Terms in this set (67)

- def: "A set of rules, compliance procedures, and moral and ethical behavioral norms designed to constrain the behavior of individuals in the interests of maximizing the wealth or utility of principals." - Douglas North
- Theories of Institutions:
- There are no perfectly operating markets because of transaction costs (i.e. anything that makes a transaction between buyers and sellers costly).
- institutions are solutions to transaction cost problems => property rights
- institutions provide capacities for:
- the exchange of info among the actors
- the mentoring of behavior
- the sanctioning of defection from cooperative endeavor
- Economic v. Political Institutions
- economic institutions determine the economic rules of the game
- regulatory agencies in financial services, central banks, budgetary and fiscal rules, unemployment insurance schemes
- political institutions regulate the limits of political power and determine who political power changes hands
- democracy v. dictatorship; parliamentary v. presidential; multi-party v. two-party v. one party v. no party
- mitigate commitment problems
- shape the incentives of political leaders e.g. democracy v. autocracy: under democracy, leaders survive by satisfying elites (e.g. military, big business, foreign interest)
- formal (rules, laws) v. informal (codes of conduct)
- predatory v. developmental
- where institutions come from
- religion or national heritage
- initial conditions or factor endowments:
- e.g. valuable mineral resources in the colonial sugar economies and abundance of slave labor led to building of institutions that protected the privileges of elites
- a country will export goods that make intensive use of the factors of production on which it is well endowed
- factor endowments = material and human resources:
- land: esp for agriculture
- labor: refers to unskilled & undifferentiated labor
- capital: machinery/equipment & financial assets

- human capital: unskilled labor (trained, edu)
- each nation's comparative advantage arise from differences in factor endowments (land, labor, capital)
- assumptions:
- two countries: domestic and foreign. Countries differ from each other in tweets of their factors and production (e.g. the U.S. is endowed with a lot of capital and little labor, whereas China is endowed with a lot of labor and little capital)
- technical knowledge allows goods to be made with different amounts of factors of production
- factors of production are highly mobile between different industries in each economy
- preferences or tastes for one good over another are similar across countries
- perfect competition prevails in all markets
- the factor of which a country has a relatively large supply is the abundant factor in that country, and the factor of which it has a relatively small supply is the scarce factor
- goods differ in factor intensity
- a country has a comparative advantage in a good whose production is intensive in the factors that are abundantly available in that country
- problems with the Hecksher-Ohlin Model
- the model assumes that factors of production are highly mobile between different industries in each economy. But what if factors are highly specific to the sector?
- perfectly competitive markets do not exist
- trade patterns may be driven by consumers' differences in taste
- production costs are not only shaped by the relative distribution of the factors of production (e.g. economies of scale)
- trade increases the demand for locally abundant factors (and increases the real incomes of owners of those facts), while reducing demand for locally scarce factors (and decreasing the real incomes of owners of such factors)
- trade benefits owners of a country's abundant factors and hurts owners of a country's scarce factors
- LABOR ABUNDANT COUNTRY (China)

- Absent trade
- "capital" is relatively scarce in a country like China, so the return to capital can be enormous
- labor is abundant, so wages are low
- by opening up to trade
- return to capital will fall until they equal the (rising) rate of return in trading partner countries.
- wages will rise until they equal the (falling) wage in trading partner countries
- CAPITAL ABUNDANT COUNTRY (Switzerland)

- Absent trade
- capital is abundant, so returns are low
- labor is relatively scarce in a country like Switzerland, so wages can be enormous
- by opening up to trade
- return to capital will rise until it equals the (dropping_ rate in trading pattern countries
- wages will drop until they equal the (rising) wage in trading parter countries
- factor returns are equalized throughout the economy => factor price equalization theorem
- owners of abundant factors should favor trade openness, while owners of scarce factors should be protectionist (the scare factor is a loser!)
- trade policy is driven by conflict between labor and capital
- e.g. American business should be string supporter of free trade and American workers have an incentive to advocate protectionist policies. Why?
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