introduction neo-classical economics general structure of the neo-classical model
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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
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
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
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
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
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
• 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
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
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
Production functionsInternational Trade & the World Economy; Charles van Marrewijk
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).
Production functionsInternational Trade & the World Economy; Charles van Marrewijk
0
1
2
3
0 1 2 3
labor
capi
tal
4.0m
4.0m
6.0m
6.0mCapital intensity alpham influences substitution
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
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
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
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
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
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
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
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
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