Neo-Classical Trade Models:

The Ricardian Model

 Assumptions

Two commodities, One factor of production (Labour).

Perfect Competition in all the three markets – 2

commodities markets and one factor market.

FIXED COEFFICIENT TECHNOLOGY – aLF and aLM

Labour is sectorally mobile and homogeneous ⇒

wF = wM = w

Technology differs across nations

Sunandan Ghosh, CDS, 2013 2

 Production in Autarky

Let labour be L

Hence, equation of the PPC is given by

L = aLF X F + aLM X M

Given wage flexibility we have full employment.

Slope of PPC is a LF
a LM

Constant opportunity cost

Sunandan Ghosh, CDS, 2013 3

 Production in Autarky

Sunandan Ghosh, CDS, 2013 4

 Production in Autarky

We can not determine supply or output level.

Bring in demand – CIC

a LF

Price is also = slope of PPC = a LM
a LF

Regardless of demand, autarkic price is =
a LM

Cost determined price but demand determined

output.
Sunandan Ghosh, CDS, 2013 5
 Trade

Suppose H and F have similar structures and we have

a LF

For home pa =
a LM
*
a

For foreign p a* = LF
*
a LM

Will there be trade? What will be the pattern? Will

there be any GFT?

Any trade model should answer these questions.

Sunandan Ghosh, CDS, 2013 6
 World PPC, TOT and Patterns of
Specialization

Suppose H has a CA in Food that is

a LF *
> LF
a
a LM a * LM
a LF

Slope of H’s PPC is a LM
*

Slope of F’s PPC is a LF
a * LM

Sunandan Ghosh, CDS, 2013 7

 PPCs

Sunandan Ghosh, CDS, 2013 8

 World PPC

The world PPC captures the locus of

(X F + X , XM + X )
*
F
*
M
using
(L + L )
*

We get a kinked PPC with two parts having two

different slopes.

Sunandan Ghosh, CDS, 2013 9

 World PPC

Sunandan Ghosh, CDS, 2013 10

 Specialization: Position of
World CIC

Sunandan Ghosh, CDS, 2013 11

 Ricardo’s Point

Sunandan Ghosh, CDS, 2013 12

 Supply Story

Sunandan Ghosh, CDS, 2013 13

 Pattern of Trade and Wages

Home will produce food if wa LF < w a * *
LF
and vice-versa.

We can also predict the same pattern of trade by

rearranging the equation as follows –

a LF w
*
< *
a LF w

Sunandan Ghosh, CDS, 2013 14

 Pattern of Trade and Wages

Suppose we are at the Ricardo point, that is, the case of
complete specialization for both Home and Foreign.

PF = w . a LF

World prices will be {
PM = w * . a LM
*

*
w a P

Rearranging the equations we have
*
= . LM
F

w w a LF PM

is*called the double-factoral TOT. PF Is the
w
commodity TOT. PM

Sunandan Ghosh, CDS, 2013 15

 Many Country

Sunandan Ghosh, CDS, 2013 16

Questions
aLF

What if World Price = ( ) ratio of the ith
aLM
Country in a n-country framework?

All countries will be completely specialized except the

ith Country.

What if World Price ≠ (aLF ) ratio of any country

aLM
in a n-country framework?

All will be completely specialized.

Sunandan Ghosh, CDS, 2013 17
 Two country, many goods
Extra Slide (Use as hint to the problem)

Suppose there are n number of goods – (1, 2, … , n).

Wage is same due to sectoral mobility and

homogeneity ⇒ we have price of ith good to be
Pi = w . a Li

We can rank the goods as follows –

* * * *
P P P P
< 1
<
2
........ <
3 n
a L1 a L 2 aL3 a Ln

Sunandan Ghosh, CDS, 2013 18

 Questions

Which one will be an equilibrium? Eqm. wage = ?
P1 * P 2* P3* P n*
< < ........ < < w
a L1 aL2 a L3 a Ln
P1* P2* P3* Pn*
w < < < ........ <
a L1 aL2 a L3 a Ln
P1* P2* P3* Pn*
< < = w < ........ <
a L1 aL2 aL3 a Ln
* * * *
P P P P
1
< 2
< 3
........ < n
= w
a L1 aL2 aL3 a Ln
Sunandan Ghosh, CDS, 2013 19