Ch2_Ricardian Model.docx

Ch2_Ricardian Model.docx - Chapter 2 Trade and Technology...

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Chapter 2 Trade and Technology: The Ricardian Model Goals: Understand how technological differences across countries give rise to comparative advantage, which leads to specialization and trade; understand how the level of technology affects wages. Background: The Ricardian model was formulated in response to the mercantilist idea that exports are good and imports are bad (Google mercantilism ). David Ricardo in his 1817 book showed that free balanced trade could enhance welfare in both England and Portugal. Assumptions of the model: 1. Two countries: Home and Foreign (denoted by a *) 2. Two goods: wheat and cloth 3. One factor of production: labor 4. Constant returns to labor 5. Labor is free to move between sectors 6. Perfect competition in both goods and labor markets The Home Country Suppose there are ´ L = 25 workers in Home. Each worker can produce 4 bushels of wheat ( MPL W = 4 ) or 2 yards of cloth ( MPL C = 2 ). MPL: _______________________________________. The assumption of ______________ returns to labor implies that ¿ ¿ MPL W = ¿ ¿ and ¿ ¿ MPL C = ¿ ¿ will always hold for each additional worker hired to produce the specified good. The magnitude of MPL in this model reflects the level of technology used in a country. Higher MPL is a result of using or having access to ___________ technology. 1
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Depicting Home Production: Production Possibilities Frontier (PPF) Slope of PPF: the opportunity cost of producing one more unit of wheat is ________ unit of cloth that must be given up. Depicting Home Preferences: Indifference Curves An indifference curve shows the combinations of wheat and cloth that gives Home consumers _________ satisfaction. Compared to PPF that focuses on _____________, indifference curves focus on ___________. Putting Production and Preferences together: Pre-trade (Autarky) Equilibrium At the equilibrium, relative price of wheat ___________ the opportunity cost of wheat.
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