05 The Ricardian Model, Part 3

05 The Ricardian Model, Part 3 - The Ricardian Model, Part...

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1 1 The Ricardian Model, Part 3 • Agenda – Misconceptions about Comparative Advantage – Comparative Advantage with Many Goods – Transportation Costs and Non-Traded Goods – Empirical Evidence 2 Misconceptions • The Productivity/Competitiveness Argument – Free trade is beneficial only if a country is more productive than foreign countries. 3 Misconceptions • The Productivity / Competitiveness Argument – The benefits of free trade do not depend on absolute advantage . – The benefits of free trade depend on comparative advantage . 4 Misconceptions • The Pauper Labor Augment – Free trade with countries that base competition on low wages is unfair and hurts other countries that pay high wages.
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2 5 Misconceptions • The Pauper Labor Augment – Lower foreign wages are irrelevant to whether a country gains from trade. – While trade may reduce wages for some workers, thereby affecting the distribution of income within a country, trade benefits consumers and other workers. 6 Misconceptions • The Exploitation Argument – Free trade exploits a country and makes it worse off if its workers receive much lower wages than workers in other nations. 7 Misconceptions • The Exploitation Argument – If one is asking about the desirability of free trade, the point is not to ask whether low-wage workers deserve to be paid more but to ask whether they and their country are worse off exporting goods based on low wages than they would be if they refused to enter into such demeaning trade, i.e., what is the alternative? – There are real gains from trade. 8 Comparative Advantage, Many Goods • Assumptions: – Only 2 countries: Home and Foreign. – Only 1 factor of production: Labor. – Many goods, i = 1, 2, …, N.
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9 Comparative Advantage, Many Goods • Assumptions: – Unit labor requirements: •a Li is Home’s unit labor requirement for good i. •a* Li is Foreign’s unit labor requirement for good i. – Wage rates • W is Home’s wage rate. • W* is Foreign’s wage rate. 10 Comparative Advantage, Many Goods • Assumptions: – Calculate the ratio of Home’s to Foreign’s unit labor requirement for each good, a Li / a* Li . – Re-number the goods so that the lower the ratio of unit labor requirements the lower the number, i.e., a L1 / a* L1 < a L2 / a* L2 < a L3 / a* L3 < … < a LN / a* LN 11 Comparative Advantage, Many Goods 12 Comparative Advantage, Many Goods • Relative Wages and Specialization: – The pattern of trade depends the ratio of Home to Foreign wages, i.e., W / W*. – The rule for allocating world production: goods
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05 The Ricardian Model, Part 3 - The Ricardian Model, Part...

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