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# Ricardian Model - PowerPoint PPT Presentation

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

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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

• Derive range of wages that will permit trade

### Assumptions

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

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

### 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

### 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

• 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

### 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.

• Compare one good across countries.

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

• Calculate opportunity costs.

• Compare one good across countries.

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

• Absolute advantage is a special case.

• Comparative advantage is the general case.

• Once trade begins, an international equilibrium results

• Results in one world price for a good

• Complete specialization in Comparative Advantage good

• CIC & ToT tangent at consumption point

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

• More of both goods attainable

• GDP increases at pre-trade prices

• Higher CIC is attainable

### 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 . . .

• 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)

• PX = MC for a good, X

• MC = w/MPPL (Labor, L, is only var. input)

• w=MRPL =(MR) MPPL=(P) MPPL=VMPL

### 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

• 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

• 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 ___________.

### 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 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 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

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)

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