Consider the Krugman model. Let us suppose that trade exists between two countries.
Graph the following curves by clicking here
Draw a graph with per capita consumption, c, on the horizontal axis, and the ratio of the price to the wage, P/W, on the vertical axis.
Draw the PP line. Why is it upward-sloping?
Draw the ZZ line. Why is it downward-sloping?
Label the equilibrium point E. Label equilibrium per capita consumption on the horizontal axis as c1, and the equilibrium price-wage ratio on the vertical axis as (P/W)1.
Suppose now that protectionist sentiment causes this country to become closed to trade. Show this change on your graph. What would happen to the real wage as a result of this change?
Does the Krugman model explain intra-industry trade? Explain.
Draw a graph that represents Vernon’s Product Cycle theory. Put production and consumption on the vertical axis, and time on the horizontal axis.
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Draw the curve that represents consumption in the innovating country. Why would it be upward-sloping?
Draw the curve that represents production in the innovating country. Why would it first rise, then fall?
Mark the three stages in the PCT. What does the PCT have to say about the nature of comparative advantage?
