Short2 - E 101: Short Note 2 (Ricardian Model) (* Lectures...

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1 E 101: Short Note – 2 (Ricardian Model) (* Lectures are mainly based on our textbook, Krugman’s International Economics: Theory and Policy. Thorough reading of the text in addition to active participation in classes is strongly recommended. This note is just a short list of topics we discuss in class for your reference.) I. Classic Trade Theory * Major Questions: i) Why trade at all? Æ What is the source of gains from trade? ii) What is the effect of trade? - the effects of trade on income redistribution - the effects on social welfare
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2 2. Ricardian Model (Comparative advantage due to productivity difference) O Assumptions: - two countries (H, F): small countries (with no market powers) - two commodities (industries: C, W) - one perfectly mobile production factor (labor) - perfectly competitive market ( Æ wage: marginal product value of labor) - technology asymmetry in two countries ( Æ different labor productivity)
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3 Unit labor requirements for domestic and foreign countries (per unit of each product) Cheese Wine Domestic a LC = 1 hour a LW = 2 hours Foreign a* LC = 6 hours a* LC = 3 hours i) Absolute advantage : o Using 1 hour of labor , i) Domestic country can produce 1 unit of cheese (1/ a LC unit of cheese) while foreign country can produce 1/6 unit of cheese (1/ a* LC unit of cheese) Î Domestic country has absolute advantage in the production of cheese because ( a LC < a* LC )
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4 ii) Comparative advantage : O Using 1 hour of labor , i) Domestic country can produce 1 unit of cheese (1/ a LC unit of cheese) or can produce 1/2 unit (1/ a LW unit of wine) ( * in domestic country, the value of 1 hour’s labor should be equal: Æ P Cheese (1/ a LC ) = P Wine (1/ a LW ) Æ The opportunity cost of cheese in terms of wine = a LC / a LW =1/2 ii) Foreign country can produce 1/6 unit of cheese (1/ a* LC unit of cheese) or can produce 1/3 unit (1/ a* LW unit of wine) Æ The opportunity cost of cheese in terms of wine = a* LC / a* LW = 2 Î Domestic country has comparative advantage in the production of cheese
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5 iii) Gains from Trade Unit labor requirements for domestic and foreign countries (per unit of each product) Cheese Wine Domestic (H) a LC = 1 hour a LW = 2 hours Foreign (F) a* LC = 6 hours a* LC = 3 hours O Let us say that Initial endowment of labor is 12 hours (L = 12) & international relative price is “(P C /P W ) I = 1” - Before trade, H could consume either 12 units of cheese or 6 units of wine. Î
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This note was uploaded on 10/01/2008 for the course ECON 101 taught by Professor Jacobson during the Summer '03 term at UCSD.

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Short2 - E 101: Short Note 2 (Ricardian Model) (* Lectures...

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