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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
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Assumptions
• #8 -- Factors of production cannot move
between countries
• #9 -- There are no barriers to trade in goods.
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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
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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
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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
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Differing technologies and resource
endowments
Labor
productivity
Country A
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
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Differing Opportunity Costs
Opportunity
Costs
Soybeans
(m./kg.)
Textiles
(kg./m.)
Country A
Country B
Production possibility frontiers: (a) 11
country A; (b) country B.
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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.
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Absolute Advantage
• Compare one good across countries.
• Country with greater output per labor hour
has an absolute advantage in that good.
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Comparative Advantage
• Calculate opportunity costs.
• Compare one good across countries.
• Country with lower opportunity cost has a
comparative advantage in that good.
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Which Advantage?
• Absolute advantage is a special case.
• Comparative advantage is the general case.
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Terms of Trade
• Once trade begins, an international
equilibrium results
• Results in one world price for a good
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International Trade Equilibrium
• Complete specialization in Comparative
Advantage good
• CIC & ToT tangent at consumption point
• Congruent trade triangles imply balanced
trade
Posttrade equilibriums: (a) country A;
(b) country B.
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Gains From Trade
• More of both goods attainable
• GDP increases at pre-trade prices
• Higher CIC is attainable
The gains from trade (country A).
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Country A’s trading equilibrium.
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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
PS < E x PS*
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Buy 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
Perfect Competition Review
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(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
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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,
aLX, or units of X per hour worked, OLX.
aLX = 1/OLX
• PX = w /OLX
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Trade & Wages (Cont.)
W
O LS

E  W * O*LS
W
O LT

*
*
E W
O LT
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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
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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.
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Derivation of country A’s offer curve.
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International trade equilibrium.
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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
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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
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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
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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
CIC2
CIC1
CIC0
2
PPF
0
1.8
2
4
4.7
6
8
10
SOYBEANS, S (millions of bushels per year)
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Tony Auth, NY Times editorial cartoon, December 2, 1999