GLEF Tutorial
Global and Regional Economic Integration
QIU Jinyuan (linusqiu@[Link])
November ,
/
Table of Contents
Part B: Scale Economic and Comparative Advantage
! Part B: Scale Economic and Comparative Advantage
! Part C: Aggregated Trade
/
Environment
Part B: Scale Economic and Comparative Advantage
Consider a country whose production possibilities frontier is given by
L ≥ ac Qαc + aw Qαw
where ai gives the unit labour cost and Qi the quantity produced of good i ∈ {c, w}. Suppose there is a
foreign country of comparable size whose variables are denoted with an asterisk.
Assume that α < 1 for both countries.
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Returns to Scale
Part B: Scale Economic and Comparative Advantage
. Explain returns to scale in this economy.
— Shut down one production and convert the PPF to a production function
! "1/α
L
L= ac Qαc ⇒ Qc =
ac
1−α
dQc 1L α
=
dL α a1/α
c
1−α
α<1⇒ >0
α
— dQc /dL is increasing with L means increasing return of scale
. Does either country have an absolute advantage? Explain: It depends on the production point
. Does either country have a comparative advantage? Explain: we only need the oppo. cost gap to
construct CA.
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Gains from Trade
Part B: Scale Economic and Comparative Advantage
. Draw two graphs, each showing the production and consumption possibilities frontiers for the
domestic and foreign economies. Qw
. Are there gains from trade? Explain. Qc
— Yes. When ac %= a∗c , aw %= a∗w , gains from trade are from oppo. cost gap.
• Bound : What if ac = a∗c , aw = a∗w ? Now there is no CA (same oppo. cost). But because of the
increasing return of scale, when each country specializes in a different good, the will produce more
and exchange with each other. Now, the gains from trade are a result of specialization.
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Table of Contents
Part C: Aggregated Trade
! Part B: Scale Economic and Comparative Advantage
! Part C: Aggregated Trade
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Autakry Environment
Part C: Aggregated Trade
Consider an economy producing a single consumption good. Quantity demanded is Qd = D and quantity
supplied is Qs = ps . The price is p and D, s > 0 are parameters.
. Derive the autarkic equilibrium quantity QA and price pA .
pA
Qd = Qs ⇒ D = ⇒ pA = sD, QA = D
s
. Derive consumer and producer surplus under autarky, CSA and PSA .
pA
QA
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Open Economy
Part C: Aggregated Trade
Suppose the domestic economy opens up to trade with a foreign country of comparable size. The foreign
economy functions identically to the domestic, but its parameters may differ unrestrictedly. Denote its
variables with an asterisk. Assume the domestic country is a net importer.
. Draw a graph of the international trade market showing the quantity of goods traded Qw and the
world price pw under free trade, as functions of pA and p∗A .
. Draw a graph showing foreign consumer and producer surplus under free trade, CS∗W and PS∗W , as
functions of pw .
pw p∗
Qw Q∗
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Tariff
Part C: Aggregated Trade
Suppose the domestic country imposes a tariff T per unit of imported good.
. Label on a new graph of the international trade market the quantity traded internationally under
tariffs QT and the world price pT .
. Label on a new graph domestic consumer and producer surplus and government revenue under
tariffs, CST , PST , and GRT .
. Draw a new graph showing foreign consumer and producer surplus change under free trade, ∆CS∗W
p and ∆PSW , as functions of pw . p
∗
w p∗
Qw Q Q∗
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Monopoly Market
Part C: Aggregated Trade
Now assume the domestic economy has a monopoly product market.
. Draw a graph comparing CS and PS in an autarky economy under perfect competition versus
monopoly.
• What’s the difference between monopoly and perfect competition? The producer can set the price.
• Q = D means that demand is perfectly inelastic (like water, food) such that the consumer will accept
any price even ∞ if there is no outer option
• So CSm = 0 and PSm = ∞
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Monopoly Market
Part C: Aggregated Trade
Now assume the domestic economy has a monopoly product market.
. Draw a graph showing CS and PS in a free trade economy under monopoly.
. Draw a graph showing CS and PS in a free trade economy with an import tariff under monopoly.
p p p
Q Q Q
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Welfare of Inelastic Demand Setting
Part C: Aggregated Trade
Bonus : Derive a condition for which domestic welfare (CS + PS + GR) is lower under tariffs than under
free trade with perfect competition.
p
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Welfare of Inelastic Demand Setting
Part C: Aggregated Trade
What’s the difference between inelastic and elastic demand?
• In the inelastic demand setting, there is no
consumer side deadweight loss d" .
• Why? The origin of deadweight loss is the
demand reduction due to the tariff. But
inelastic demand means constant
demand, which won’t be affected by the
tariff. No consumer side deadweight loss
d" .
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