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10 in competitive equilibrium each firm equate the

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Unformatted text preview: rium, each firm equate the value of the marginal product of labor to the wage rate, denoted w, as in the Ricardian model. (10.6) Total industry output in X1 is given by summing the first equation in (10.5) over all i firms. Total industry output X1 is as follows. (10.7) 11 Since " < 1, the exponent on the right-hand equation of (10.7) is greater than one: total industry output exhibits increasing returns to scale in its total labor input. Differentiate the middle equation in (10.7) along with the equation for X2 output, making use of the total labor supply constraint. (10.8) Divide the first equation of (10.8) by the second and rearrange. (10.9) 12 which is the slope of the production frontier, the marginal rate of transformation. The production frontier is a convex function: IRS Figure 10.4 Now combine (10.9) with the competitive pricing condition in (10.6). This gives us a relationship between the marginal rate of transformation and the equilibrium price ratio. (10.10) There is also a distortion between the MRT and the price ratio. Let’s ignore this for now. 13 Consider two identical economies as shown in Figure 10.5. Significant gains from trade exist through specialization. But, this is not the only possibility: there is no reason that equilibrium prices just happen to equal the cord connecting the endpoints of the ppf. Figure 10.6 shows an outcome...
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