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Introduction Neo-classical economics General structure of the neo-classical model

International Trade & the World Economy;  Charles van Marrewijk. CHAPTER 4; PRODUCTION STRUCTURE. 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

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Introduction Neo-classical economics General structure of the neo-classical model

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  1. International Trade & the World Economy;  Charles van Marrewijk CHAPTER 4; PRODUCTION STRUCTURE 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

  2. International Trade & the World Economy;  Charles van Marrewijk CHAPTER 4; PRODUCTION STRUCTURE 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

  3. International Trade & the World Economy;  Charles van Marrewijk Introduction Chapter 4 reviews the production structure of the neo-classical model Paul Samuelson (1915 - )

  4. International Trade & the World Economy;  Charles van Marrewijk CHAPTER 4; PRODUCTION STRUCTURE 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

  5. International Trade & the World Economy;  Charles van Marrewijk Neo-classical economics International trade based on differences in endowments results Factor price equalization (FPE) Trade in goods (which equalizes final goods prices) leads to equalization of factor prices Rybczynski theorem (Ryb) 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 Stolper-Samuelson theorem (St-Sa) 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 Heckscher-Ohlin theorem (H-O) A country will export the final good which makes relatively intensive use of the relatively abundant factor of production

  6. International Trade & the World Economy;  Charles van Marrewijk CHAPTER 4; PRODUCTION STRUCTURE 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

  7. International Trade & the World Economy;  Charles van Marrewijk General structure of the neo-classical model International trade based on differences in endowments assumptions • 2 countries; Austria and Bolivia (A and B) • 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 • No transport costs • Identical technology in the two countries • No factor-intensity reversal • Identical homothetic tastes in the two countries • Differences in (relative) factor endowments

  8. International Trade & the World Economy;  Charles van Marrewijk General structure of the neo-classical model The capital-stock per worker varies significantly between countries NBER data for 1990 in 1985 $ (*1000)

  9. International Trade & the World Economy;  Charles van Marrewijk CHAPTER 4; PRODUCTION STRUCTURE 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

  10. International Trade & the World Economy;  Charles van Marrewijk Production functions An isoquant = the set of all efficient input combinations to produce a given amount of output.

  11. International Trade & the World Economy;  Charles van Marrewijk Production functions The substitution possibilities between capital and labour in the neo-classical model are important (see the isoquant = 1 table below).

  12. International Trade & the World Economy;  Charles van Marrewijk Production functions Capital intensity alpham influences substitution

  13. International Trade & the World Economy;  Charles van Marrewijk CHAPTER 4; PRODUCTION STRUCTURE 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

  14. International Trade & the World Economy;  Charles van Marrewijk Cost minimization

  15. International Trade & the World Economy;  Charles van Marrewijk We assume that the production of manufactures is more capital-intensive than the production of food, that is: Also note that: So alpha also represents the share of costs paid to capital Cost minimization The parameters play an important role. They indicate the capital-intensity of the production process:

  16. International Trade & the World Economy;  Charles van Marrewijk CHAPTER 4; PRODUCTION STRUCTURE 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

  17. International Trade & the World Economy;  Charles van Marrewijk Impact of wage rate and rental rate Impact of lower wage rate on cost minimizing input combination (substitution away from capital)

  18. International Trade & the World Economy;  Charles van Marrewijk CHAPTER 4; PRODUCTION STRUCTURE 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

  19. International Trade & the World Economy;  Charles van Marrewijk Constant returns to scale With CRS isoquants are radial blow-ups of one another

  20. International Trade & the World Economy;  Charles van Marrewijk CHAPTER 4; PRODUCTION STRUCTURE 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

  21. International Trade & the World Economy;  Charles van Marrewijk Conclusions • Neo-classical trade model • 222 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)

  22. International Trade & the World Economy;  Charles van Marrewijk Conclusions Primary products; share of exports (%), 1998; Source: ITC

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