt worth as
much. You are hurt by trade
Corn
? (c, t)
? (c1, t1)
? (c2, t3)
Tractors
35
Trade between countries
Suppose we were looking at individuals trading
within a country. Now, suppose this country was
going to trade with the rest of the world.
Corn
? (c, t)
? (c1, t1)
Tractors
36
Trade between countries
Suppose we were looking at individuals trading
within a country. Now, suppose this country was
going to trade with the rest of the world. In
this example, the relative price of corn rose, so
the corn you were trading is worth even more.
Corn
? (c, t)
? (c1, t1)
Tractors
37
Trade between countries
Suppose we were looking at individuals trading
within a country. Now, suppose this country was
going to trade with the rest of the world. In
this example, the relative price of corn rose, so
the corn you were trading is worth even
more. You are helped by trade
Corn
? (c, t)
? (c2, t3)
? (c1, t1)
Tractors
38
Who is helped and who is hurt

• If people are trading within a region
• If you are an exporter of good 1 within the
  region and the relative price of good 1 in the
  world market is higher(lower), then you are
  helped(hurt).
• If you are an importer of good 1 within the
  region and the relative price of good 1 in the
  world market is higher(lower), then you are
  hurt(helped).

39
To the rescue
Suppose we were looking at individuals trading
within a country. Now, suppose this country was
going to trade with the rest of the world. In
this example, the relative price of corn fell, so
the corn you were trading isnt worth as much.
Corn
? (c, t)
? (c1, t1)
Tractors
40
To the rescue
Suppose we were looking at individuals trading
within a country. Now, suppose this country was
going to trade with the rest of the world. In
this example, the relative price of corn fell, so
the corn you were trading isnt worth as
much. You are hurt by trade
Corn
? (c, t)
? (c1, t1)
? (c2, t2)
Tractors
41
To the rescue
What if individuals traded within the country
first, before trading with the world?
Corn
? (c, t)
? (c1, t1)
Tractors
42
To the rescue
What if individuals traded within the country
first, before trading with the world? Now, you
are better off after trade with the world.
Corn
? (c3, t3)
? (c1, t1)
? (c2, t2)
Tractors
43
Trade between countries
Suppose we were looking at individuals trading
within a country. Now, suppose this country was
going to trade with the rest of the world. In
this example, the relative price of corn rose, so
the corn you were trading is worth even more.
Corn
? (c, t)
? (c1, t1)
Tractors
44
Trade between countries
Suppose we were looking at individuals trading
within a country. Now, suppose this country was
going to trade with the rest of the world. In
this example, the relative price of corn rose, so
the corn you were trading is worth even
more. You are helped by trade
Corn
? (c, t)
? (c2, t3)
? (c1, t1)
Tractors
45
Trade between countries
Suppose we let individuals trade within the
region trade first before trading with the world
Corn
? (c, t)
? (c2, t3)
? (c1, t1)
Tractors
46
Trade between countries
Suppose we let individuals trade within the
region trade first before trading with the
world. Still better off after trade, just less
better off.
Corn
? (c, t)
? (c2, t2)
? (c1, t1)
? (c3, t3)
Tractors
47
Key result

• The government can reallocate resources before
  trade to make trade better off for everyone
  relative to not trading at all.