04 The Ricardian Model, Part 2

04 The Ricardian Model, Part 2 - The Ricardian Model Part 2...

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1 1 The Ricardian Model, Part 2 • Agenda – The Foreign Country – Opportunity Cost, Relative Prices, and Wages – Absolute and Comparative Advantage – The Pattern of Trade –The Ga ins from Trade – Relative Wages after Trade 2 The Ricardian Model • The Foreign Country: – Suppose that a* LW = 3. – Suppose that a* LC = 6. – Suppose that L* = 6,000. 3 The Ricardian Model • Foreign’s Production Possibilities Frontier: ¾ If Q* W is the quantity of wine produced, then ¾ a* LW * Q* W is the labor used in producing wine. ¾ If Q* C be the quantity of cheese produced, then ¾ a* LC * Q* C is the labor used in producing cheese. 4 The Ricardian Model • Foreign’s Production Possibilities Frontier – Because Foreign has limited resources, there are limits on how much it can produce. L* W + L* C <= L* a* LW * Q* W + a*
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2 5 The Ricardian Model • Foreign’s Production Possibilities Frontier: – When using all of its resources, Foreign also faces a trade-off . • If a* LW * Q* W + a* LC * Q* C = L • Then Q* W = L* / a* LW –a* LC / a* LW * Q* C 6 Foreign’s Production Possibilities Q* C Q* W 7 The Ricardian Model • Foreign’s Production Possibilities Frontier: – When the economy uses all of its resources, what is the opportunity cost of increased cheese production? • It is the quantity of wine that has to be given up in order to increase cheese production. 8 The Ricardian Model • Foreign’s Production Possibilities Frontier: – Let a* LC = 6 and a* LW = 3. – If 1 unit of labor is moved from wine production to cheese production, then •Q* C rises by 1/6 units of cheese and •Q* W falls by 1/3 units of wine.
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3 9 The Ricardian Model • Foreign’s Production Possibilities Frontier: – The opportunity cost or trade-off of increased cheese production is the decreased amount of wine produced. •a* LC / a* LW = 2. 10 The Ricardian Model • Foreign’s Indifference Curves: – What combination of Wine and Cheese will Foreign actually produce? • This will depend on the country’s demand for each of the two goods. • This can be summarized by the Foreign’s community indifference curves. 11 Foreign’s Indifference Curves Q* C Q* W 12 The Ricardian Model • Foreign’s Autarky Equilibrium: – The production possibilities curve shows what the economy can produce. – The community indifference curves show what the economy wants to consume. – Equilibrium exists where the economy maximizes its utility subject to its production possibilities.
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4 13 Foreign’s Autarky Equilibrium Q* C Q* W 14 The Ricardian Model • Opportunity Cost, Relative Prices, and Wages: –Le t P* C be the price of cheese in Foreign and P* W
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04 The Ricardian Model, Part 2 - The Ricardian Model Part 2...

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