2_3150_ricardo

# 2_3150_ricardo - 1. Setup 2. Absolute Advantage 3....

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1 Ricardian Model 1. Setup 2. Absolute Advantage 3. Comparative Advantage 4. Production possibility frontier and autarky equilibrium 5. Trade equilibrium 6. Wages 7. Opportunity cost 8. Gains from trade: big versus small countries 1. Setup 2 goods: X, Y 2 countries: H, F Production functions: y x y x L L L bL Y aL X + = = = a, b>0 – marginal products of labour In case of 2 countries: Home: y x L b Y L a X = = ; Foreign: f y f f f x f f L b Y L a X = = Assumptions: A1. Production functions (technology) differ across countries. A2. 1 factor of production (labour) i.e. no difference in relative endowments A3. Constant returns to scale (i.e. labour efficiency is independent of output) A4. Identical and homogenous tastes in all countries A5. Absence of distortions (tariffs, taxes, subsidies etc.) A2, A3 => linear PPF

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2 2. Absolute Advantage Definition 1 Country H has an absolute advantage in production of X if a h > a f . Country H has an absolute advantage in production of Y if b h > b f . Example 1 1 unit of labour produces (MP l ): Home Foreign Absolute advantage X a=20 a f =30 Foreign (20<30) Y b =20 b f =10 Home (20>10) ->H specializes in Y, F specializes in X Changes in output as a result of reallocation of 1 unit of labour: H: 1 worker moves from X to Y F: 1 worker moves from Y to X Home Foreign Change in world output X a=-20 a f =+30 +10 Y b=+20 b f =-10 +10 3. Comparative Advantage Definition 2 Country H has a comparative advantage in the production of X if a h /b h > a f /b f. Country H has a comparative advantage in the production of Y if a h / b h < a f /b f.
3 Example 2 1 unit of labour produces (MP l ): Home Foreign Absolute advantage X a=5 a f =30 Foreign (5<30) Y b=5 B f =10 Foreign (5<10) Comparative advantage a/ b =1 a f / b f =3 H has CA in Y, F has CA in X. AA- compare absolute MPL, CA - compare relative MPL. Foreign worker is 3 times more efficient at producing X => 3 home workers can be replaced by 1 foreign worker Is trade welfare improving? Yes! Changes in output as a result of reallocation of labour: H: 3 L moves from X to Y F: 1 L moves from Y to X Home Foreign Change in world output X a h =-15 a f =+30 +15 Y B h =+15 b f =-10 +5 If ratios of marginal products differ for 2 countries, there are gains from specialization

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4 We will show that comparative advantage gives rise to autarky price differences between home and foreign countries, which in turn make trade beneficial to both countries. 4. Production possibility frontier and autarky equilibrium
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## This note was uploaded on 06/09/2010 for the course AP 3150 taught by Professor Allalileeva during the Winter '09 term at York University.

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2_3150_ricardo - 1. Setup 2. Absolute Advantage 3....

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