Introduction Neo-classical economics General structure of the neo-classical model

Introduction

Neo-classical economics

General structure of the neo-classical model

Production functions

Cost minimization

Impact of wage rate and rental rate

Constant returns to scale

Conclusions

CHAPTER 4; PRODUCTION STRUCTUREInternational Trade & the World Economy; Charles van Marrewijk

Explanations for trade

Classical 2. Opportunity costs 3. Comparative advantage

Neo-classical 4. Production structure 5. Factor prices 6. Production volume 7. Factor abundance

1. The world economy

New trade 9. Imperfect competition 10. Intra-industry trade

Policy

8. Trade policy

11. Strategic trade policy

12. Int. trade organizations 13. Economic integration

17. Applied trade policy modeling

Economicgeography

New interactions 14. Geographical economics 15. Multinationals 16. New goods, growth, and development

Industrialorganization

Internationalbusiness

Growth theory

Part

IP

art

IIPa

rt I

IIPa

rt I

V

18. Concluding remarks

Introduction




Cost minimization



Conclusions


IntroductionInternational Trade & the World Economy; Charles van Marrewijk

Objectives / key terms

Production functions Isoquants

Cost minimization Factor intensity

Constant returns to scale Unit costs

Paul Samuelson (1915 - )

Chapter 4 reviews the production structure of the neo-classical model

Introduction




Cost minimization



Conclusions


Factor price equalization (FPE)

International trade based on differences in endowments results

Rybczynski theorem (Ryb)

Stolper-Samuelson theorem (St-Sa)

Heckscher-Ohlin theorem (H-O)

An increase in the price of a final good increases the reward to the factor used intensively in the production of that good and reduces the reward to the other factor

Trade in goods (which equalizes final goods prices) leads to equalization of factor prices

An increase in the quantity of a factor of production at constant final goods prices leads to an increase in the production of the good using that factor intensively and a decreased production of the other good

A country will export the final good which makes relatively intensive use of the relatively abundant factor of production

Neo-classical economics International Trade & the World Economy; Charles van Marrewijk

Introduction




Cost minimization



Conclusions


• 2 countries; Austria and Bolivia (A and B)

International trade based on differences in endowments assumptions

• No transport costs

• 2 goods; Food and Manufactures (F and M)

• 2 factors of production; labor and capital (L and K)

• Constant returns to scale; CRS

• Labor and capital mobility between sectors, not between countries

• Perfect competition

• Identical technology in the two countries

• No factor-intensity reversal

• Identical homothetic tastes in the two countries

• Differences in (relative) factor endowments

General structure of the neo-classical model International Trade & the World Economy; Charles van Marrewijk

General structure of the neo-classical model International Trade & the World Economy; Charles van Marrewijk

0

10

20

30

40

50

60

70

80

Switzerland

W. Germany

USAJapan

India

UK

The capital-stock per worker varies significantly between countriesNBER data for 1990

in 1985 $ (*1000)

Introduction




Cost minimization



Conclusions


Production functionsInternational Trade & the World Economy; Charles van Marrewijk

1,0;; 11

fm

inputlabor

f

inputcapital

f

inputlabor

m

inputcapital

mffmm LKFLKM

An isoquant = the set of all efficient input combinations to produce a given amount of output.

labor

capital

0

Isoquant M = 1

C

BA


Table 4.1 Substitution possibilities ( 5.0m )

mL mK Extra capitalmL mK Extra capital

1.0 1.000 - 0.5 2.828 0.677

0.9 1.171 0.171 0.4 3.953 1.124

0.8 1.398 0.226 0.3 6.086 2.133

0.7 1.707 0.310 0.2 11.180 5.095

0.6 2.152 0.444 0.1 31.623 20.442

The substitution possibilities between capital and labour in the neo-classical model are important (see the isoquant = 1 table below).


0

1

2

3

0 1 2 3

labor

capi

tal

4.0m

4.0m

6.0m

6.0mCapital intensity alpham influences substitution

Introduction




Cost minimization



Conclusions


Cost minimization International Trade & the World Economy; Charles van Marrewijk

labor

capital

),( rwKm

),( rwLm

r

w

L

K

m

m

m

m

1

0

M = 1

M = 1

Isocost line0

r

wC

B

A

Isocost line1m

m

L

K

Cost minimization International Trade & the World Economy; Charles van Marrewijk

The parameters play an important role.

They indicate the capital-intensity

of the production process:r

w

L

K

r

w

L

K

f

f

f

f

m

m

m

m

1;

1

fm ,

We assume that the production of manufactures is more capital-intensive than the production of food, that is: fm

costtotal

mm

capitalofcost

mm wLrK

rK

mm wLrKcoststotal

Also note that:

So alpha also represents the share of costs paid to capital

Introduction




Cost minimization



Conclusions


Impact of wage rate and rental rate International Trade & the World Economy; Charles van Marrewijk

l a b o r

c a p i t a l

),( 0 rwK m

),( 0 rwL m0

M = 1

M = 1

C

E),( 1 rwK m

),( 1 rwL m

D

Impact of lower wage rate on cost minimizing input combination

(substitution away from capital)

Introduction




Cost minimization



Conclusions


Constant returns to scale International Trade & the World Economy; Charles van Marrewijk

0

1

2

3

4

5

0 1 2 3 4 5

labor

capi

tal

M = 1

M = 2

M = 3

A

B

C

D

E

F

With CRS isoquants are radial blow-ups of one another

Introduction




Cost minimization



Conclusions


ConclusionsInternational Trade & the World Economy; Charles van Marrewijk

Neo-classical trade model

• 222 structure (countries, goods, factors)

• perfect competition, constant returns to scale

• 4 main results (FPE, St-Sa, Ryb, HOS)

• different production factor intensities for goods

• different (relative) factor endowments for countries

UNCTAD/WTO International Trade Center (ITC) website

http://www.intracen.org provides empirical data

• Primary product exports mainly in Africa, Middle East and Latin America (next slide)

ConclusionsInternational Trade & the World Economy; Charles van Marrewijk

Primary productsshare of exports (%)

88.2 to 100 (28)60.4 to 88.2 (31)30.5 to 60.4 (30)15.5 to 30.5 (30)

1.4 to 15.5 (32)

Primary products; share of exports (%), 1998; Source: ITC

Documents

Introduction Neo-classical economics General structure of the neo-classical model