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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





Autarky
Autarky B.

  • Given perfect competition,

    • P = MC

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

    • Resource payments correspond to their productivity



Absolute advantage
Absolute Advantage B.

  • Compare one good across countries.

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


Comparative advantage
Comparative Advantage B.

  • Calculate opportunity costs.

  • Compare one good across countries.

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


Which advantage
Which Advantage? B.

  • Absolute advantage is a special case.

  • Comparative advantage is the general case.


Terms of trade
Terms of Trade B.

  • Once trade begins, an international equilibrium results

  • Results in one world price for a good


International trade equilibrium
International Trade Equilibrium B.

  • Complete specialization in Comparative Advantage good

  • CIC & ToT tangent at consumption point

  • Congruent trade triangles imply balanced trade



Gains from trade
Gains From Trade B.

  • More of both goods attainable

  • GDP increases at pre-trade prices

  • Higher CIC is attainable




Exchange rates
Exchange Rates B.

  • 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 . . . B.

  • 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 B.(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 B.

  • 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



Competitive advantage
Competitive Advantage B.

  • 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 B.

  • 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
Cambodian Textiles Update B.

  • 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 B.

  • 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 B.

  • 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 B.

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, B.NY Times editorial cartoon, December 2, 1999


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