; Classical Trade Theory Devaluation
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Classical Trade Theory Devaluation


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									Classical Trade Theory

 Globalization: It’s the Factor
             2 x 2 x 2 Model
• Two goods, two countries, two factors of
  production: neat analytical framework
• General competititve equilibrium: markets clear,
  resource constraints and optimization of
  production (marginal productivity conditions)
• Relative prices are given
• Country is better off when it moves to a higher
  indifference curve. This is the economic
  meaning of “welfare”.
    Hecksher – Ohlin Theorem
• Specialization and comparative advantage:
  works out the Ricardian theory of comparative
  advantage in a full general equilibrium
  framework with capital and labor, abandons
  fixed coefficient production function
• Result: countries that are relatively labor
  abundant should specialize in relative labor
  intensive goods; countries that are capital
  abundant should specialize in capital abundant
Factor Price Equalization Theorem
• Trade is a substitute for movement of factors of
  production: this is a fundamental reason for
  trade agreements such as NAFTA.
• If two countries move from autarky to free trade,
  wages will fall in the capital abundant country
  and rise in the labor abundant country, while
  rental rates will rise in capital abundant country
  and fall in labor abundant country
  Stolper-Samuelson Theorem
• Tariffs and relative returns to factors of
• A tariff on a labor intensive good (or a rise
  in its price) will lead to an increase in
  wages relative to rental rates on capital
• A tariff on a capital intensive good will lead
  to a fall in wages relative to capital
        Rybczynski Theorem
• Effect of changes in supply of labor or
• An increase in capital in a country will lead
  to an expansion in the production of the
  capital intensive good and a contraction in
  the production of the labor-intensive good
• An increase in labor will lead to expansion
  of labor-abundant good and a contraction
  of the capital-abundant good.
     General Equilibrium Issues
•  What about a third factor of production, land, and
  production of agricultural goods as well as capital and
  labor intensive manufactured goods?
• Example: cut in tariffs on agriculural goods. Labor is
  freed from farms and there is migration to cities, so
  wages should fall. But with cheaper food, wages may
  actually increase.
• Skilled labor and increasing returns: skilled labor
  actually goes to places where there are already pools of
  skilled labor. Not just for social reasons! Productivity of
  good surgeons higher with good nurses, internists.
  Skilled labor ofen compliments, rather than substitutes,
  other skilled labor.
     Measurement of Capital
     Mobility: What is Capital?
• Interest Parity Theorem (relating to issue of
  independent monetary policy).
• Feldstein-Horioka Paradox: savings and
  investment correlations
• Arbitrage and claims on capital (k and k*)
R = R* = f’(k) + ln[Q(t+1)]-ln[Q(t)]=
          f’(k*) + ln[Q*(t+1)]-ln[Q(t)]
Q and Q*: real share prices of claims on capital,
  f’(k) and f’(k*) marginal productivity of capital
 Issue of Growth and Productivity:
     Growth Is All That Matters
• Solow model and sources of growth
 log(Y) = ln(A) + alpha *ln(K) + (1-
   alpha)ln(L), this is Cobb-Douglas function
   in logarithmic form
If A is constant, we can describe growth,
Diff(y) = alpha Diff(k) + (1-alpha) Diff(l),
Where y is the log of Y, k log of K, l log of L,
And Diff is the difference operator.
           Solow Residuals
• Is A really constant? We call Diff(a), the
  total factor productivity, or TFP effect.
• We can rewrite the growth equation
Diff(y) = Diff(a) + alpha Diff(k) + (1-alpha)
According to many studies, the TFP effect
  explains more than half of growth of
  industrial countries
       Krugman Controversy
• Asian miracle: fast growth in the NIC’s or
  Gang of Four, for over 10 years.
• Krugman said it was due to forced saving
  and investment, long hours of work, little of
  the growth can be explained by the TFP
• So if we are forced to saving 40% of our
  income, and get only two weeks off a year,
  of course a country will grow.
  Real Business Cycle Theory
• Kydland-Prescott and macroeconomic
  fluctuations in US GDP for over a century.
• Measured shocks to GDP productivity as
  the Solow residual.
• They concluded that over 80 percent of
  the variance of real GDP is due to real
  productivity shocks, not due to demand
  factors such as fiscal policy or monetary
  policy. Hard anti-Keynesian theory.
   Emerging Markets and RBC
• Terms of trade shocks drive GDP cycles,
  not productivity shocks
• Real exchange rate and the terms of
• Harberge-Laursen-Metzler Effect vs
  classical effect of a devaluation (change in
  terms of trade
         Devaluation Effects
• Elasticity pessimism vs. optimism
• Income distribution effects
• Effects on imported inputs: the
  contractionary effects of a devaluation
• J-curve effects

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