Ricardian model
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Ricardian Model. INTERNATIONAL ECONOMICS, ECO 486 JDE notes to supplement the text. David Ricardo April 18, 1772 — September 11, 1823 . Learning Objectives. Understand five more assumptions Determine and understand comparative and absolute advantage Find international trade equilibrium

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Ricardian model

Ricardian Model

  • INTERNATIONAL ECONOMICS,ECO 486

  • JDE notes to supplement the text.

David Ricardo

April 18, 1772 — September 11, 1823


Learning objectives

Learning 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


Assumptions

Assumptions

  • #8 -- Factors of production cannot move between countries

  • #9 -- There are no barriers to trade in goods.


Assumptions 10

Assumptions #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


Assumptions1

Assumptions

  • #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


Ricardian theorem

Ricardian 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


Differing technologies and resource endowments

Differing technologies and resource endowments


Differing opportunity costs

Differing Opportunity Costs


Production possibility frontiers a country a b country b

Production possibility frontiers: (a) country A; (b) country B.


Autarky

Autarky

  • Given perfect competition,

    • P = MC

    • Autarky price of S (on x-axis) equals slope of PPF

    • Resource payments correspond to their productivity


Pretrade equilibriums a country a b country b

Pretrade equilibriums: (a) country A; (b) country B.


Absolute advantage

Absolute Advantage

  • Compare one good across countries.

  • Country with greater output per labor hour has an absolute advantage in that good.


Comparative advantage

Comparative Advantage

  • Calculate opportunity costs.

  • Compare one good across countries.

  • Country with lower opportunity cost has a comparative advantage in that good.


Which advantage

Which Advantage?

  • Absolute advantage is a special case.

  • Comparative advantage is the general case.


Terms of trade

Terms of Trade

  • Once trade begins, an international equilibrium results

  • Results in one world price for a good


International trade equilibrium

International Trade Equilibrium

  • Complete specialization in Comparative Advantage good

  • CIC & ToT tangent at consumption point

  • Congruent trade triangles imply balanced trade


Posttrade equilibriums a country a b country b

Posttrade equilibriums: (a) country A; (b) country B.


Gains from trade

Gains From Trade

  • More of both goods attainable

  • GDP increases at pre-trade prices

  • Higher CIC is attainable


The gains from trade country a

The gains from trade (country A).


Country a s trading equilibrium

Country A’s trading equilibrium.


Exchange rates

Exchange 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*


Buy low

Buy 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


Perfect competition review product resource markets

Perfect 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


Prices wages

Prices & 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


Trade wages cont

Trade & Wages (Cont.)


Competitive advantage

Competitive 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


Losing competitive advantage

Losing 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 ___________.


Country a s price consumption curve

Country A’s price-consumption curve.


Derivation of country a s offer curve

Derivation of country A’s offer curve.


International trade equilibrium1

International trade equilibrium.


Cambodian textiles update

Cambodian 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


Cambodian textiles update1

Cambodian 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


Cambodian textiles update2

Cambodian 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.


Quantity of soybeans demanded

Quantity of Soybeans Demanded

PS/PT = 2.5 yd.T/bu.S

10

H

Autarky General Equilibrium|slope PPF| = PS/PT =2 yd.T/bu.S

8

G

TEXTILES, T (millions of yards per year)

6

L

PS/PT = 1 yd.T/bu.S

4

CIC2

2

CIC1

CIC0

PPF

1.8

0 2 4 6 8 10

4.7

SOYBEANS, S (millions of bushels per year)


Ricardian model

Tony Auth, NY Times editorial cartoon, December 2, 1999


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