econ434notes9a

econ434notes9a - David Ricardo(1772-1823-Ricardo Malthuss...

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David Ricardo (1772-1823): -Ricardo: Malthus’s concerns about Aggregate Demand were nonsense, people always desire more goods, if there is an excess supply of a product, the price will eventually come down, resulting in the product being sold. C + (S) = C + (I) S = I: anything not purchased will be available in the future. -Relied on Adam Smith’s invisible hand -In the long run, demand doesn’t matter because price = cost, only supply matters in regards to pricing -Believed free trade to be superior -Prices will converge due to trade, thus allowing gains from trade because the possibility consumption frontier will be expanded -Theorized that gluts would solve themselves because prices would fall with excess supply and the market would adjust -Developed the first concept of comparative advantage -comparative advantage focus on the relative costs of international trade -Adam Smith focused on absolute advantage Children Example a) Children can be seen in various ways i) Investment Good (farm the land) ii) Consumption Good (“buy” a child or a dog) iii) Inferior Good (as income increases, people have less children) iv) Sociobiology (the more offspring, the greater chance of passing on genes) v) Opportunity Cost (as a woman’s income increases, the opportunity cost of children increases) Trade and Comparative Advantage David Ricardo replaced the “absolute advantage” approach of Adam Smith as a foundation for trade with the “law of comparative advantage.” Ricardo also argued that trade facilitates focusing on more and better specialization and divisions of labor. law of comparative advantage: The law of comparative advantage is an assertion that mutually beneficial trade can always take place between two countries (or individuals) whose pretrade cost and price structures differ. No Trade Ex: Suppose that, initially, without trade, the exchange rate is 10 coffees for one acrylic bearskin rug in Brazil, and one coffee for 10 acrylic rugs in Brazil. The absolute value of the slope of the PPF = relative prices of goods. The interior straight lines in this figure are
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the initial production possibilities frontiers and the consumption possibilities frontiers as well. Free Trade with Complete Specialization When trade commences, both nations’ consumption possibility curves shift outward so that more consumption of both goods occurs in both countries. With trade, the slope of the consumption possibilities frontier (CPF) equals the relative prices ( terms of trade ) given by the red line above. Why? Trade allows for one to focus on the thing that you are best at à you sell the things that you are relatively good at producing, in exchange for purchases of the things that you are relatively less efficient in producing. Thus trade in accord with comparative advantage ultimately allows both Brazilians and Alaskans to consume more of both goods.
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