Wk2_corrected_25Aug_Ch_3

# Wk2_corrected_25Aug_Ch_3 - Week 2(Thursday Week 3(Tuesday...

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Week 2 (Thursday, 8/25/2011) Week 3 (Tuesday, 8/30/2011) Chapter 3 Development of Ricardo Model Focus on Supply Side differences that arise from differences in production technologies across countries

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Adam Smith: First to Focus on Technology Differences Adam Smith and Absolute Productivity Countries will export whatever they are “best at producing” Wherever labor productivity is highest Absolute productivity advantage should translate into lower price
Two Measures of Productivity Units of output per one hour of Labor We write: A c = .25 C per hr This means one hour of labor produces 1/4 th of a cloth Hours of labor per unit of output We write: a c = 4 hrs per 1 C This means that it takes 4 hours to produce one unit of cloth

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Price of A Product ω is the wage rate Price of Cloth P c = (wage) (labor productivity) = ω a c = \$10 (4 hrs per 1 C) = \$40 per 1 Cloth
Improved Productivity: a c New Price of Cloth P c = (wage) (labor productivity) = ω a c = \$10 (3 hrs per 1 C) = \$30 per 1 Cloth

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Smith & Absolute Productivity Two economies: U.S. & RoW Two goods: cloth (C) & wheat (W) One resource: labor (L) Same amount in each nation. Different t echnology: U.S. absolutely better in Wheat
Smith & Absolute Productivity U.S. RoW a i a i * 4 hrs per 1 C 1.0 hr per 1 C 2 hrs per 1 W 2.5 hrs per 1 W

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Smith & Absolute Productivity Smith’s Prediction: U.S. Lower Price in W produce and export W RoW Lower Price in C produce and export C
INTRODUCE MONEY FOR THE MOMENT ω = \$3, ω*= €1, and E \$/€ = 1 \$/€ U.S. P i = ω a i RoW E \$/€ P i * = E \$/€ ω* a i * P c = \$3 (4 hr/C ) = \$12 E \$/€ P c * = (1 \$/€ )(€1)(1 hr/C ) = \$1 P w = \$3 (2 hr/W )= \$6 E \$/€ P w * = (1 \$/€ )(€1)(2.5 hr/W ) = \$2.5

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Not Sustainable in Long Run U.S. exports nothing, imports everything and as a result, it runs a trade deficit.
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Wk2_corrected_25Aug_Ch_3 - Week 2(Thursday Week 3(Tuesday...

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