chapter1_2008 - L Karp International Trade March 6 2008 1...

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LKarp International Trade March 6, 2008 1 Ricardian model The Ricardian model provides the simplest setting to illustrate comparative advantage and the gains from trade in a general equilibrium setting. This chapter has the following objectives: Make sure that everyone knows what comparative advantage means. Definition of com- parative advantage : A country (e.g. Canada) has a comparative advantage in the produc- tion of a commodity (e.g. corn) if the ratio between it’s pre-trade marginal costs of that commodity (corn), and its pre-trade marginal cost of producing “the other” commodity (umbrellas) is lower than that of its trading partner. Show how you use equilibrium conditions (here, zero profit conditions) to determine endogenous variables (here, relative prices). Provide a simple setting in which to understand the relation between commodity prices and factor prices. Understand the meaning of "real returns to a factor" and show how trade affects this "real return". Put all of this together in order to be able to do comparative statics experiments. In particular, show how a change in technology affects equilibrium welfare. I will use a simple example to discuss the Ricardian model. Two countries, Canada and the US produce two commodities, corn and umbrellas. (The obvious alliteration is used asamnemonicdevice.) 1.1 Technology and markets The Ricardian model assumes that production uses only 1 input (labor), with constant returns to scale. This assumption means that the technology in each country and each sector is entirely determined by the labor requirement per unit of output. The other assumptions are that (a) labor moves freely between sectors within a country, but (b) labor cannot move between countries. Assumption (a) implies that in a particular country, the wage must be the same in both sectors; 1
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assumption (b) means that the wage need not be the same (and typically is not the same) in the two countries. In addition, all agents are price takers, i.e. there is perfect competition. In my example, the unit labor requirements are unit labor requirement Corn (good 1) Umbrellas (good 2) US a u 1 =1 a u 2 =1 Canada a c 1 =3 a c 2 =6 Table 1, Labor requirements (Cornisgood1,umbrellasaregood2.Subscripts indicate commodity, superscripts indicate country.) I assume that both goods require one unit of labor to produce one unit of output in the US. This assumption is without loss of generality; it merely amounts to a choice of units. Production of both goods require less labor in the US than in Canada. In this sense, the US has an absolute advantage in the production of both goods. I make this assumption not because of any anti-Canadian bias, but in order to emphasize that comparative and absolute advantage are distinct concepts. The gains from trade are not related to absolute advantage. In this and in more general models, a “country” benefits from trade if and only if the relative prices at which it can trade differ from the equilibrium autarkic relative prices. In this particular example of the
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chapter1_2008 - L Karp International Trade March 6 2008 1...

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