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.
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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- Winter '14
- tax revenues, price ratio