Group 3 (United Kingdom) - Chapter 2 Slide

CHAP INTERNATIONAL ECONOMICS
TER
II
LABOR
PRODUCTIVITY &
ABDURROHMAN RANGGA MU'MIN HANDAYANI
FRENTIS PRATAMA KIPANG SUKA
RADEN AYU FADIAH ALI
COMPARATIVE LAVENIA
ADVANTAGE:
THE RICARDIAN MODEL GR
OUP
- 2
M A
B
N
A
I
G
E M E N T
TER
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The Concept of
Comparative Advantage
A country has a comparative advantage The following is an important insight into

in producing a good if the opportunity comparative advantage and international
cost of producing that good in terms of trade: Trade between two countries can
other goods is lower in that country benefit both countries if each country exports
than it is in other countries. goods that have comparative advantage.
02
TER
II
One-Factor Economy
PRODUCTION POSSIBILITIES
Because any economy has limited resources, there are

limits to what it can produce, and there are always trade-
offs; to produce more than one good the economy must
sacrifice some production of other goods.
RELATIVE PRICES AND SUPPLY

In a competitive economy, offering decisions are
determined by individual efforts to maximize their income.
In our simplified economy, since labor is the only factor of
production, the supply of cheese and wine will be
determined by the movement of labor to whichever sector
pays the higher wages.
03
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Trade in a One-Factor World

ASSUMPTIONS OF THE MODEL
There are two countries in the world (Home and Foreign).

Each of the two countries produces two goods (say wine and cheese).
Labor is the only factor of production.
The supply of labor is fixed in each country.
The productivity of labor in each good is fixed.
Labor is not mobile across the two countries.
Perfect competition prevails in all markets.
All variables with an asterisk refer to the Foreign country.
04
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Absolute Advantage Comparative Advantage

A country has an absolute advantage in a production of a good if it has a Assume that aLC /aLW < a*LC /a*LW
lower unit labor requirement than the foreign country in this good. This assumption implies that the opportunity cost of cheese in terms of
wine is lower in Home than it is in Foreign.
Assume that a*LC < a*LC and a*LW < a*LW
In other words, in the absence of trade, the relative price of cheese at
This assumption implies that Home has an absolute advantage in the
Home is lower than the relative price of cheese at Foreign.
production of both goods. Another way to see this is to notice that
Home is more productive in the production of both goods than Foreign.
Home has a comparative advantage in cheese and will export it to
Even if Home has an absolute advantage in both goods, beneficial trade
Foreign in exchange for wine.
is possible.
The pattern of trade will be determined by the concept of comparative
advantage.
05
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Determining the
Relative Price
After Trade
What determines the relative price (e.g., PC /PW) after trade?
To answer this question we have to define the relative supply and relative demand
for cheese in the world as a whole.
The relative supply of cheese equals the total quantity of cheese supplied by both
countries at each given relative price divided by the total quantity of wine supplied,
(QC+Q*C )/(QW+Q*W).
The relative demand of cheese in the world is a similar concept. 06
TER
II
If countries specialize according to their comparative advantage, they all gain from
this specialization and trade.
We will demonstrate these gains from trade in two ways.
First, we can think of trade as a new way of producing goods and services (that is, a
new technology).
Another way to see the gains from trade is to consider how trade affects the
consumption in each of the two countries.
The consumption possibility frontier states the maximum amount of consumption

of a good a country can obtain for any given amount of the other commodity.
In the absence of trade, the consumption possibility curve is the same as the

production possibility curve.

Trade enlarges the consumption possibility for each of the two countries.
07
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PRODUCTIVITY AND THE PAUPER LABOR EXPLOITATION

COMPETITIVENESS ARGUMENT
Myth 3 Trade makes the workers
Myth 1 Free trade is beneficial only Myth 2 Foreign competition is worse off in countries with lower
if a country is strong enough to unfair and hurts other countries wages.
withstand foreign competition. when it is based on low wages. In the absence of trade these
workers would be worse off.
This argument fails to recognize Again in our example Foreign has
Denying the opportunity to export
that trade is based on comparative lower wages but still benefits from is to condemn poor people to
not absolute advantage. trade. continue to be poor.
08
TER
II
COMPARATIVE
ADVANTAGE
WITH MANY
GOODS
This simplified analysis allows us to
capture many essential points about
comparative advantage and trade and, as
we saw in the last section, gives us a
surprising amount of mileage as a tool for
discussing policy issues.
09
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II
SETTING UP THE Relative Wages and

MODEL Specialization
The pattern of trade will depend on

the ratio of Home to Foreign wages.
Goods will always be produced where
it is cheapest to make them.
Each of these countries will now, however, be For example, it will be cheaper to produce
assumed to consume and to be able to good i in Home if wa Li < w*a*Li , or by
rearranging if a*Li la Li/a*Li > w/w*.
produce a large number of goods—say, N
different goods alto- gether. We assign each
of the goods a number from 1 to N;
10
TER
II
Determining the Relative Wage

in the Multigood Model
To determine relative wages in a multigood

economy we must look behind the relative
demand for goods (i.e., the relative derived
demand).
The relative demand for Home labor depends
negatively on the ratio of Home to Foreign
wages.
11
TER
II
Adding
Transport Costs
and Nontraded
Goods
THERE ARE THREE MAIN
REASONS WHY SPECIALIZATION THE RESULT OF IN SOME CASES
IN THE REAL INTERNATIONAL INTRODUCING TRANSPORTATION IS
ECONOMY IS NOT EXTREME TRANSPORT COSTS VIRTUALLY MPOSSIBLE.
MAKES SOME GOODS
1. The existence of more than one NONTRADED.
factor of production.
Example Services such as haircuts
2. Countries sometimes protect
and auto repair cannot be traded
industries from foreign competition.
3. It is costly to transport goods and internationally.
services. 12
TER
II
Empirical Evidence on The

Ricardian Model
There are a number of ways in which In spite of these failings, however, the basic Ricardian theory would lead us
it makes misleading predictions prediction of the Ricardian model that broadly to expect that the
about international trade. countries should tend to export those goods higher the relative productivity
in which their productivity is relatively high - in the U.S. industry, the more
has been strongly confirmed by a number of likely U.S. rather than U.K. firms
studies over the years. would export in that industry.
13
TER
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SUMMARY
We examined the Ricardian model, the simplest model We can show that trade enlarges a countrys consumption
that shows how differences between countries give rise possibilities.
to trade and gains from trade.
The distribution of the gains from trade depends on the
In this model, labor is the only factor of production and relative prices of the goods countries produce.
countries differ only in the productivity of labor in
Extending the one-factor, two-good model to a world of
different industries.
many commodities makes it possible to illustrate that
In the Ricardian model, a country will export that transportation costs can give rise to the existence of
commodity in which it has comparative (as opposed to nontraded goods.
absolute) labor productivity advantage.
The basic prediction of the Ricardian model-that
The fact that trade benefits a country can be shown in countries will tend to export goods in which they have
either of two ways. relatively high productivity- has been confirmed by a
number of studies.
We can think of trade as an indirect method of
production.
14
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II
Thank
You

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CHAP INTERNATIONAL ECONOMICS

A country has a comparative advantage The following is an important insight into

Because any economy has limited resources, there are

RELATIVE PRICES AND SUPPLY

Trade in a One-Factor World

There are two countries in the world (Home and Foreign).

Absolute Advantage Comparative Advantage

production possibility curve.

PRODUCTIVITY AND THE PAUPER LABOR EXPLOITATION

SETTING UP THE Relative Wages and

The pattern of trade will depend on

Determining the Relative Wage

To determine relative wages in a multigood

Empirical Evidence on The

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