Exrateandwagelimits

Exrateandwagelimits - Extensions and Tests of Classical...

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Unformatted text preview: Extensions and Tests of Classical Model The classical trade model (Ricardos presentation of comparative advantage principle) is very simple Extensions in this chapter (Chap 4) keep the straight line ppf - still simplistic add transportation costs increase the number of goods or countries Introduce price into the model Once wages and prices are introduced, the condition for exporting a good is export if the world price is higher than the price at home in autarky need wage and exchange rate Use wages to find exchange rate Cloth Wine Wage/hr Labour/unit Price Labour/unit Price England 1/hr 1 hr/yd 1 3 hrs/bbl 3 Portugal 0.6 esc/hr 2 hrs/yd 1.2 esc. 4 hrs/bbl 2.4 esc Example In table with prices, we see that with trade, England will export cloth because it is less costly to make and import wine from Portugal Portugal would export wine for the same reason Cloth Wine Wage/hr Labour/unit Price Labour/unit Price England 1/hr 1 hr/yd 1 3 hrs/bbl 3 Portugal 0.6 esc/hr 2 hrs/yd 1.2 esc. 4 hrs/bbl 2.4 esc Price The price is derived by multiplying the hours needed to produce a good by the wage paid to workers for those hours. Example, in Portugal, it takes 4 hours to produce a barrel of wine, and each worker is paid 0.6 escudo per hour, Price = 4 x 0.6 = 2.4 escudos Exchange rate We need to compare the English and Portuguese prices Exchange rate = number of units of one currency needed to purchase a second currency Example: The Canadian U.S. exchange rate is about 1.232 (in 2005 was 1.171, in 2003 was 1.485) e C/US =1.232 For trade to occur, the Portuguese/British exchange rate must lie within a specific range. With only two countries and two goods, these limits will always hold Example In this example, assume exchange rate is 1= 1 esc. English cloth purchased in Portugal costs 1 esc. Portuguese produced cloth costs 1.2 esc Portuguese buy cloth from England Portuguese wine sold in England costs 2.4 English wine costs 3 English buy wine from Portugal Wine is more expensive than cloth The terms of trade for England are P C /P W = 1/2.4 Exchange Rate limit The exchange rate limit can be defined through the prices or wages. With prices, the export condition for a good from country 1 to country 2 is P j 1 e < P j 2 Which simply says that the price of the good must be cheaper when translated into country 2s currency. We could use wages and labour hours to get the price. Exchange rate limits How high could the English currency reach with England exporting to Portugal? Export condition: 2 2 1 1 W a e W a j j < Import condition: 2 2 1 1 W a e W a j j Example In example: England exports cloth 1hr x 1/hr x 1 esc/ < 2 hrs x 0.6 esc/hr England doesnt export wine 3 hrs x 1/hr x 1esc/ > 4 hrs 0.6 esc/hr Example Limit exchange rate for England to export cloth would be 1hr x 1/hr x ? esc/ = 2 hrs x 0.6 esc/hr ? is 1.2 Limit exchange rate for Portugal to export wine is: 3 hrs x 1/hr x ? = 4 hrs x 0.6 esc/hr ? is 2.4/3 = 0.8 Wage limits...
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Exrateandwagelimits - Extensions and Tests of Classical...

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