1Ricardian Model

• INTERNATIONAL ECONOMICS,ECO 486

• JDE notes to supplement the text. David Ricardo

April 18, 1772 — September 11, 1823

2Learning Objectives

• Understand five more assumptions

• Determine and understand comparative and absolute advantage

• Find international trade equilibrium

• Explain gains from trade

• Derive range of wages that will permit trade

4Assumptions

• #8 -- Factors of production cannot move between countries

• #9 -- There are no barriers to trade in goods.

5Assumptions #10

• #10 -- Exports must pay for imports

• Assumptions 8-10 apply to both the Classical and HO Models

• Assumptions 11 & 12 apply only to Classical Model

6Assumptions

• #11 -- Labor is the only relevant factor of production in terms of productivity analysis or costs of production.

• #12 -- Production exhibits constant returns to scale, CRS, between labor and output.

– If both inputs, K & L, are doubled, output doubles

– Implies Linear PPF and complete specialization

7Ricardian Theorem

• A country exports that good which has higher comparative factor productivity and imports the commodity which has lower comparative factor productivity than the other country.

– Page 48, Ravendra N. Batra, Studies in the Pure Theory of International Trade

8Differing technologies and resource

endowmentsLabor productivity

Country A Country B

Soybeans 4 (kg./hr.) 1 (kg./hr.)

Textiles 2 (m./hr.) 1.5 (m./hr.)

Labor endowment

1000 (hr./yr.) 800 (hr./yr.)

9Differing Opportunity Costs

Opportunity Costs

Country A Country B

Soybeans(m./kg.)

Textiles (kg./m.)

11Production possibility frontiers: (a) country A; (b) country B.

12Autarky

• Given perfect competition,

1. P = MC

2. Autarky price of S (on x-axis) equals slope of PPF

3. Resource payments correspond to their productivity

13Pretrade equilibriums: (a) country A; (b) country B.

15Absolute Advantage

• Compare one good across countries.

• Country with greater output per labor hour has an absolute advantage in that good.

16Comparative Advantage

• Calculate opportunity costs.

• Compare one good across countries.

• Country with lower opportunity cost has a comparative advantage in that good.

17Which Advantage?

• Absolute advantage is a special case.

• Comparative advantage is the general case.

19Terms of Trade

• Once trade begins, an international equilibrium results

• Results in one world price for a good

21International Trade Equilibrium

• Complete specialization in Comparative Advantage good

• CIC & ToT tangent at consumption point

• Congruent trade triangles imply balanced trade

22Posttrade equilibriums: (a) country A; (b) country B.

24Gains From Trade

• More of both goods attainable

• GDP increases at pre-trade prices

• Higher CIC is attainable

26The gains from trade (country A).

27Country A’s trading equilibrium.

29Exchange Rates

• State exchange rate, E, in US dollars per UK pound

– say $2/£

• A good will be imported if its foreign pre-trade price (x E) is less than the domestic price

PS < E x PS*

30Buy Low . . .

• Trade requires

PS < E x PS*

PT > E x PT*

autarky prices

Home (A) has comparative advantage in S

Foreign (B) has comparative advantage in T

31Perfect Competition Review

(Product & Resource Markets)

• PX = MC for a good, X

• MC = w/MPPL (Labor, L, is only var. input)

• w=MRPL =(MR) MPPL=(P) MPPL=VMPL

33Prices & Wages

• PX = MC = w/MPPL

• MPPL is measured as units of X per hour, OLX

• Productivity may be stated as hours per unit of X, aLX, or units of X per hour worked, OLX.

aLX = 1/OLX

• PX = w /OLX

35Trade & Wages (Cont.)

O

O

WE

W

O

O

WE

W

LT

LT

LS

LS

**

**

38Competitive Advantage

• The ability to sell a good at the lowest price.

• Usually results from comparative advantage

• Alternatively, it may be the result of . . .

– Government subsidies for inefficient industries

– An undervalued exchange rate

39Losing Competitive Advantage

• If Home’s relative wage ratio (W/W*) exceeds its relative productivity (OLS/OLS*), its S will cost _______ than Foreign’s.

• If a country’s currency is overvalued (say $1/£ instead of $2/£), comparative advantage may be lost -- both goods may be cheaper in ___________.

41Country A’s price-consumption curve.

42Derivation of country A’s offer curve.

43International trade equilibrium.

44Cambodian Textiles Update

• US offered to expand Cambodia’s export quota by 14% if “working conditions is the Cambodia textile and apparel sector substantially comply with” local and internationally recognized core standards.

• Dec ’99 – US officials decide that Cambodia has fallen short, but offered 5%– Cambodia to establish independent monitoring

with the International Labor Organization, ILO

45Cambodian Textiles Update

• ILO leery, fearing weakening of local monitoring capability

• ILO agrees after US pledges $500,000 in technical assistance to Cambodian labor ministry

• US also paying $1 million (of $1.4 mil.) for a 3-year monitoring effort– USTR press release 18 May 2000

46Cambodian Textiles Update

• Sep ’00 – US officials grant Cambodia another 4% increase– 9% increase continued for ’01

• Other news:– Nov ’00 -- ILO rules Burma’s progress on forced labor

inadequate. Section 33 action authorized. As of March ’01, no member country has taken action. US & EU considering sanctions

– Bush proposed reducing US contributions to the ILO budget.

47

0 2 4 6 8 10

2

4

6

8

10

SOYBEANS, S (millions of bushels per year)

L

Quantity of Soybeans Demanded

H

CIC1

CIC2

CIC0

G

Autarky General Equilibrium|slope PPF| = PS/PT = 2 yd.T/bu.S

TE

XT

ILE

S, T

(mil

lion

s of

yar

ds

per

yea

r)

PPF

PS/PT = 1 yd.T/bu.S

PS/PT = 2.5 yd.T/bu.S

4.71.8

49

Tony Auth, NY Times editorial cartoon, December 2, 1999