International Economics: The Standard Trade Model: Part 1

Summary

The video script introduces the standard trade model, a comprehensive framework encompassing previous models like Ricardian and specific factors models. It emphasizes the production possibilities frontier, which reflects an economy's technology and inputs, and the determination of a country's optimal production and trade points based on relative prices. The script also introduces indifference curves to determine the optimal consumption point, highlighting the model's utility in analyzing the effects of changes in the terms of trade on a country's welfare.

Takeaways

• 📚 The video discusses the 'standard trade model', which is a more general version of previous models discussed in class.
• 🔍 It covers models like the Ricardian model, specific factors model, and the Hechscher-Ohlin model, all sharing certain characteristics with the standard trade model.
• 🛑 The production possibility frontier (PPF) represents the technology and inputs of an economy and is a key concept in these models.
• 📈 The PPF can be linear or bowed out, depending on the model, and determines the potential output of an economy.
• 🌐 The relative supply curve is derived from the PPF and is essential for understanding how a country will trade with others.
• 🔄 World equilibrium is determined by the intersection of two countries' relative supply curves, influencing trade patterns.
• 💰 The 'terms of trade' is defined as the ratio of the price of exports to the price of imports, indicating a country's trade advantage.
• ↔️ Each country's terms of trade is the inverse of the other's, reflecting the reciprocal relationship in trade.
• 📉 Indifference curves will be introduced to determine the optimal consumption point, which has not been discussed in previous models.
• 📝 The model is based on four key relationships: PPF and relative supply, relative prices and demand, supply and demand equilibrium, and the terms of trade.
• 📊 The optimal production point is determined by the tangency between the PPF and the iso value line, maximizing the value of production based on relative prices.

Q & A

What is the standard trade model discussed in the video?

The standard trade model is a more general version of previous trade models, such as the Ricardian model, specific factors model, and the Heckscher-Ohlin model. It incorporates characteristics from these models and adds indifference curves to determine the consumption point.

What are the key relationships in the standard trade model?

The key relationships in the standard trade model include the relationship between the production possibilities frontier and the relative supply curve, the relationship between relative prices and relative demand, the equilibrium between relative demand and relative supply, and the terms of trade.

How is the production point determined in the standard trade model?

The production point is determined by the relative price of goods, where the country maximizes the value of its production. This is achieved at the point where the iso value line is tangent to the production possibilities frontier.

What is the significance of the iso value line in the standard trade model?

The iso value line represents the combinations of goods that yield the same value of production. It is significant because the optimal production point is where this line is tangent to the production possibilities frontier, indicating the most valuable production mix given relative prices.

What is the relationship between the relative price of cloth and the quantity of cloth produced?

As the relative price of cloth increases, the quantity of cloth produced also increases, and vice versa. This is shown by the movement along the production possibilities frontier as the iso value line's slope changes with relative prices.

What is the terms of trade and how is it calculated?

The terms of trade is the relative price of a country's exports to its imports, calculated as the price of exports divided by the price of imports. It affects the welfare of a country by influencing the cost of imported goods relative to the revenue from exported goods.

How does the relative supply curve relate to the production possibilities frontier?

The relative supply curve is derived from the production possibilities frontier and shows the relationship between the relative price of goods and the relative quantity of output. It is upward sloping, indicating that as the relative price of one good increases, more of it is produced.

Why are indifference curves introduced in the standard trade model?

Indifference curves are introduced to determine the optimal consumption point, which was not explicitly considered in previous models. They represent different combinations of goods that provide the same level of utility or satisfaction to consumers.

What is the role of utility functions in the standard trade model?

Utility functions in the standard trade model help to determine the optimal consumption point by showing the different combinations of goods that satisfy a consumer's preferences to the same degree, represented by indifference curves.

How does the change in the relative price of cloth affect the terms of trade?

A change in the relative price of cloth affects the terms of trade by altering the ratio of the price of exports (cloth) to the price of imports (food). This change influences the cost of imported goods and the revenue from exports, impacting the country's welfare.