1 Ricardian Model INTERNATIONAL ECONOMICS ECO 486

1 Ricardian Model • INTERNATIONAL ECONOMICS, ECO 486 • JDE notes to supplement the text. David Ricardo April 18, 1772 — September 11, 1823

2 Learning 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

4 Assumptions • #8 -- Factors of production cannot move between countries • #9 -- There are no barriers to trade in goods.

5 Assumptions #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

6 Assumptions • #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

7 Ricardian 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

8 Differing technologies and resource endowments Labor Country A productivity Country B Soybeans 4 (kg. /hr. ) 1 (kg. /hr. ) Textiles 2 (m. /hr. ) 1. 5 (m. /hr. ) 1000 (hr. /yr. ) 800 (hr. /yr. ) Labor endowment

9 Differing Opportunity Costs Soybeans (m. /kg. ) Textiles (kg. /m. ) Country A Country B

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

12 Autarky • 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

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

15 Absolute Advantage • Compare one good across countries. • Country with greater output per labor hour has an absolute advantage in that good.

16 Comparative Advantage • Calculate opportunity costs. • Compare one good across countries. • Country with lower opportunity cost has a comparative advantage in that good.

17 Which Advantage? • Absolute advantage is a special case. • Comparative advantage is the general case.

19 Terms of Trade • Once trade begins, an international equilibrium results • Results in one world price for a good

21 International Trade Equilibrium • Complete specialization in Comparative Advantage good • CIC & To. T tangent at consumption point • Congruent trade triangles imply balanced trade

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

24 Gains From Trade • More of both goods attainable • GDP increases at pre-trade prices • Higher CIC is attainable

The gains from trade (country A). 26

Country A’s trading equilibrium. 27

29 Exchange Rates • State exchange rate, E, in US dollars per UK pound – say $2/£ • A good will be imported if its foreign pretrade price (x E) is less than the domestic price Þ P S < E x P S*

30 Buy Low. . . • Trade requires Þ P S < E x P S* Þ PT > E x P T * * autarky prices * Home (A) has comparative advantage in S * Foreign (B) has comparative advantage in T

Perfect Competition Review 31 (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

33 Prices & 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, a. LX, or units of X per hour worked, OLX. a. LX = 1/OLX • PX = w /OLX

35 Trade & Wages (Cont. )

38 Competitive 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

39 Losing 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 ______.

Country A’s price-consumption curve. 41

Derivation of country A’s offer curve. 42

International trade equilibrium. 43

44 Cambodian 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

45 Cambodian 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

46 Cambodian 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.

TEXTILES, T (millions of yards per year) Quantity of Soybeans Demanded 10 PS/PT = 2. 5 yd. T/bu. S H Autarky General Equilibrium |slope PPF| = PS/PT = 2 yd. T/bu. S 8 G 6 L PS/PT = 1 yd. T/bu. S 4 CIC 2 CIC 1 CIC 0 2 PPF 0 47 1. 8 2 4 4. 7 6 8 10 SOYBEANS, S (millions of bushels per year)

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