chapter  2
13 Pages

Basic models of international trade I

Figure 2.1(a) depicts a linear PPF, VP. The slope of the PPF is a1/a2. Both goods are produced at Home only if the wages earned in the two sectors are the same. Denote pi the price of good i, wage rate in i-th sector is pi/ai. Then, wage rates are equalized across sectors if and only if

p1___a1 =

p2___a2 . (2.2)

In other words, in autarky (i.e., no international trade), the relative price of good 1 is determined by its opportunity cost:

p A2 =

a1__a2, (2.3)

where superscript A represents the autarky equilibrium. In Figure 2.1(a), the autarky equilibrium might occur at point A. Panel (b) depicts Foreign PPF, P*V* and the autarky equilibrium at A*. Suppose that Home has a comparative advantage in producing good 1, meaning that

a1__a2 < a

Combining this with (2.3) and its Foreign counterpart, the Home autarky relative price of good is lower than Foreign:

< p1 *A ____p2*A .