Title: Macalester College Introduction to International Economics Spring 2006
1Macalester CollegeIntroduction to International
EconomicsSpring 2006
2Example 1
Country B
Country A
4
2
Cars
2
4
Wheat
TOTAL
200
200
Units of Labor
Production without Trade
Consumption without Trade
Production after Trade
Consumption after Trade
3Example 2
Country B
Country A
2
2
Cars
2
4
Wheat
TOTAL
100
200
Units of Labor
Production without Trade
Consumption without Trade
Production after Trade
Consumption after Trade
4Example 3
Country B
Country A
1
2
Cars
2
4
Wheat
TOTAL
200
200
Units of Labor
Production without Trade
Consumption without Trade
Production after Trade
Consumption after Trade
5Assumptions of the Ricardian Model
- Fixed, fully employed, and homogenous resources
- Fixed technology within a country
- Zero transportation costs
- Homogeneous products
- No trade barriers
- Perfect competition
6Ricardian Model
- Two countries (A and B) use a single input
(labor) to produce two commodities (X and Y). - LA Labor units in country A
- LB Labor units in country B
- aLX the number of units of labor required to
produce a good X in country A. - bLX the number of units of labor required to
produce good X in country B.
7Definitions
- The production opportunity set is the set of all
possible combinations of X and Y a country could
produce. - The consumption opportunity set is the set of all
possible combinations of X and Y a country could
consume. - The opportunity cost of good X is the number of
units of good Y forgone to produce an additional
unit of good X. - The marginal rate of transformation (MRT) is the
rate at which good X can be transformed into
good Y by transferring labor out of the X
industry and into the Y industry.
8Example 3
Country B
Country A
bLC
aLC
Cars
bLW
aLW
Wheat
TOTAL
LB
LA
Units of Labor
Production without Trade
Consumption without Trade
Production after Trade
Consumption after Trade
9General Case What Can Country A Produce?
YA
Slope -(aLX/aLY MRTA )
/a
L
A
III
LY
II
I
XA
/a
L
A
0
LX
10Country A in Autarky
YA
Slope MRTA
Slope MRSA
LA/aLY
A
YA
LA/aLX
0
XA
XA
11Comparative and Absolute Advantage
- Country A has absolute advantage in good X if it
needs less labor than country B in the production
of good X - Country A has comparative advantage in good X if
it has a lower opportunity cost than country B in
the production of good X
aLX lt bLX
(aLX/aLY) lt (bLX/bLY).
12International Equilibrium with Trade
- The equilibrium price ratio at which trade occurs
(written as PX/PYtt and called the Terms of
Trade) must lie between the two countries
autarky price ratios. - Assume country A has comparative advantage in the
production of good X. Then - aLX/aLYPX/PYA lt PX/PYtt lt PX/PYB
bLX/bLY - A country would never trade voluntarily at
international terms of trade less favorable than
its own autarky price ratio.
13Country A under Free Trade
YA
Slope - (aLX/aLY) MRTA - (PX/PY)A
LA/aLY
XA
A
0
LA/aLX
14Wages in the Ricardian Model
- Assume that country A has comparative advantage
in the production of good X. - Due to perfect competition, the price of each
good equals its marginal cost. - Autarky wages are given by
- wA PX/aLX PY/aLY and wB PX/bLX PY/bLY
- After trade wages are given by
- wA PX/aLX gt PX/aLX wA
- wB PY/bLY gt PY/bLY wB
A
A
B
B
tt
A
tt
tt
tt
B
15Gains from Exchange and Specialization
YA
LA/aLY
A
AP
LA/aLX
0
XA
16Relative Labor Productivity and Export
Performance
17Demand and Supply with Trade
- Each country is willing to import its good of
comparative disadvantage at prices below its
autarky price. - At each price, the quantity demanded of imports
equals the difference between quantity demanded
and quantity produced domestically. - Each country also is willing to export its good
of comparative advantage at prices above its
autarky price. - At each price, the quantity supplied of exports
equals the difference between quantity supplied
and quantity demanded domestically.
18Solving for Equilibrium
- Suppose there are only two countries the U.S.
and Spain. Both countries can produce cars. The
Spanish supply curve for cars is ps(1/3)qs. The
Spanish demand can be described by pd6-qd. The
U.S. supply can be described by ps3qs and U.S.
demand is pd6-qd. - Find the numerical autarky price and quantity in
each country. Who will import cars? - Derive the export supply and import demand
functions. - What is the numerical equilibrium price and
quantity traded on the world market? Illustrate
with a graph of the international market.
19What Can the World Produce?
YW YA YB
Slope - (aLX/aLY)
3
(LA/aLY) (LB/bLY)
(LA/aLY)
2
(LA/aLX)
Slope - (bLX/bLY)
LB/bLY
LB/bLX
1
(LA/aLX) (LB/bLX)
0
XW XA XB