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Transcript of 1 Ricardian Model INTERNATIONAL ECONOMICS, ECO 486 JDE notes to supplement the text. David Ricardo...
1Ricardian Model
• INTERNATIONAL ECONOMICS,ECO 486
• JDE notes to supplement the text. David Ricardo
April 18, 1772 — September 11, 1823
2Learning Objectives
• Understand five more assumptions
• Determine and understand comparative and absolute advantage
• Find international trade equilibrium
• Explain gains from trade
• Derive range of wages that will permit trade
4Assumptions
• #8 -- Factors of production cannot move between countries
• #9 -- There are no barriers to trade in goods.
5Assumptions #10
• #10 -- Exports must pay for imports
• Assumptions 8-10 apply to both the Classical and HO Models
• Assumptions 11 & 12 apply only to Classical Model
6Assumptions
• #11 -- Labor is the only relevant factor of production in terms of productivity analysis or costs of production.
• #12 -- Production exhibits constant returns to scale, CRS, between labor and output.
– If both inputs, K & L, are doubled, output doubles
– Implies Linear PPF and complete specialization
7Ricardian Theorem
• A country exports that good which has higher comparative factor productivity and imports the commodity which has lower comparative factor productivity than the other country.
– Page 48, Ravendra N. Batra, Studies in the Pure Theory of International Trade
8Differing technologies and resource
endowmentsLabor productivity
Country A Country B
Soybeans 4 (kg./hr.) 1 (kg./hr.)
Textiles 2 (m./hr.) 1.5 (m./hr.)
Labor endowment
1000 (hr./yr.) 800 (hr./yr.)
9Differing Opportunity Costs
Opportunity Costs
Country A Country B
Soybeans(m./kg.)
Textiles (kg./m.)
11Production possibility frontiers: (a) country A; (b) country B.
12Autarky
• Given perfect competition,
1. P = MC
2. Autarky price of S (on x-axis) equals slope of PPF
3. Resource payments correspond to their productivity
13Pretrade equilibriums: (a) country A; (b) country B.
15Absolute Advantage
• Compare one good across countries.
• Country with greater output per labor hour has an absolute advantage in that good.
16Comparative Advantage
• Calculate opportunity costs.
• Compare one good across countries.
• Country with lower opportunity cost has a comparative advantage in that good.
17Which Advantage?
• Absolute advantage is a special case.
• Comparative advantage is the general case.
19Terms of Trade
• Once trade begins, an international equilibrium results
• Results in one world price for a good
21International Trade Equilibrium
• Complete specialization in Comparative Advantage good
• CIC & ToT tangent at consumption point
• Congruent trade triangles imply balanced trade
22Posttrade equilibriums: (a) country A; (b) country B.
24Gains From Trade
• More of both goods attainable
• GDP increases at pre-trade prices
• Higher CIC is attainable
26The gains from trade (country A).
27Country A’s trading equilibrium.
29Exchange Rates
• State exchange rate, E, in US dollars per UK pound
– say $2/£
• A good will be imported if its foreign pre-trade price (x E) is less than the domestic price
PS < E x PS*
30Buy Low . . .
• Trade requires
PS < E x PS*
PT > E x PT*
autarky prices
Home (A) has comparative advantage in S
Foreign (B) has comparative advantage in T
31Perfect Competition Review
(Product & Resource Markets)
• PX = MC for a good, X
• MC = w/MPPL (Labor, L, is only var. input)
• w=MRPL =(MR) MPPL=(P) MPPL=VMPL
33Prices & Wages
• PX = MC = w/MPPL
• MPPL is measured as units of X per hour, OLX
• Productivity may be stated as hours per unit of X, aLX, or units of X per hour worked, OLX.
aLX = 1/OLX
• PX = w /OLX
35Trade & Wages (Cont.)
O
O
WE
W
O
O
WE
W
LT
LT
LS
LS
**
**
38Competitive Advantage
• The ability to sell a good at the lowest price.
• Usually results from comparative advantage
• Alternatively, it may be the result of . . .
– Government subsidies for inefficient industries
– An undervalued exchange rate
39Losing Competitive Advantage
• If Home’s relative wage ratio (W/W*) exceeds its relative productivity (OLS/OLS*), its S will cost _______ than Foreign’s.
• If a country’s currency is overvalued (say $1/£ instead of $2/£), comparative advantage may be lost -- both goods may be cheaper in ___________.
41Country A’s price-consumption curve.
42Derivation of country A’s offer curve.
43International trade equilibrium.
44Cambodian Textiles Update
• US offered to expand Cambodia’s export quota by 14% if “working conditions is the Cambodia textile and apparel sector substantially comply with” local and internationally recognized core standards.
• Dec ’99 – US officials decide that Cambodia has fallen short, but offered 5%– Cambodia to establish independent monitoring
with the International Labor Organization, ILO
45Cambodian Textiles Update
• ILO leery, fearing weakening of local monitoring capability
• ILO agrees after US pledges $500,000 in technical assistance to Cambodian labor ministry
• US also paying $1 million (of $1.4 mil.) for a 3-year monitoring effort– USTR press release 18 May 2000
46Cambodian Textiles Update
• Sep ’00 – US officials grant Cambodia another 4% increase– 9% increase continued for ’01
• Other news:– Nov ’00 -- ILO rules Burma’s progress on forced labor
inadequate. Section 33 action authorized. As of March ’01, no member country has taken action. US & EU considering sanctions
– Bush proposed reducing US contributions to the ILO budget.
47
0 2 4 6 8 10
2
4
6
8
10
SOYBEANS, S (millions of bushels per year)
L
Quantity of Soybeans Demanded
H
CIC1
CIC2
CIC0
G
Autarky General Equilibrium|slope PPF| = PS/PT = 2 yd.T/bu.S
TE
XT
ILE
S, T
(mil
lion
s of
yar
ds
per
yea
r)
PPF
PS/PT = 1 yd.T/bu.S
PS/PT = 2.5 yd.T/bu.S
4.71.8
49
Tony Auth, NY Times editorial cartoon, December 2, 1999