Unit 2 - Trade and Technology - The Ricardian Model (CM)

Casiano
Manrique de Lara Peñate

Chapter Outline
•  Reasons for Trade
  Proximity
  Resources
  Absolute Advantage
  Compara=ve Advantage
•  Ricardian Model
  The Home Country
  The Foreign Country
•  Determining the PaBern of Interna=onal Trade
  Interna=onal Trade Equilibrium
  Solving for Wages Across Countries
•  Solving for Interna=onal Prices
  Home Export Supply Curve
  Foreign Import Demand Curve
  Interna=onal Trade Equilibrium
•  Conclusions
© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
Learning Objec=ves
•  Understand the reasons why countries trade
•  Dis=nguish between absolute and compara=ve advantage
•  Understand the Ricardian model
•  Understand the no-‐trade equilibrium using each country’s PPF and

Indifference Curve
•  Understand how the paBern of interna=onal trade is determined
•  Understand how to solve for prices and wages across countries
•  Understand how to derive the export supply curve and the import demand
curve
•  Understand the interna=onal trade equilibrium
•  Understand how to determine a country’s terms of trade and how they
affect that country
Introduc=on
•  Why does the U.S. import goods that it could
easily produce itself with its great
manufacturing capability?
•  The first part of this book looks at the various
reasons for trade:
 Technological differences
 Differences in amounts of resources
 Differences in costs of outsourcing
 The proximity of countries to each other
Table 2.1 U.S. Imports of Snowboards, 2005
Introduc=on
•  This chapter focuses on how technology differences
across countries affect trade.
•  This is referred to as the Ricardian model because it
was proposed by the 19th century economist David
Ricardo.
•  It explains how the level of a country’s technology
affects wages paid to labor in a way that countries
with beBer technology have higher wages.
•  We use this to explain a country’s trade pa9ern—the
products it exports and imports.
Reasons for Trade
1. Proximity
  The closer countries are the lower the costs
of transporta=on.
  For example, the largest trading partner of
most European countries is another
European country.
  Proximity o[en leads to countries joining
into a free trade area.

Reasons for Trade
2.  Resources
  A country can have resources that give it an edge in the produc=on of
certain goods.
  A country with a lot of snow may be very good at producing snowboards.
  Geography includes natural resources (including land and minerals),
labor resources, and capital.
  Resources are also called factors of produc<on—the land, labor, and
capital used to produce goods and services.
  Some countries produce unfinished products that are then processed
in another country.
  Unfinished snowboards produced in Mexico
  Trade in unfinished goods is an example of outsourcing—when
produc=on ac=vi=es are spread across several countries and trade
semi-‐finished products between them.

Reasons for Trade
3. Absolute Advantage
  When a country has the best technology for
producing a good, it has an absolute advantage in
the produc=on of that good.
  Germany has an absolute advantage in the
produc=on of snowboards.
  Why is it that so many are imported from China
then?
  Or why doesn’t the U.S. just make all its own
snowboards?

Reasons for Trade
4.  Compara=ve Advantage
  Absolute advantage is actually not a good
explana=on for trade paBerns.
  Compara=ve advantage is the primary explana=on
for trade among countries.
  A country has a compara<ve advantage in producing
those goods that it produces best compared with
how well it produces other goods.
  China does not have an absolute advantage compared to
U.S. but is beBer at producing snowboards than some
other goods.

Ricardian Model
•  To develop a Ricardian model of trade, we will use an example
with two goods: wheat and cloth.
  Wheat and other grains are major exports of the U.S. and Europe.
  Many types of cloth are imported into these countries.
•  Home will be the country expor=ng wheat and impor=ng cloth.
•  The Home Country
  We will assume that labor is the only resource used to produce both
goods.
  One worker can produce 4 bushels of wheat or 2 yards of cloth.
  The Marginal Product of Labor is the extra output obtained by using one
more unit of labor.
  MPLW = 4 and MPLC = 2.

Ricardian Model
•  Home Produc=on Possibili=es Fron=er
  We can use the marginal products of labor to construct Home’s PPF.
  Assume there are 25 workers in Home.
  If all the workers were employed in wheat, the country could produce 100 bushels.
  If they were all employed in cloth they could produce 50 yards.
  The PPF connects these two points.
•  Showing these calcula=ons we can see:

  Labor = 25, MPLW = 4, MPLC = 2
  QW = MPLW(L) = 25(4) = 100
  QC = MPLC(L) = 25(2) = 50
•  This gives us a straight line PPF which is a unique feature of the Ricardian model.
  It assumes the marginal products of labor are constant.
  There are no diminishing returns because the model ignores the use of other
resources.
Ricardian Model
•  The slope of the PPF can be calculated as the ra=o of marginal
products of the two goods.
•  The slope also equals the opportunity cost of wheat—the

amount of cloth that must be given up to obtain one more
unit of wheat.

Ricardian Model
Figure 2.1

PPF

Ricardian Model
•  Home Indifference Curve
  Given Home’s PPF, how much wheat and cloth will home actually
produce. The answer depends on demand.
  Demand can be represented with indifference curve.
  An indifference curve shows the combina=ons of two goods that the
country can consume and be equally sa=sfied.
•  All points on an indifference curve have the same level of
u=lity.
•  Points on higher indifference curves have higher u=lity.
•  Indifference curves are o[en used to show the preferences of
an individual.
•  But we use indifference curves to show the preferences of an
en=re country.
Ricardian Model
Figure 2.2
The country is indifferent between A
and B
The country is better off on U2 but
cannot produce that much
U0<U1<U2

Ricardian Model
•  Home Equilibrium
  Without trade, the PPF acts as a budget constraint for the
country.
  With perfectly compe==ve markets, the country will produce at

its highest level of u=lity within the limits of the PPF.
  In the graph, the highest level of u=lity that can be reached and
s=ll stay within the PPF is U1 with produc=on at point A.
  Point A is the no-‐trade equilibrium.
  The country can reach point A its own produc=on.

  The assump=on of perfect compe==on will assure the country
ends up at the highest level of u=lity possible.

Ricardian Model
Figure 2.2
The country could produce at point D
but would be at a higher level of utility
at point A.
At point A, on U1, is the best the
country can do

Ricardian Model
•  Opportunity Cost and Prices

 The slope of the PPF reflects the opportunity
of producing one more bushel of wheat.
 Under perfect compe==on the opportunity

cost of wheat should equal the price of
wheat.
 Price reflects the opportunity cost of a good.

Ricardian Model
•  Wages
  Determina=on of wages
  In compe==ve markets firms hire workers up to the point at which
the hourly wage equals the value of one more hour of produc=on.
  The value of one more hour of labor equals the amount of goods
produced in that hour (MPL) =mes the price of the good.
  Labor hired up to the point where wage equals P*MPL for each
industry.
  In compe==ve markets, labor can move freely between
industries.
  Labor will move to the higher paid industry.
  This will con=nue un=l there is equaliza=on of wages
between industries.

Ricardian Model
•  The equaliza=on of wages will give us the following:
  The right hand side is the slope of the PPF and the opportunity cost of
obtaining one more bushel of wheat.
  The le[ hand side is the rela=ve price of wheat.
•  The price ratio, PW/PC, always denotes the relative price of the good in the
numerator, measured in terms of how much of the good in the denominator must
be given up.
•  The slope of the PPF equals the relative price of wheat, the good on the horizontal
axis.
Retricción Presupuestaria

Ricardian Model
•  The Foreign Country
 Assume Foreign’s technology is inferior to Home’s.
 Foreign has an absolute disadvantage in producing
both wheat and cloth as compared to Home.
 Foreign Produc=on Possibili=es Fron=er
  Assume a Foreign worker can produce one bushel of wheat or one yard
of cloth.
  MPL*W = 1, MPL*C = 1
  Assume there are 100 workers available in Foreign.
  If all workers were employed in wheat they could produce 100 bushels.
  If all workers were employed in cloth they could produce 100 yards.
Ricardian Model
Figure 2.3

Ricardian Model
•  Compara=ve Advantage
 Given the informa=on we have gathered, we
can begin to talk about the opportunity cost
of produc=on of each good in each country.
 Given the opportunity cost informa=on, we

can determine compara=ve advantages in
each country for each good.

Ricardian Model
Opportunity Costs for Goods in
Home and Foreign
Cloth Wheat
(1 Yard) (1 Bushel)
Home 2 Bushels ½ Yard

of Wheat of Cloth
Foreign 1 Bushel 1 Yard

of Wheat of Cloth

Ricardian Model
•  Compara=ve Advantage
 A country has a compara=ve advantage in a good
when it has a lower opportunity cost of producing
than another country.
 By looking at the chart we can see that Foreign has a
compara=ve advantage in producing cloth.
  Foreign’s Opportunity cost of cloth is lower.
 Home has a compara=ve advantage in producing

wheat.
  Home’s opportunity cost of wheat is lower.
Ricardian Model
•  Equilibrium in Foreign
  Foreign’s preferences can also be represented by an
indifference curve.
  Its economy produces at the point of highest u=lity for the
country within the PPF constraint.
  The slope of the PPF is the opportunity cost of wheat.
  The no-‐trade rela=ve price of wheat is P*W/P*C = 1.
  The rela=ve price exceeds Home’s no-‐trade rela=ve price of
wheat: P*W/P*C = ½ .
  The difference in rela=ve prices comes from the compara=ve
advantage that Home has in wheat.
Ricardian Model—Foreign
Figure 2.4

Compara've Advantage in Apparel,
Tex'les, and Wheat
•  U.S. Tex=le and apparel industries face intense import compe==on.
•  Burlington Industries announced in January 1999 it would reduce produc=on
capacity by 25% due to increased imports from Asia.
•  A[er layoffs they employed 17,400 persons in the U.S. with sales of $1.6 billion in
1999.
•  Sales per employee were therefore $92,000.
•  This is the average for all U.S. apparel producers.
•  Tex=les are even more produc=ve with annual sales per employee of $140,000 in the
U.S.
•  In China, however, sales per employee are only $13,500 in apparel and $9,000 in
tex=les.
•  The U.S. is 7 =mes more produc=ve in apparel and 16 =mes more produc=ve in
tex=les.
•  So the U.S. has the absolute advantage in these products.

Compara've Advantage in Apparel,
Tex'les, and Wheat
•  For wheat, the U.S. produces 27.5 bushels per hour of labor.
•  China produces only 0.1 bushel per hour of labor.
•  The U.S. is thus 275 =mes as produc=ve in wheat.
•  It thus has the absolute advantage in wheat.
•  Since the absolute advantage in wheat for the U.S. is even greater than in
apparel and tex=les, it has the compara=ve advantage in wheat.
•  China has the compara=ve advantage in apparel and tex=les because its
produc=ve disadvantage rela=ve to the U.S. is less than in wheat.
•  This explains why the U.S. imports apparel and tex=les from China despite
higher produc=vity in the U.S.

Can Compara've Advantage be Created?
The Case of “Icewine”
•  In general we think of a country having a compara=ve advantage
in a good.
  Certain countries have a compara=ve advantage in the produc=on of wine.
•  Can a country create a compara=ve advantage?
  Areas that get very cold are not good wine producers because the vines get
too cold.
  The Niagara Falls region of Canada began producing a product called
“icewine” in 1983; it’s now made in Bri=sh Columbia, too.
  The grapes are allowed to freeze on the vine before they are picked.
  The unique flavor of the wine has led to a rela=vely high demand.
  This has created a compara=ve advantage in a certain type of wine, even
though Canada does not have the advantage in tradi=onal wine produc=on.

Determining the PaBern of Interna=onal Trade
•  What happens now when goods are traded between
Home and Foreign?
•  We will see the country’s no-‐trade rela=ve price
determines which product it will export and which it
will import.
•  The no-‐trade rela=ve price equals its opportunity cost
of produc=on.
  Therefore, the paBern of exports and imports will be
determined by the opportunity costs of produc=on in each
country—their compara=ve advantage.

•  Interna=onal Trade Equilibrium
  Rela=ve price of cloth in Foreign is PC/PW = 1.
  Rela=ve price of cloth in Home is PC/PW = 2.
  Therefore Foreign would want to export their cloth to Home
—they can make it for $1 and export it for more than $1.
  The opposite is true for wheat.
  Home will export wheat and Foreign will export cloth.
  Both countries export the good for which they have the
compara=ve advantage.

•  How Trade Occurs
  As Home exports wheat, quan=ty of wheat sold at Home
falls.
  The price of wheat at Home is bid up.
  More wheat goes into Foreign’s market.
  The price of wheat in Foreign falls.
  As Foreign exports cloth, the quan=ty sold in Foreign falls,
and the price in Foreign for cloth rises.
  The price of cloth at Home falls.

  Two countries are in a trade equilibrium when:
  the rela=ve price of each good is the same in the two countries
  the amount of each good that the countries want to trade is
equal
  In understanding the trade equilibrium we need to do
two things:
  Determine the rela=ve price of wheat or cloth in the trade
equilibrium.
  See how the shi[ from the no-‐trade equilibrium to the trade
equilibrium affects produc=on and consump=on in both Home
and Foreign.

 The rela=ve price of wheat in the trade equilibrium
will be between the no-‐trade price in the two
countries.
 For now we will assume the free-‐trade price of PC/
PW is 2/3. This is between the price of ½ in Home
and 1 in Foreign.
 We can now take this price and see how trade
changes produc=on and consump=on in each
country.
•  Change in Produc=on and Consump=on
  Home producers of wheat can earn more than the

opportunity cost of wheat by selling it to Foreign.
  Home will therefore shi[ labor resources toward the

produc=on of wheat and increase its produc=on.
  Remember wages are calculated by the price of the good
=mes its marginal product.
  Given the informa=on from before, we can calculate the

ra=o of wages in the two industries.

•  Home’s workers will want to work in wheat and no
cloth will be produced.
•  With trade, Home will be fully specialized in wheat
produc=on.
•  Interna=onal Trade
  Home can export wheat at the interna=onal rela=ve price of
2/3.
  For each bushel of wheat it exports, it gets 2/3 yards of cloth
in return.
  In figure 2.5 we trace this out to get a new price line
showing the world price.
  The world price line shows the range of consump<on possibili=es
that a country can achieve by specializing in one good and trading.
  Remember: this is only a consump=on possibility because produc=on

is s=ll constrained by the PPF.

•  The new world price, PW/PC = 2/3,

Cloth, QC (yards) shows us the new range of
consumption possibilities
•  The country can now achieve a
higher utility with the new
consumption possibilities
50
World price line,

U2 Slope = –2/3
25 A
U1
Home production
50 100 Wheat, QW (bushels)

Home produces 100 bushels but

consumes only 40, so exports equal 60
Cloth, QC (yards)
Home produces 0 yards of cloth but

consumes 40, so imports equal 40.
Home consumption
50
40 C World price line,

U2 Slope = –2/3
25 A
Home imports 40
yards of cloth U1 Home production
40 50
50 100
100 Wheat, QW (bushels)
Home exports 60 bushels of wheat

Figure 2.5

•  Interna=onal Trade
  Trade allows a country to engage in consump=on possibili=es it did not
have before trade.
  We can see this as Home can now be on a higher indifference curve with
trade than they were without it.
  This is the first demonstra=on of gains from trade.
•  PaBern of Trade and Gains from Trade

  From figure 2.5, we can also see that Home’s exports and imports are equal
when valued in the same units.
  Home exports 60 bushels of wheat; mul=plying this by the price of wheat in
terms of cloth, 2/3, gives 40. This equals the amount of cloth that is
imported.
  Now consider Foreign. Condi=ons there are shown in figure 2-‐6.
Figure 2.6

•  PaBern of Trade and Gains from Trade
  Each country is expor=ng the good for which it has the compara=ve
advantage.
  This confirms that the paBern of trade is determined by compara=ve
advantage.
  This is the first lesson of the Ricardian model.
  There are gains from trade for both countries.
  This is the second lesson of the Ricardian model.
  However, we have not yet determined the level of wages across countries.
  Rela=ve prices converge. Do wages?
  Wages do rise in each country, but they do not converge.
  They are determined by absolute advantage, not compara=ve advantage.

•  Solving for Wages Across Countries
  As stated before, in compe==ve labor markets, firms will pay
workers the value of their marginal product.
  Since Home produces and exports wheat, they will be paid
in terms of that good—the real wage is MPLW = 4 bushels of
wheat.
  The workers sell the wheat on the world market at a rela=ve
price of PW/PC = 2/3.
  We can use this to calculate the real wage in terms of cloth:
(PW/PC)MPLW = (2/3)4 = 8/3 yards.

•  Solving for Wages Across Countries
  We can do this for Foreign as well and summarize:
  Home real wage is
  4 bushels of wheat
  8/3 yards of cloth
  Foreign real wage is
  3/2 bushels of wheat
  1 yard of cloth
  Foreign workers earn less than Home workers as measured
by their ability to purchase either good.
  This fact reflects Home’s absolute advantage in the produc=on of
both goods.
•  Wages are determined by absolute advantage and
trade is determined by compara=ve advantage.
•  This should make sense.
  The only way a country with poor technology can export
at a price others are willing to pay is by having low
wages.
•  As a country develops beBer technology, its wages will
rise.
  Workers become beBer off through receiving higher
wages.
  As countries engage in trade, the Ricardian model
predicts that their real wages will rise.
•  We can see this in the real world
 Per capita income in China in 1978 was es=mated at
$925.
 In 2000, per capita income in China had risen to
$3750.
 Per capita income in India more than doubled from
$1180 in 1978 to $2480 in 2000.
 It is strongly believed that the opportunity for these
countries to engage in interna=onal trade has been
crucial in raising their standard of living.
Labor Produc'vity and Wages
•  Labor produc=vity can be measured by the value-‐added per
hour in manufacturing.
  Value-‐added is the difference between sales revenue in an industry and
the costs of intermediate inputs.
  Equals the payments to labor and capital in an industry.
  The Ricardian model ignores capital so we can measure labor
produc=vity as value-‐added divided by the number of hours worked, or
value-‐added per hour.
•  Figure 2.7 shows value-‐added per hour in manufacturing for

several countries.
  Countries with higher labor produc=vity pay higher wages, just as the
Ricardian model predicts.

Figure 2.7: Labor Productivity and Wages, 2001

•  We can also see the connec=on between

produc=vity and wages over =me.
•  Figure 2.8 shows that the general upward

movement in labor produc=vity is matched by
upward movement in wages.
 This is also predicted by the Ricardian Model.

Figure 2.8

Solving for Interna=onal Prices
•  In the previous analysis we assumed the world price of
wheat was 2/3.
•  In reality world price is determined by a market for
exports and imports.
•  We will derive a Home export supply curve.
  Shows the amount it wants to export at various rela=ve
prices.
•  Similarly we will derive a Foreign import demand
curve.
  Shows the amount of wheat that it will import at various
rela=ve prices.
•  Home Export Supply Curve
 We can use the informa=on we gathered from before
to derive an export supply curve.
 The export supply curve will have the rela=ve price of
wheat on the Y-‐axis and the amount of wheat on the X-‐
axis.
 We saw before a rela=ve price of 2/3 related to exports
of 60 bushels.
  The first point on the export supply curve: the horizontal
distance from point B to C in figure 2-‐9(a) and point C’ in
figure 2-‐9(b).
•  To derive other points on the export supply curve we
look at the no-‐trade equilibrium.
 When the rela=ve price of wheat is ½, Home exports
of wheat are zero (no-‐trade equilibrium).
  Point A and A’ in figure 2.9
 For the 3rd point, we keep the rela=ve price of wheat
at ½.
  At this price, Home could export some wheat in exchange for cloth.
  Produc=on could shi[ from A to any other place on the PPF.
•  Workers are willing to shi[ between industries as the wages are the same.
•  If we assume that all workers have moved into
wheat produc=on.
•  With the rela=ve price of ½, consump=on is s=ll

at point A and the difference between A and B
is the amount of wheat that Home is expor=ng.
 At the rela=ve price of ½, with wheat exports of 50,
gives another point on the Home export supply
curve: B’.

Figure 2.9
•  The flat por=on of the export supply curve is a
special feature of the Ricardian model.
 The PPF is a straight line.
 Produc=on can occur anywhere along the PPF as

workers shi[ between industries.
 This leads to all the export levels between A’ and B’.
 At prices above ½, produc=on is the same but

consump=on changes, rising above point A.

•  Foreign Import Demand
  We can use a similar analysis to construct the import demand
for wheat in figure 2.10.
  At the world rela=ve price of 2/3, Foreign imports 60 bushels of
wheat, C* and C*’.
  The no-‐trade equilibrium in Foreign, with a rela=ve price of 1, is
zero imports, A* and A*’.
  Produc=on can shi[ from point A, at a price of 1, as workers
move between industries:
  If workers all shi[ to cloth.
  Foreign imports 50 bushels of wheat, B* and B*’.
  This gives us the import demand curve.
Figure 2.10
  We need to put the Home export supply together with the
Foreign import demand.
  The exports from Home come from the excess domes=c
supply.
  The imports to Foreign come from the excess domes=c
demand.
  This is the World market for wheat (figure 2.11):
  Equilibrium price of 2/3 and trade of 60 bushels of wheat.
  This is the amount that clears the world market.
  Desired sales of Home equal the desired purchases by Foreign.
Solving for International Prices
Figure 2.11

•  The Terms of Trade
  The price of a country’s exports divided by the price of its
imports.
  For Home, PW/PC is their terms of trade.
  An increase in PW or a fall in PC will raise Home’s terms of
trade.
  An increase in the terms of trade is good for a country: it
makes it beBer off.
  A country will earn more for its exports.
  A country will pay less for its imports.
  For Foreign, PC/PW is the terms of trade and a higher rela=ve
price for cloth makes it beBer off.
The Terms of Trade for Primary Commodi'es
•  La=n American economist Raúl Prebisch
and Bri=sh economist Hans Singer each put
forward the hypothesis that the price of
primary commodi=es would decline over
=me rela=ve to the price of manufactured
goods.
•  Primary commodi=es are o[en exported by

developing countries, so their terms of
trade would decline over =me.
•  This theory might be true for a couple of reasons:
•  First,
  As countries become richer, they spend a smaller share of their income on
food.
  As world income grows, demand for food falls rela=ve to the demand for
manufactured goods.
  Therefore, the price of agricultural products can also be expected to fall
rela=ve to manufactured goods.
•  Second,
  For mineral products, industrialized countries con=nually find subs=tutes in the
produc=on of manufactured products.
  The subs=tu=on away from mineral products is a form of technological progress,
and as it proceeds, can lead to a fall in the price of raw materials.

•  There are also reasons why the theory might not be
true:
•  First,
  Technological progress in manufactured goods can certainly
lead to a fall in the price of these goods as they become
easier to produce.
  This is a fall in terms of trade for industrialized countries
rather than developing countries.
•  Second,
  At least for oil, the cartel restric=ng prices has caused an
increase in the terms of trade for oil-‐expor=ng countries.

•  Figure 2.12 shows 24 primary commodi=es from 1900–
1998, with their world price rela=ve to the overall price
of manufactured goods.
•  From these results for different commodi=es, we can

conclude that there are some that follow the paBern
predicted by Prebisch and Singer, with falling prices
rela=ve to manufacturing.
•  However, this is not the general rule—other primary

commodi=es have had increasing or non-‐consistent
change in their prices.

Figure 2.12 Relative Price of Primary Commodities

Conclusions
•  The Ricardian model was devised to respond to the mercan=list
idea that exports are good and imports are bad.
•  David Ricardo found this was not true and considered an example
where trade between two countries was balanced.
•  The paBern of trade is determined by compara=ve advantage,
and both countries gain from trade.
•  The Ricardian model is presented with only one factor of
produc=on—labor.
•  Because wages depend on the marginal products of labor in each
country, we conclude that wages are determined by absolute
advantage.
  Country with beBer technology will be able to pay higher wages.

Conclusions
•  In addi=on, wages depend on the prices prevailing on world
markets for the goods exported by each country.
•  The terms of trade is the price of a country’s exports divided by
the price of its imports. Because we assume that labor is the
only resource, the PPF in the Ricardian model is a straight line.
  This leads to the export supply and import demand curves each have a
flat segment.
•  The gains from trade become much more complicated when we
allow for more realis=c assump=ons using several factors of
produc=on.
  We will discuss this in future chapters.

Key Points
1.  A country has compara=ve advantage in producing a good when the
opportunity cost of producing the goods is lower than the opportunity cost
of producing the good in another country.
2.  The paBern of trade between countries is determined by compara=ve
advantage.
3.  All countries experience gains from trade.

7.  The level of wages in each country is determined by its absolute advantage,
that is, by the amount the country can produce with its labor.
8.  The equilibrium price of a good on the world market is determined where
the export supply of one country equals the import demand of the other
country.
9.  A country’s terms of trade, the price of its export good divided by the price
of its import good, affect how well off a country is from trade.

Unit 2 - Trade and Technology - The Ricardian Model (CM)

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Unit 2 - Trade and Technology - The Ricardian Model (CM)

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Casiano

Manrique de Lara Peñate

• Dis=nguish between absolute and compara=ve advantage

• Understand the Ricardian model

• Understand the no-­‐trade equilibrium using each country’s PPF and

• Understand how the paBern of interna=onal trade is determined

• Understand the interna=onal trade equilibrium

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

• Showing these calcula=ons we can see:

• The slope also equals the opportunity cost of wheat—the

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

 With perfectly compe==ve markets, the country will produce at

 Point A is the no-­‐trade equilibrium.

 The country can reach point A its own produc=on.

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

• Opportunity Cost and Prices

 Under perfect compe==on the opportunity

 Price reﬂects the opportunity cost of a good.

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

 Given the opportunity cost informa=on, we

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Home 2 Bushels ½ Yard

Foreign 1 Bushel 1 Yard

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

 Home has a compara=ve advantage in producing

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

• China produces only 0.1 bushel per hour of labor.

• It thus has the absolute advantage in wheat.

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

• Change in Produc=on and Consump=on

 Home producers of wheat can earn more than the

 Home will therefore shi[ labor resources toward the

 Given the informa=on from before, we can calculate the

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

 Remember: this is only a consump=on possibility because produc=on

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

• The new world price, PW/PC = 2/3,

World price line,

50 100 Wheat, QW (bushels)

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Home produces 100 bushels but

Home produces 0 yards of cloth but

40 C World price line,

Home exports 60 bushels of wheat

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

•  Dis=nguish between absolute and compara=ve advantage

•  Understand the Ricardian model

•  Understand the no-‐trade equilibrium using each country’s PPF and

•  Understand how the paBern of interna=onal trade is determined

•  Understand the interna=onal trade equilibrium

•  Showing these calcula=ons we can see:

•  The slope also equals the opportunity cost of wheat—the

  With perfectly compe==ve markets, the country will produce at

  Point A is the no-‐trade equilibrium.

  The country can reach point A its own produc=on.

•  Opportunity Cost and Prices

 Under perfect compe==on the opportunity

 Price reﬂects the opportunity cost of a good.

 Given the opportunity cost informa=on, we

 Home has a compara=ve advantage in producing

•  China produces only 0.1 bushel per hour of labor.

•  It thus has the absolute advantage in wheat.

•  Change in Produc=on and Consump=on

  Home producers of wheat can earn more than the

  Home will therefore shi[ labor resources toward the

  Given the informa=on from before, we can calculate the

  Remember: this is only a consump=on possibility because produc=on

•  The new world price, PW/PC = 2/3,

  This is the ﬁrst demonstra=on of gains from trade.

•  PaBern of Trade and Gains from Trade

•  Figure 2.7 shows value-‐added per hour in manufacturing for

•  We can also see the connec=on between

•  Figure 2.8 shows that the general upward

 This is also predicted by the Ricardian Model.

•  With the rela=ve price of ½, consump=on is s=ll

 Produc=on can occur anywhere along the PPF as

 At prices above ½, produc=on is the same but

  This is the amount that clears the world market.

•  Primary commodi=es are o[en exported by

•  From these results for diﬀerent commodi=es, we can

•  However, this is not the general rule—other primary

3.  All countries experience gains from trade.