04.05.2023 Ricardo Model#

Continuation from Last Week

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Gains of Trade Example#

trough specialization

  • higher wages (at least one side)

  • higher income (for other goods)

without Trade#

Unit labor requirements

Cheese

Wine

Home

1 hour / lb

2 hours / gallon

Foreign

6 hours / lb

3 hours / gallon

Results without Trade (L=3000)

Cheese

Wine

Home

1500

750

Foreign

250

500

Opportunity Costs#

  • Home: \(\frac{a_{LC}}{a_{LW}} = \frac{1}{2}\) (one cheese = one half gallon of wine)

  • Foreign: \(\frac{a_{LC}^*}{a_{LW}^*} = 2\)

Comparative Advantage

  • Home: \(\frac{a_{LC}}{a_{LW}} < \frac{a_{LC}^*}{a_{LW}^*}\) => cheese advantage

  • Foreign: \(\frac{3}{6} = \frac{a_{LC}^*}{a_{LW}^*} < \frac{a_{LC}}{a_{LW}} = 2\) => wine advantage

Opportunity Costs

Cheese

Wine

Home

1/2

2

Foreign

6/3 = 2

3/6 = 1/2

Trade#

Prices

  • somewhere in between for both goods

  • maybe \(\frac{P_C}{P_W}= 1\), so one cheese for one wine

Result

  • Home Price of Cheese rises

    • before: 2 cheese for 1 wine

    • after: 1 cheese for 1 wine

Absolute Result (L = 3000)

  • Production Home: 3000 cheese

    • Trade as much as possible for wine

  • Production foreign: 1000 wine

    • trades half of it for cheese

Results after Trade

Cheese

Wine

Home

2500

500

Foreign

500

500

Wages#

with \(P_C = 12\$, P_W = 12\$\)

  • home wages: \(\frac{P_C}{a_{LC}}=\frac{12}{1}=12\$ / hour \)

  • foreign wages: \(\frac{P_W}{a_{LW}}=\frac{12}{3}=4\$/ hour\)

  • relative Wage home workers: \(\frac{12}{4}= 3\)

both countries have cost advantage in Production:

  • home: high productivity + high wages

  • foreign: low prod. + low wages

=> rich countries can attain advantage in international trade

Many Goods#

  • w = wage reat home country

  • \(a_{Li}\) = labor req. for good i

  • relative home prod.´: \(\frac{a_{Li}}{a_{Li}^*}\)

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Assumption: \(\frac{w}{w^*}= 3\)

  • Apples, Bananas, Caviar = Home Production

  • Dates, Enchiladas = Foreign Production

relative Wage Determination#

relative Supply of and derived demand for labor

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Intersection of RD and RS

Problems with Trade#

Reality: Wage and Productivity#

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Wages and Productivity do not go Hand in Hand (Thanks Reagan)

Workers in Rich Countries#

  • Trade reduces wages for some workers in rich home countries

  • affects distribution of income

  • consumers benefit

Ricardion Model Shortcomings#

  • More than one Factor (Capital)

  • protectionism

  • Transportation Costs reduce trade