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Consumer and producer surplus in autarky.
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The effects of imports on surplus
If the world price is higher than the autarky price, trade leads to exports and a rise in the domestic price compared to the world price.
There are overall gains from trade because producer gains exceed the consumer losses.
The graph that follows shows the domestic market with exports.
52 Try to apply the Heckscher-Ohlin model to determine the comparative advantages of Russia in international trade.
The relationship between comparative advantage and factor availability is found in an influential model of international trade, the Heckscher-Ohlin model, developed by two Swedish economists in the first part of the twentieth century. A key concept in the model is factor intensity. Economists use the term `factor intensity` to describe this difference among goods: oil refining is capital-intensive, because it tends to use a high ratio of capital to labor, but clothing manufacture is labor intensive, because it tends to use a high ratio of labor to capital.
According to the Heckscher-Ohlin model, a country will have a comparative advantage in a good, whose production is intensive in the factors that are abundantly available in that country compared to other countries.
Russia has a wealth of natural resources. It is the leading producer of natural gas and the second producer of oil in the world, as well as being one of the main producers and exporters of diamonds, nickel and platinum. So it has a comparative advantage in these goods.
Russia sells a broad range of commodities and manufactures including petroleum and petroleum products, natural gas, wood and wood products, metals, chemicals, and a wide variety of civilian and military manufactures. Russia's largest trading partners for exports are Ukraine, Germany, United States, Belarus, the Netherlands, and China. Russia imports machinery and equipment, consumer goods, medicines, meat, grain, sugar, and semi-finished metal products, because these goods are abundantly available and their production is intensive.
53 What are the links between skill and comparative advantages?
Comparative Advantage
Definition: If one country has a lower opportunity cost in production of a good than another country, the first country has a comparative advantage in production of that good.
Human Capital and Comparative Advantage
Human capital is the skills, education, training, talent, and motivation that make you more productive in the work world.
We can apply the insights from comparative advantage to people as well as to countries. For people, comparative advantage insights tell us that each person should specialize in what he or she does best. If you are a talented musician that is what you should do. If you a computer wizard, that is what you should specialize in.
Sometimes people have more than one talent or skill. You might be very good at fixing machines and also very good at art. Then you may have to choose which of those skills your comparative advantage is. This will depend both on other people’s strengths and on the value of your skills to society.
54 How to account for that international trade tends to increase the demand for factors that are abundant in the given country compared with other countries and to decrease the demand for factors that are scarce in this country compared with other countries?
The prices of factors of production, like the prices of goods and services, are determined by supply and demand. Compared with autarky, international trade leads to higher production in exporting industries and lower production in import-competing industries. This indirectly increases the demand for the factors used by exporting industries and decreases the demand for factors used by import-competing industries. In addition, the Heckscher-Ohlin model says that a country tends to export goods that are intensive in its abundant factors and to import goods that are intensive in its scarce factors. As a result, the prices of abundant factors tend to rise, and the prices of scarce factors tend to fall as international trade grows. In other words, international trade tends to redistribute income toward a country’s abundant factors and away
55 What are the methods to determine the optimal consumption bundle?
An individual’s consumption bundle is the collection of all the goods and services consumed by that individual. A consumer’s consumption possibilities are the set of all consumption bundles that can be consumed given the consumer’s income and prevailing prices. A consumer’s optimal consumption bundle is the consumption bundle that maximizes the consumer’s total utility given his or her budget constraint.
The 1st method: At the optimal consumption bundle, the marginal utility per dollar spent on clams is equal to the marginal utility per dollar spent on potatoes. The optimal consumption rule says that when a consumer maximizes utility, the marginal utility per dollar spent must be the same for all goods and services in the consumption bundle.
Whenever marginal utility per dollar is higher for one good than for another good, the consumer should spend $1 more on the good with the higher marginal utility per dollar and $1 less on the other. By doing this the consumer will move closer to his or her optimal consumption bundle
The 2nd method: with a help of indifference curves.
56 How to account for the demand curves downward slope using utility concept?
The demand curve has the form of a descending curve DD (downward slope) and expresses the inverse relationship between price and demand - at low prices increases the number of goods to be purchased, and vice versa. From the law of demand, it follows that if the factors that determine the value of demand, remain constant, if the price of associated goods are constant, then with the increase of the price of the goods separate buyers will cease to buy it. And what is growing more and the price for it, the more people are being forced to abandon its purchase or buy less and less.
We can account for the demand curve slope downward by using law of diminishing marginal utility. It is assumed that if all things remain constant, once the price of a good decreases, you buy more hence the reason for the negative slope downwards of the demand curve.
(If the price of clams falls the marginal utility per dollar spent on clams, MUC/PC, increases at any given level of clam consumption. As a result, a consumer can increase his or her utility by purchasing more clams and less of other goods when the price of clams falls. So when the price of a good increases, an individual will normally consume less of that good and more of other goods. Correspondingly, when the price of a good decreases, an individual will normally consume more of that good and less of other goods. This explains why the individual demand curve, which relates an individual’s consumption of a good to the price of that good, normally slopes downward—that is, it obeys the law of demand. And since the market demand curve is the horizontal sum of all the individual demand curves of consumers, it, too, will slope downward).
57 What's the difference between substitution and income effect?
The effect of a change in price on consumer choice can be decomposed into substitution effect and the income effect.
The substitution effect of a change in price of a good is the change in the quantity of that good consumed as the consumer substitutes the good that has become relatively cheaper in place of the good that has become relatively more expensive. he substitution effect is shown by a movement along the original indifference curve in response to the change in relative price, as the consumer substitutes more of the relatively cheaper goods in place of the relatively more expensive goods.
The income effect of a change in the price of a good is the change in the quantity of that good consumed that results from a change in the consumer's purchasing power due to the change in the price of the good. The income effect is shown by a change to a new indifference curve, reflecting the fact that a change in a good's price alters the purchasing power of a given level of income.
The income and substitution effects work in the same direction for normal goods, ensuring that demand curves slope downward.
For most purposes, however, there are only two things you need to know about the distinction between these two effects.
First, for the great majority of goods and services, the income effect is not important and has no significant effect on individual consumption. So most market demand curves slope downward solely because of the substitution effect—end of story.
Second, when it matters at all, the income effect usually reinforces the substitution effect. That is, when the price of a good that absorbs a substantial share of income rises, consumers of that good become a bit poorer because their purchasing power falls. And the vast majority of goods are normal goods, goods for which demand decreases when income falls. So this effective reduction in income leads to a reduction in the quantity demanded and reinforces the substitution effect. However, in the case of an inferior good, a good for which demand increases when income falls, the income and substitution effects work in opposite directions. Although the substitution effect tends to produce a decrease in the quantity of any good demanded as its price increases, in the case of an inferior good the income effect of a price increase tends to produce an increase in the quantity demanded. As a result, there are hypothetical cases involving inferior goods in which the distinction between income and substitution effects are important.
58 What is the economic model used to rank the consumption bundles in terms of desirability?
It is Utility theory that bases its beliefs upon individuals’ preferences. It is a theory postulated in economics to explain behavior of individuals based on the fact that people order their choices depending upon their preferences.
The utility of consumer is measure of the satisfaction the consumer derives from consumption of goods and services.
An individual`s consumption bundle is the collection of all the goods and services consumed by that individual.
An individual’s utility function gives the total utility generated by his or her consumption bundle. The unit of utility is util.
The marginal utility of a good or service is the change in total utility generated by consuming one additional unit of that good or service.
The principle of diminishing marginal utility says that each successive unit of a good or service consumed adds to total utility less than the previous unit.
*(A budget constraint requires that the cost of a consumer`s consumption bundle be no more than the consumer`s total income.
A consumer`s consumption possibilities is the set of all consumption bundles that can be consumed given the consumer`s income and prevailing prices. A consumer`s budget line shows the consumption bundles available to consumer who spends all of his or her income.
The right answer for marginal decisions involving consumption is that the marginal utility per dollar spent on each good must be the same optimal consumption bundle. By factoring in prices, this comparison takes into account the fact that a consumer has limited amount of money to spend).
Optimal consumption rule.
The optimal consumption rule says that when a consumer maximizes utility, the marginal utility per dollar spent must be the same for all goods and services in the consumption bundle.
59 What is meant by tangency condition and what is its practical application?
The tangency condition between the indifference curve and the budget line holds whenthe indifference curve and the budget line just touch. This condition determines the optimalconsumption bundle when the indifference curves have the typical convex shape. The tangencycondition doesn’t work if the MRS is constant (the indifference curves are straight lines), for instance: perfect substitutes, if either the indifference curves or budget constraint are non-differentiable (complements), if the individual prefers to consume zero of one of the goods.
60 What are the effects of a price increase and of a change in income on the budget line?
Budget line shows the consumption bundles available to a consumer who spends all income. The budget line is an important component when analyzing consumer behavior. The budget line illustrates all the possible combinations of two goods that can be purchased at given prices and for a given consumer budget. Remember, that the amount of a good that a person can buy will depend upon their income and the price of the good.
A change in consumer income and the budget line. If consumer income increases then the consumer will be able to purchase higher combinations of goods. Hence an increase in consumer income will result in a shift in the budget line. Note that the prices of the two goods have remained the same; therefore, the increase in income will result in a parallel shift in the budget line.If consumer income fell then there would be a corresponding parallel shift to the left to represent a fall in the potential combinations of the two goods that can be purchased.
A change in the price of a good and the budget line. If income is held constant, and the price of one of the goods rises then the slope of the curve will change.
When the price of rooms rises, the relative price of rooms in terms of restaurant meals rises; as a result, Ingrid’s budget line changes (for the worse—but we’ll get to that). She responds to that change by choosing a new consumption bundle.
If we increase not only the the price of housing and at the same time also increase the price of restaurant meals and Ingrid’s income, all three numbers—the price of rooms, the price of restaurant meals, and Ingrid’s income—has no effect on her budget line. Because the relative price is unchanged, it won’t affect her consumption choice
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