Lecture - The Ricardian Model Ch.3-part 3 Agenda 1 Pattern of trade and specialization 2 Gains from trade 3 Wage 4 Misconceptions 5 Conclusion PPF

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The Ricardian Model Ch.3-part 3
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Agenda 1. Pattern of trade and specialization 2. Gains from trade 3. Wage 4. Misconceptions 5. Conclusion
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PPF
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Relative Supply and Relative Demand (cont.) RD 1 a LC /a LW a * LC /a * LW RS Relative price of cheese, P C /P W Relative quantity of cheese, Q C + Q * C Q W + Q * W L/a LC L * /a * LW
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Pattern of trade and specialization Each country specializes in the production of the goods in which it has a comparative advantage. If H has comparative advantage in cheese. H produces only cheese and F only wine. H exports cheese. F exports wine.
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3-6 Gains From Trade Gains from trade come from specializing in the type of production which uses resources most efficiently, and using the income generated from that production to buy the goods and services that countries desire. where “using resources most efficiently” means producing a good in which a country has a comparative advantage.
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3-7 Gains From Trade (cont.) Domestic workers earn a higher income from cheese production because the relative price of cheese increases with trade. Foreign workers earn a higher income from wine production because the relative price of cheese decreases with trade (making cheese cheaper) and the relative price of wine increases with trade.
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3-8 Gains From Trade (cont.) Think of trade as an indirect method of production that converts cheese into wine or vice versa. Without trade, a country has to allocate resources to produce all of the goods that it wants to consume. With trade, a country can specialize its production and exchange for the mix of goods that it wants to consume.
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3-9 Gains From Trade (cont.) Consumption possibilities expand beyond the production possibility frontier when trade is allowed. With trade, consumption in each country is expanded because world production is expanded when each country specializes in producing the good in which it has a comparative advantage.
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Numerical Example (Gain from trade). Home: a lc =1, a lw =2, , L=1200 Foreign: a lc *=6, a lw *=3, L*=2400 Home has CA in cheese. Foreign has CA in wine.
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Cont. No trade: Suppose each country split the labor force equally between the two industries Total world output: Cheese: 600+200=800, Wine 300+400=700
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Cont. Trade: Both countries specialize in the good
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This note was uploaded on 02/02/2012 for the course ECONOMICS 239 taught by Professor Wu during the Winter '11 term at Wilfred Laurier University .

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Lecture - The Ricardian Model Ch.3-part 3 Agenda 1 Pattern of trade and specialization 2 Gains from trade 3 Wage 4 Misconceptions 5 Conclusion PPF

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