Timeline for Do I make correct conclusions about international trade (and ways to increase GDP) from the expedenture approach formula for GDP?
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| Jan 6, 2020 at 18:48 | comment | added | 1muflon1♦ | I meant to say can’t be maximized in autarky sorry for the typo | |
| Jan 6, 2020 at 18:30 | comment | added | 1muflon1♦ | Has to “waste” labor on wine sector that does not give a lot of production instead of allocating it to cloth sector that can produce a lot. Hence the GDP under trade has to be higher (if under autarky c=100 there won’t be any trade to begin with), because there is no way how in any scenario where trade would occur the production can be maximized in autarky. It’s simply not possible as trade cannot occur in scenario where demand is only for cloth, and as long as there was any demand for wine the pre trade production simply could not be at its peak. It’s physically impossible. | |
| Jan 6, 2020 at 18:27 | comment | added | 1muflon1♦ | @user161005 productivity in the industry will remain the same but actual production will increase. 1 form economic perspective producing 100c and exchanging it for 100w is the same as producing 100w domestically this is not possible under autarky but possible under trade. 2. Because cloth is the more productive sector in 1st country the aggregate production will always be maximized when all labor is in cloth but the only way how this can happen is 1. There is no demand for the other good - which conflicts with basic utility assumptions 2. There is trade. Otherwise the country... | |
| Jan 6, 2020 at 18:19 | comment | added | 1muflon1♦ | Btw this is the reason why on that other question I gave you an “obscure” answer. Best way how to prove this rigorously is to show you full Ricardian model (what is above is only extremely simplified snippet). However, if you are fine with just intuition and don’t need rigorous proof than take pen and paper and try to make any assumption on demand other than the demand is solely for C and you will see that once you calculate pre and post trade GDP the post trade will be higher assuming both countries don’t have exactly the same productivity in both sectors (ie exclude no trade scenarios) | |
| Jan 6, 2020 at 18:15 | comment | added | KarmaPeasant | I agree that utility leading to 100,0 in Autarky is extreme case and for any other utility function there will be gains from trade (i.e. increased consumption). But why would increased consumption imply that PPF increased? If anything, it would mean that distribution of goods became more optimal while production capabilities stayed the same. And that people are more motivated to realize full potential of said production capabilities. "as people want multiple goods point 100,0 it’s not possible" It's possible, just not desirable. | |
| Jan 6, 2020 at 18:05 | comment | added | 1muflon1♦ | In that case trade is 0 M=0, X=0 so under behavioral assumption that only cloth gives utility there is only autarky there is no trade scenario to compare autarky with. But under any trade scenario where X &M are not zero production will be higher because that implies utility is derived from both goods so in autarky not all workers can be in productive sector. Thus in trade the GDP and production will be actually higher because some people move from producing only 0.5 wine for 1L to producing 1 cloth for 1L and wine can be exchanged for 1c so it’s like if the country could produce 1w for 1L | |
| Jan 6, 2020 at 18:01 | comment | added | 1muflon1♦ | @user161005 yes but the point is that as long as people want multiple goods point 100,0 it’s not possible. It will never be an equilibrium as long as people’s utility function has the second good as well. Let’s make it concrete and put any assumption on demand other that the demand is solely for cloth let’s say we want 1c for every wine then in autarky the production would be approx 33c and 33w then this is lower production at adjusted prices than a production of 100c. Also, as mentioned earlier if the consumption is only for c so under autarky C=100 that is no trade scenario because... | |
| Jan 6, 2020 at 17:48 | comment | added | KarmaPeasant | I agree that trade allows to have higher mixed consumption than under autarky. But PPF is based on what is produced, not on what is consumed. We could introduce something like Consumption Possibilities Frontier, but it would be a thing different from PPF. | |
| Jan 6, 2020 at 17:43 | comment | added | 1muflon1♦ | to explain the intuition it is very unrealistic to assume only one good will be produced and if you want any of the other good in autarky you cannot commit all your labor to first product if you want both cloth and wine (does not matter in what proportion) then you have to tell at least one worker to go work in unproductive sector. Hence the aggregate productivity is lower. It’s better to have all labor in the most productive sector but without trade no country can do that. It’s like on individual level it’s better to specialize not to produce everything yourself as it lets you produce more | |
| Jan 6, 2020 at 17:41 | comment | added | 1muflon1♦ | @user161005 it is wrong because with trade consumption point 50,50 is possible but in autarky it’s impossible point to achieve. It is true that 100,0 is possible under both autarky and trade but that is just a single point. For any other choice of consumption trade will have higher production possibility than autarky that’s literary the only point of overlap. Also this is best seen graphically just maybe look at Kerguman et all international trade textbook, there should even be free pirated versions somewhere online. | |
| Jan 6, 2020 at 17:35 | comment | added | KarmaPeasant | My problem with trade leading to increase of PPF is that it would change motivation rather than production capatibilities. People could produce more without trade, they just didn't want to. It's like saying that invention of a whip in a slave economy would lead to increased PPF. I thought that PPF already included maximum motivation. Was I wrong? | |
| Jan 6, 2020 at 16:32 | comment | added | 1muflon1♦ | Not possible as marginal utility of 1 good must decline in consumption. If you already have 100 pizzas you would kill for a drink and if you already have 100 sodas you would do anything to get at least some food. Also if the countries would only want to produce one good of their comparative advantage then there is always only autarky. In such case trade scenario does not exist... (probably should have mentioned this last point as first instead of going in depth into utility but still both of them are good points). | |
| Jan 6, 2020 at 16:29 | comment | added | 1muflon1♦ | User) but this case actually nicely illustrates that difference trade represents one time increase in production so it’s an increase in Level of GDP, but you are right it does not make any of the industries inherently more productive so (at least in Ricardian model) trade does not lead to sustained growth of GDP. But there is increase in GDP because there is also one off increase in production. However, are right that in case where any country would only consume one product of its comparative advantage then GDP would be unchanged but that’s a special case and from utility perspective it is | |
| Jan 6, 2020 at 16:25 | comment | added | 1muflon1♦ | The trade in its essence allows both countries to get the more expensive product just for 1 unit of labor than for 2 so their production possibilities frontiers expand. If you would draw it the PPF in autarky would have vertexes in c,w space at 50,0 0,100 and after trade at 100,0 0,100 and the second country vice versa so the production actually expands because more labor is put toward productive use. GDP is not calculated based on potential but actual production. Also I think I remember you once asked about a difference between growth and level increase (or maybe that was some other.. | |
| Jan 6, 2020 at 16:18 | comment | added | 1muflon1♦ | @user161005 it’s not inconsistent. I did not made an assumption that they will want to consume equal amount of goods that was just an example although with proportional increase to demand this would actually be the result. The model I showed did not had explicit utility function although full Ricardian model would actually include that as well. And yes in any case other than a corner case where in first country demand for wine is 0 and demand for cloth is 100% and vice versa the actual production of the country increases. This is because... | |
| Jan 6, 2020 at 16:08 | comment | added | KarmaPeasant | 1."In real trade allows countries to produce more". But in Ricardian model the only thing that prevents countries from producing only good of their comparative advantage WITHOUT trade is their utility function. Trade doesn't increase production, it increases consumption. 2."both split their labor supply equally between wine and cloth" But later while trading they both consume equal amount of goods. It seems inconsistent. If they want to consume equal amount of both goods, then under autarky they must invest 2/3 of their labor on production of the disadvantaged good. | |
| Jan 6, 2020 at 14:57 | comment | added | 1muflon1♦ | The deflator and afterwards real GDP. For example, check the Bureau of Economic Analysis methodology to estimate the average prices and also output at this link bea.gov/resources/methodologies/nipa-handbook. So while d=100*nGDP/rGDP is completely valid in real life we actually use rGDP=100*nGDP/d because it’s simply easier to estimate nGDP and deflator than first estimate real GDP. Also in theoretical model you can easily calculate price levels just by averaging pricing like in this example so you use that formula for rGDP instead of first calculating rGDP and then deflator | |
| Jan 6, 2020 at 14:56 | comment | added | 1muflon1♦ | ... or deflator so they are actually all estimated based on surveys. It’s not like we actually measure all consumer spending in economy. There is a survey of let’s say 2000 consumers in every major area and spending for whole population is estimated based on that. The deflator is based on estimation of average prices. Again it’s not measuring directly all prices there is sample of some stores and every month an employee comes and check their prices but nobody checks all prices so in the end it’s an estimate. Once you get estimate for nominal GDP and price level you can easily just calculate | |
| Jan 6, 2020 at 14:53 | comment | added | 1muflon1♦ | @user161005 it’s actually not, I am actually aware that deflator is usually in bachelor level textbook written like D=100*nGDP/rGDP (I teach macro tutorials at University) but that is because this is easier for Bsc. Students. In real life the deflator is being estimated based on econometrics (I actually had internship in statistical office where we did that) and deflator is just a measure of price level. The formula works because also 100*nGDP/rGDP also gives you price level but in real life we cannot directly get result for for either nGDP or rGDP... | |
| Jan 5, 2020 at 18:26 | comment | added | 1muflon1♦ | @user161005 so if we select the old GDP we can create the deflator by dividing all price levels with the old GDP price level by 1.5. So the deflator for old GDP obviously will be 1, for the new GDP it will be 0.67. So now we can compare the old real GDP 100/1=100 with new 100/0.67=150 (Note: previously I made a small mistake, in my previous calculation I thought 1/1.5=0.5 which would make new GDP 200 but it’s 0.67 - my bad, I was writing it in the late night, I should have double check it, but this little arithmetic error does not change the point of the comment that new real GDP is higher) | |
| Jan 5, 2020 at 17:49 | comment | added | 1muflon1♦ | @user161005 I already showed you how to adjust for the price level above so now I am just repeating itself but I will try to do it in greater detail . 1. Estimate deflator. Deflator is a measure of price level so in this case we can just directly calculate the price level instead of estimating it by statistics. This can be done by averaging the prices. The old price level was 1.5 the new one is 1. Now we also have to select our base time period since you could either adjust new GDP for old price level or old GDP for new price level. Let’s just do the former for sake of time... | |
| Jan 5, 2020 at 17:28 | comment | added | KarmaPeasant | "The consumption can’t be 50 since they consume both 50 cloth and 50 wine." I see the mistake, but then real GDP=C+X-M=(50+2*50)+50-2*50=100, still not 200. "You should first calculate the new GDP at current prices ..." Already done, it's nominal GDP=C+X-M=(50+50)+50-50=100. "and then adjust it for price level". How to do this? | |
| Jan 5, 2020 at 17:13 | comment | added | 1muflon1♦ | must happen in any classical trade model: that is X-M=0 as otherwise the model would not be consistent with basic assumptions that went into building it in the first place. Also in real life empirically this is the case that in the long run the trade seems to balance itself. Also generally when you calculate GDP it’s always at current prices and then independently of GDP statistical offices publish deflators based on price level and inflation that can be used for inter-temporal comparisons of GDP. | |
| Jan 5, 2020 at 17:07 | comment | added | 1muflon1♦ | @user161005 1. The consumption can’t be 50 since they consume both 50 cloth and 50 wine. When calculating GDP under C there is any consumption no matter where it comes from that’s why M enters GDP with negative sign to adjust for the fact that part of C is not produced domestically. 2. You should first calculate the new GDP at current prices and then adjust it for price level. The reason why you have to do that this way is that the new trade is not 50 value of cloth for 100 cloth worth of wine but 50c for 50c worth of wine. If you ignore this then the trade won’t balance which in long run... | |
| Jan 5, 2020 at 16:56 | comment | added | KarmaPeasant | (NOT related to endowment economy) "Doing that new real GDP is 200" How did you come to this for trading Utopia? My calculations show that real GDP must be 0. real GDP=C+X-M=50+50-2*50=0 Utopia consumes 50 cloth, exports 50 cloth and imports 50 wine, where 1 wine has price of 2 cloth by standards of old prices (i.e. prices during autarky) | |
| Jan 1, 2020 at 15:19 | comment | added | 1muflon1♦ | @user161005 NFFI is by definition GNP -GDP. Technically everything in GNP and GDP is part of NFFI but the part that matter (that is the part that makes GNP not equal to GDP and hence NFFI zero) is the part when a national of a country has a factory or by simply relocating and working there etc increases GNP but not GDP, and vice versa when we look at it from point of view of immigrants or foreign business. | |
| Jan 1, 2020 at 15:13 | comment | added | KarmaPeasant | "For it to be NFFI you would have to have factory abroad". Just to be clear, do you assume that NFFI is the difference between interest/profit earned from foreign capital in this country and interest/profit earned from our capital abroad? Does it mean that income of remote workers working on foreign firms via the Internet is NOT included in NFFI? Does it mean that income of citizens who live outside of the country and earn their income abroad isn't included in NFFI? | |
| Jan 1, 2020 at 15:01 | comment | added | 1muflon1♦ | @user161005. No for example Berries have to be picked up with labor. This being said when you are explaining an endowment economy picking up sticks or stones is probably closest you can get to it if you ignore that little bit of labor involved there. Also just because endowment economy is not real it does not mean it’s not a good analytical tool for some situations. In economics we sometimes on purpose want to assume that production is just given to turn of any general equilibrium effects on labor etc | |
| Jan 1, 2020 at 14:50 | comment | added | KarmaPeasant | " In real life pure endowment economy is impossible". But isn't it exactly how people in the Stone Age lived (at the least before they started making things like spears, clothing and pottery), collecting gifts of the Nature? | |
| Jan 1, 2020 at 14:10 | comment | added | 1muflon1♦ | This is fallacy. You are using outdated labor theory of value. Let’s suppose I gift you Rembrandt for a free. Does that mean it has 0 value? Would you not be able to sell Rembrandt on eBay for millions of euros? The value is subjective not objective just because you got the rock for free it does not mean to someone it might not have any value. If you pick up diamond from some open ground deposit it’s an valuable endowment | |
| Jan 1, 2020 at 14:07 | comment | added | KarmaPeasant | "exports are positive" Oh my, how could I mess it up. Yes, you're correct. But if we assume that selling the rock on eBay isn't retail, then from it we can conclude that export=0 because export means goods and services sold abroad. But as you said, selling picked rock on eBay doesn't add any value (we got the rock itself for free, thus its value=0. No values was added by us, thus 0+0=0), you get your money for nothing. Thus by your own logic it would seem that there would be no export. | |
| Jan 1, 2020 at 13:49 | comment | added | 1muflon1♦ | @user161005 1 exports are positive on GDP so it would be still 10. 2. In real life pure endowment economy is impossible like triangles or spheres or squares are impossible endowment economy can only exist in theory. Of course retail ads value although I would not call selling one rock on eBay retail but regardless that value added by retail would be some extra cost that you would charge for handling the good as a markup on top of it’s cost. | |
| Jan 1, 2020 at 13:47 | comment | added | KarmaPeasant | 1.Okay, so it will be compensated by Export=-10 2."selling the rock itself does not mean service or good is created." Are you telling me that retail sector makes profit by literally doing nothing of value? 3.What makes you think that L=0 in pure endowment economy? | |
| Jan 1, 2020 at 12:50 | comment | added | 1muflon1♦ | 1. Even if you would sell it abroad it would be export not NFFI, NFFI is difference between GNP and GDP. For it to be NFFI you would have to have factory abroad. 2. selling the rock itself does not mean service or good is created. You just found the rock you did not really produced it. Of course you can always argue that picking it from ground is labor and production, but thats the same as telling math teacher that real triangles dont exist as in real world it is impossible to get straight line so pytagoras theorem does not apply... | |
| Jan 1, 2020 at 12:45 | comment | added | KarmaPeasant | Because by selling the stone on eBay I will earn income from abroad (selling it inside the country would violate assumption that no services and goods are created in the economy). My profit=10, but it will be compensated by NFFI=-10 because NFFI=Income of foreigners here - Income of our citizens abroad | |
| Jan 1, 2020 at 12:42 | comment | added | 1muflon1♦ | NFFI is net foreign factor income how that gets substracted? No GDP will be 10 because consumption would be 10$ assuming nothing else beside the rock is sold | |
| Jan 1, 2020 at 12:37 | comment | added | KarmaPeasant | Then the same 10 will be substracted due to negative NFFI. Thus GDP will be zero. | |
| Jan 1, 2020 at 11:35 | history | edited | 1muflon1♦ | CC BY-SA 4.0 |
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| Jan 1, 2020 at 11:33 | comment | added | 1muflon1♦ | @user161005 the endowment is an output of the country so GDP won’t be zero. For example, if you find nice stone on your walk you can think of it as an endowment if you sell that stone on eBay for 10$ GDP increases by 10$. The prices in endowment economy are determined the same way as always for example if the endowment is 25w and 50c then prices would be 2 and 1 (using c as numeraire). Also even in endowment economy endowments must be same for trade to be 0sum I forgot to mention that I will edit it to include that as well | |
| Jan 1, 2020 at 11:03 | comment | added | KarmaPeasant | You said that my logic works in a pure endowment economy. Yet I don't see how we are supposed to calculate GDP for pure endowment economy. How would we determine prices of endowed goods before trade begins? Besides, wouldn't GDP=0 for such economy, given that it supposedly measures wealth created IN the country? | |
| Dec 30, 2019 at 13:10 | comment | added | 1muflon1♦ | Different price levels so you either have to convert pre trade GDP to post trade prices or post trade GDP to pre trade prices. Both are valid, and I already explained above how to do that. So you can always express gains from trade from any model not just Ricardos model in GDP formula. GDP is measure of an output anything that increases countries output must increase real GDP by definition. In fact to generalize it anything that increases output be it a trade or technology or even if there would be some wizard making things more productive would raise real GDP | |
| Dec 30, 2019 at 13:06 | comment | added | 1muflon1♦ | Also about how do you translate the gains well GDP measures production given the prices. Using consumption approach Y=C+I+G +X-M, where in this I and G are zero so it reduces to Y=C+X-M if country produces 25w retailing at price 2 and 1 c retailing at the price 1 then at current prices GDP is 100. After trade the country produces 100c at price 1 but 50c is sent to foreign country at equilibrium price 1c =1w and home imports 50w so X-M=0 as it always will be in long run. So the new nominal GDP is also 100. However you can’t directly compare new and old GDP because they are expressed at | |
| Dec 30, 2019 at 12:33 | comment | added | 1muflon1♦ | Comparing two nominal GDPs at different price levels is like comparing temperature in degrees Celsius to some temperature in degrees Fahrenheit. Or comparing weight in stones to weight in Kg. You first have to make sure both variables have the same unit of measurement 1$ in 2000 is not the same unit of measurement as 1$ in 2001. You first have to make a conversion of 2001 dollar into 2000 dollar also I use years just as an example you can choose any time unit per which you do it. The point is you always have to make sure you are using the same units when making any comparisons | |
| Dec 30, 2019 at 12:29 | comment | added | 1muflon1♦ | You adjust GDP by calculating a deflator which expresses the new GDP at old prices in this case the deflator would be 1/2 so the real GDP or GDP at pre trade prices is 100/(1/2)=200 you always have to adjust GDP for price levels if you compare 2 GDPs because otherwise you are comparing apples and oranges if you don’t account for the change in the value of money. For example, if a country A produces 100 cars at 10$ nominal GDP would be 1000 and if price changes to 9$ nominal GDP will be 900$ but real GDP will always be 1000$ because production did not changed there was just deflation | |
| Dec 30, 2019 at 12:24 | comment | added | 1muflon1♦ | @user161005 you said you are familiar with Ricardian model. The prices are given by the relative scarcity of the goods given production possibilities of both countries (if you want full explanation post it as a different question it’s hard to imbed equations in comments). In simple terms if there is twice as much cloth as wine wine must be twice as expensive. That’s the average price level in country, in this simple example you can just average prices (2+1)/2=1.5. Regarding the calculation of equilibrium price after trade that again depends on relative scarcity post trade. | |
| Dec 30, 2019 at 12:16 | comment | added | KarmaPeasant | What do you mean by "aggregate average price" and how do you measure it? How did you calculate that 1 wine would be traded for 1 cloth after trade started? How did you adjust GDP for inflation? "What exactly is not clear there?" It's unclear how to translate gains from trade in Ricardian model into the expenditure formula. | |
| Dec 30, 2019 at 9:29 | comment | added | 1muflon1♦ | Maybe an example would be good. Let’s denote cloth as a numeraire good making it a commodity money as gold once was. In that case prices in the utopia would be 2 cloth for wine and cloth would of course be worth 1 cloth, so the GDP at current prices would be 100 cloth with aggregate average prices being 1.5. After trade in this case the wine would retail at 1cloth so utopia producing 100cloth with 50c export and 50w import would have nominal GDP 100-50+50 =100 but now the average prices are only 1 so to compare it you first have to adjust it for deflation. Doing that new real GDP is 200 | |
| Dec 30, 2019 at 8:48 | comment | added | 1muflon1♦ | @user161005 GDP by definition measures amount of output. If country has 50 wine and 50 cloth then it’s real GDP has to be higher than a real GDP of the same country that only has 50 wine and 25 cloths. What exactly is not clear there? | |
| Dec 30, 2019 at 8:48 | comment | added | 1muflon1♦ | @user161005 endowment economy is an economy where output is provided without any sacrifice. If you happen to have a family dog from the dogs perspective he or she is living in an endowment economy the food just appears on its plate no matter what whereas in nature dogs have to hunt and food is “produced” based on how much labor they put into it and based on their factor productivity (hunting skill). GDP is dropped is just an expression. Imagine Santa Claus dropping goods and services. | |
| Dec 30, 2019 at 4:18 | comment | added | KarmaPeasant | "and GDP is just dropped" What does it mean? | |
| Dec 30, 2019 at 4:16 | comment | added | KarmaPeasant | Also, I know Ricardian model already, but it's not obvious for me how mutually beneficial trade (from point of view of the Ricardian model) would increase GDP. Could you elaborate this part little more? | |
| Dec 30, 2019 at 4:09 | comment | added | KarmaPeasant | What is "pure endowment economy"? | |
| Dec 29, 2019 at 19:12 | history | edited | 1muflon1♦ | CC BY-SA 4.0 |
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| Dec 29, 2019 at 18:24 | history | answered | 1muflon1♦ | CC BY-SA 4.0 |