Welcome to Econ 414 International EconomicsAssignment 1Here is the animated version of Asst 1 GraphThe Terms of TradeThe theory of reciprocal demandNote: Under constant cost assumption (linear PPFs), the supply curve of a good in each country is horizontal.Trade Under Increasing Opportunity CostsSupply Curves of a Good and the Production Possibilities Frontier Under Increasing Cost ConditionsSlide 9Static/ Dynamic Gains From TradeChapter 3: The Factor-Proportions Theory (the theory attempts to explain what determines comparative advantage.)The Factor-Proportions TheorySlide 13Slide 14Slide 15Slide 16Slide 17Slide 18Slide 19Slide 20Slide 21Slide 22Slide 23Slide 24Slide 25Factor-Price Equalization and the Distribution of IncomeSlide 27Slide 28Slide 29Slide 30Slide 31Slide 32Slide 33The Specific-Factors ModelSlide 35Slide 36Empirical Evidence on the Factor-Proportions TheorySlide 38Slide 39Slide 40Slide 41Summary1Welcome to Econ 414 International EconomicsStudy GuideWeek ThreeYou must complete all tasks outlined here by Friday, September 14. Our first exam is scheduled for Wednesday, September 19 at 2 PM. This is a 50 minutes exam. You will need to go to Thomas 223 at that time to take your exams. Under WebCT’s Discussion, I have listed the topic “Questions on Exam 1”. Post all of your questions on the material covered on exam 1 there.2Assignment 1•Is graded and mailed to you via WebCT mail.•Answer key is posted is on the homepage of WebCT–Review it carefully as it contains some lessons on •how to determine the comparative advantage•How to determine the mutually beneficial range of terms of trade•how to show that a nation is better off as a result of trade.•How to show that the world is better off as a result of a trade.3• The slope of US PPF (blue line) = 0.5 = opportunity cost of 1 computer = MRT of beer for computer• The slope of German PPF (blue line) = 1 = opportunity cost of 1 computer = MRT of beer to computer• The red lines are the trading possibility curves• The slope of the trading possibility curves = the terms of trade = 3/4.5 or 1/1.55510BBC2.553ImportsExportsExportsPC24.53Imports5PU.S.0 beercomputersGermany0 beercomputersHere is the animated version of Asst 1 Graph 4.54•The terms of trade is the relative price of the exportable good expressed in units of the importable good.The Terms of Trade5•In Assignment 1, remember that the range of mutually beneficial terms of trade was–2 computers >1beer>1 computer–But what affects the actual exact exchange rate within this limit?–The theory of reciprocal demand suggests that:1. The stronger the German demand for US computer, the higher the price German’s will pay for US computer, the closer the actual exchange rate will be to 1 beer for 1 computer2. The stronger the US demand for German beer, the higher the price US will pay for German beer, the closer the actual exchange rate will be to 1 beer for 2 computer–So the actual exchange rate will depends on how strong the demand of one nation is for the other nation’s product.The theory of reciprocal demand6Note: Under constant cost assumption (linear PPFs), the supply curve of a good in each country is horizontal. beercomputersPrice of Computer in terms of forgone beercomputersSupply510USUS0.5 The Price of computer in terms of the number of forgone beer is always constant7•Increasing Costs and the Production Possibilities–The increasing amount of a good that a country must forego to release enough resources to produce each additional unit of another good.–A country may have increasing opportunity costs because:•Factors of production are specialized in the production of a particular product.–For example, highly skilled labor is used in the computer production while low skilled labor is used in the beer production.•Production of different goods use resources in different relative proportions.–For example, the computer industry may require large amounts of capital and the beer industry may require large amounts of labor.Trade Under Increasing Opportunity Costs8Supply Curves of a Good and the Production Possibilities Frontier Under Increasing Cost ConditionsbeercomputersPrice of computerscomputers5 A4.5B1C2DE9F10Supply10.5102•The opportunity coat of first computer is 0.5 beer.• The opportunity cost of 10th computer is 2 beers.9•Study Figure 2.8 carefully–Notice that the only difference between this and constant cost case is•At any given point on PPF the slope of the tangency line = opportunity cost of the good measured on horizontal axis.•The blue line (the line representing the exchange rate) is tangent to PPF at the production level after trade.•Complete specialization is not possible under increasing cost assumption because if a nation wants to completely specialize in production of a good, its cost of producing that good will be extremely high.Trade Under Increasing Opportunity Costs10•Static Gains from trade–Gains in word output that result from specialization and trade are the static gains from trade.•Dynamic gains from trade–Gains from trade over time that occur because trade causes an increase in a country’s economic growth or induces greater efficiency in the use of existing resources.Static/ Dynamic Gains From Trade11Chapter 3: The Factor-Proportions Theory (the theory attempts to explain what determines comparative advantage.) •Assumptions of the Factor Proportions Theory1. Two countries – U.S. and India producing two goods – machines and cloth2. Production and consumption conducted under perfect competitionA. Firms are price takers.B. Prices of factors are determined by supply and demand in each market.C. In long run, prices of goods are equal to their respective costs of production.12The Factor-Proportions Theory3. No constraints to trade4. International trade will not lead to complete specialization.5. Consumers in both countries have equal tastes and preferences.6. Both countries are endowed with homogeneous factors of production and both are used in production: Capital (K) and Labor (L).13The Factor-Proportions Theory7. Technology for production same in both countries and produced under constant returns to scale.8. Capital and Labor can flow freely from one industry to the other domestically9. Labor and Capital cannot move freely between countries.14The Factor-Proportions Theory10. Production techniques available lead to cloth being a labor-intensive good and