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Macalester College Introduction to International Economics Spring 2006

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Two countries (A and B) use a single input (labor) to produce two commodities (X ... is the number of units of good Y forgone to produce an additional unit of good X. ... – PowerPoint PPT presentation

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Title: Macalester College Introduction to International Economics Spring 2006


1
Macalester CollegeIntroduction to International
EconomicsSpring 2006
  • THE RICARDIAN MODEL

2
Example 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
3
Example 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
4
Example 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
5
Assumptions 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

6
Ricardian 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.

7
Definitions
  • 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.

8
Example 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
9
General Case What Can Country A Produce?
YA
Slope -(aLX/aLY MRTA )
/a
L
A
III
LY
II
I
XA
/a
L
A
0
LX
10
Country A in Autarky
YA
Slope MRTA
Slope MRSA
LA/aLY
A

YA
LA/aLX
0
XA
XA
11
Comparative 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).
12
International 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.

13
Country A under Free Trade
YA
Slope - (aLX/aLY) MRTA - (PX/PY)A
LA/aLY
XA
A
0
LA/aLX
14
Wages 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
15
Gains from Exchange and Specialization
YA
LA/aLY
A
AP
LA/aLX
0
XA
16
Relative Labor Productivity and Export
Performance
17
Demand 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.

18
Solving 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.

19
What 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
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