Trade_LN3_2011 - International Trade Lecture Note 3 Erzo...

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
Erzo G.J. Luttmer Department of Economics University of Minnesota Spring 2011 1. Introduction The following describes a static economy with two countries and two traded ±nal goods. These goods are produced using labor-only technologies. Labor cannot be traded across borders and labor productivities may di/er across countries. This provides a motive for trade in ±nal goods. The pattern of trade is determined by ²comparative advantage.³ There is no intertemporal trade and there are no transfers, and hence the trade balance is zero by construction. Productivity di/erences and the inability of labor to move also provide an explanation for di/erences in wages across countries. This model of trade was proposed by David Ricardo in his ²Principles of Political Economy and Taxation³(1817). In his chapter On Foreign Trade, Ricardo describes the pattern of trade between England and Portugal and introduces comparative advantage to explain why England exports cloth and Portugal wine. 2. The Ricardian Technology Consider a world with two countries indexed by i 2 f H ; F g . The aggregate labor supply in country i is L i > 0 . There are two consumption goods, indexed by ! 2 f 0 ; 1 g , that can be produced using linear labor-only production technologies. The labor productivities are z !;i > 0 . Labor can only be used in its country of origin. Consumption goods can be shipped costlessly from one country to another. 2.1 The World PPF If it was possible for labor to migrate or otherwise supply its services anywhere in the world, then relatively unproductive technologies would never be used. For example, if z !; H > z !; F , then all production of good ! would make use of the home-country 1
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
technology. The set of all possible combinations of output of good 0 and good 1 would be 8 < : ( y 0 ;y 1 ) : 0 y ! max f z !; H ;z !; F g l ! , X ! 2f 0 ; 1 g l ! L H + L F 9 = ; : This is just like a budget set with prices 1 = max f z !; H ;z !; F g and income L H + L F . But labor is not mobile in a Ricardian economy. This means that the production possibility set is really Y = 8 < : ( y 0 ;y 1 ) : 0 y ! z !; H l !; H + z !; F l !; F , 0 l !;i , X ! 2f 0 ; 1 g l !;i L i 9 = ; : What does this look like? Suppose we want to produce as much of good 0 as possible. There is only one way to do this: allocate all labor everywhere to the production of good 0 . World output would be z 0 ; H L H + z 0 ; F L F units of good 0 , and nothing of good 1 . Similarly, the most the world can produce of good 1 is z 1 ; H L H + z 1 ; F L F , and this would imply no output of good 0 . The question is now: how should labor be allocated in the two countries if we want to produce some amount of good 0 , and given that amount, as much as possible of good 1 ? 2.1.1 Comparative Advantage
Background image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 02/24/2011 for the course ECON 4431H taught by Professor Erzo during the Spring '11 term at Minnesota.

Page1 / 23

Trade_LN3_2011 - International Trade Lecture Note 3 Erzo...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online