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International Economics

International Economics. Chapter 2 The Ricardian Model. Main Contents. Comparative advantage and The Ricardian Model Theoretical evidence on the Ricardian Model Misconceptions about comparative advantage Comparative advantage with multiple goods.

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International Economics

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  1. International Economics

  2. Chapter 2 The Ricardian Model Main Contents Comparative advantage and The Ricardian Model Theoretical evidence on the Ricardian Model Misconceptions about comparative advantage Comparative advantage with multiple goods

  3. Key terms absolute advantage comparative advantage derived demand gains from trade general equilibrium analysis partial equilibrium analysis nontraded goods opportunity cost pauper labor argument relative wage Ricardian model unit labor requirement

  4. Do you know what·········· ? Questions to be answered: the base of trade the pattern of trade the gains from trade the income distribution effect of trade

  5. Do you know how·········· ? Main steps to build a theoretical model assumptions main contents tests conclusion

  6. Ⅰ. Comparative advantage and The Ricardian Model ⅰ.the opportunity cost Case: Roses on Valentine’s Day

  7. If it occurs specialization,

  8. ⅱ. Three important statements 1. A country has a comparative advantage in producing a good if the opportunity cost of producing that good in terms of other goods is lower in that country than it is in other countries. 2.The law of comparative advantage:Trade between two countries can benefit both countries if each country exports the goods in which it has a comparative advantage. 3.The approach in which international trade is solely due to international differences in the productivity of labor, is known as the Ricardian Model.

  9. Ⅱ .Theoretical evidence on the Ricardian Model ⅰ. the assumption-------2*1*2 • two nations: Home Foreign • one factor: labor • two goods: wine and cheese

  10. ⅱ. several variables and the prodution possibility frontier aLW ----unit labor requirement in producing wine aLC ----unit labor requirement in producing cheese L ---- the total labor supply QW ---- the production of wine QC ----the production of cheese Similarly, Foreign: a*LW a*LC L* Q*W Q*C

  11. What is the opportunity cost of cheese in terms of wine?

  12. ⅲ.The production possibility frontier • The limits on production: QW Q*W L*/a*LW Home’ PPF Foreign’ PPF L/aLW L/aLC QC L*/a*LC Q*C

  13. ⅳ. Relative price and supply PC -----the price of cheese PW/aLW------the hourly wage rate in wine sector PC/aLC------the hourly wage rate in cheese sector PC/ PW ------the relative price of cheese PW/ PC------the relative price of wine

  14. 1. PC/PW＞aLC/aLW wages in cheese sector is higher specializing in producing cheese 2. PC/PW＜aLC/aLW wages in wine sector is higher specializing in producing wine 3. PC/PW=aLC/aLW both goods will be produced

  15. Conclusion:The economy will specialize • It will specialize in producingcheese if the relative price of cheese exceeds its opportunity cost; it will specializes in the production of wine if the relative price of cheese is less than its opportunity cost. Derived Conclusion: • In the absence of international trade, the relative prices of goods are equal to their relative unit labor requirement.

  16. ⅴ. Trade in a one-factor world PC/PW RS a *LC/a*LW aLC/aLW RD (QC+Q*C)/(QW+Q*W) (L/aLC)/(L*/a*LW)

  17. 1.PC/PW< aLC/aLW< a*LC /a*LW The supply of cheese equals to zero. 2. PC/PW= aLC/aLW Home will be willing supply any relative amount of the two goods, producing a flat section to the supply curve.

  18. 3. aLC/aLW< PC/PW< a*LC /a*LW Home: cheese Foreign: wine Theoutput of cheese: L /aLC The output of wine: L* /a*LW The relative supply of cheese: (L/aLC)/(L*/a*LW) So RS is a vertical line.

  19. 4. PC/PW = a*LC /a*LW Foreign will be willing supply any relative amount of the two goods, producing a flat section to the RS curve. 5. PC/PW＞ a*LC /a*LW＞aLC/aLW H and F will specialize in the production of cheese, there will be no wine production, so that the relative supply of cheese will be become infinite.

  20. Conclusion: (1) It therefore remains true that if a country does specialize, it will be do so in the good in which it has a comparative advantage. (2) The normal result of trade is that the price of a traded good relative to that of another good ends up some where in between its pre-trade levels in the two countries.

  21. ⅵ. The gains from trade a. Shown by graphic QW Q*W T Home Foreign P F* QC Q*C F P* T*

  22. b.Shown by table

  23. Suppose: PC/PW=1, 1/2<1<2 The gain from trade of Home: 1/2W The gain from trade of Foreign:1/6C

  24. Ⅲ. Misconceptions about comparative advantage ⅰ. Productivity and competitiveness Myth1: Free trade is beneficial only your country is strong enough to stand up to foreign competition.

  25. ⅱ. The Pauper Labor Argument Myth2: Foreign competition is unfair and hurts other countries when it is based on low wages. ⅲ. Exploitation Myth3: Trade exploits a country and made it worse off if its workers receive much lower wages than workers in other nations.

  26. Ⅳ. Comparative advantage in a multiple- good model ⅰ. Assumption and variables • two nations: Home Foreign • one factor: labor • n goods:apple, banana, ········· 2*1*n

  27. ⅱ. Relative wage and specialization The cost of i in Home: waLi The cost of i in Foreign:w*a *Li i will be produced in Home if waLi < w*a*Li w/ w* < a*Li /aLi How about w/ w* > a*Li /aLi ?

  28. Relative Home productivity advantage

  29. Determination of Relative Wages w/ w* RS apples 10 bananas 8 caviar 4 dates 2 enchiladas RD 0.75 L/ L*

  30. Ⅵ.Transport costs,non-traded goods and international trade Why specialization in the real international economy is not the extreme? What are the effects of transport costs on trade? What are the effects of non-traded goods on trade?

  31. exercises

  32. 1. According to Ricardo, a country will have a comparative advantage in the product in which its A.labor productivity is relatively low. B.labor productivity is relatively high. C.labor mobility is relatively low. D.labor mobility is relatively high. E.None of the above. Answer: B

  33. 2. Given the following information: Unit Labor Requirements Cloth Widgets Home 10 20 Foreign 60 30 A.Neither country has a comparative advantage. B.Home has a comparative advantage in cloth. C.Foreign has a comparative advantage in cloth. D.Home has a comparative advantage in widgets. E.Home has a comparative advantage in both products. Answer: B

  34. 3. Essay Questions Many countries in Sub-Saharan Africa have very low labor productivities in many sectors, in manufacturing and agriculture. They often despair of even trying to attempt to build their industries unless it is done in an autarkic context, behind protectionist walls because they do not believe they can compete with more productive industries abroad. Discuss this issue in the context of the Ricardian model of comparative advantage.

  35. Answer:The Ricardian model of comparative advantage argues that every country must have a comparative advantage in some product, and if it produces and exports them, it will gain from trade.

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