The model of Ricardo Sources: Mucchielli Mayer; Feenstra Taylor.
Eleni ILIOPULOS Paris 1
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Aim of this lecture:
Understand the reasons why countries trade Distinguish between absolute and comparative advantage Understand the Ricardian model Understand the no-trade equilibrium using each country’s PPF and Indi¤erence Curve References: Mucchielli Mayer (2005); Feenstra Taylor (2008).
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Absolute advantage
Table 1: absolute advantage. monthly output per worker. * shirts cars
China 200 5
EU 50 10
Gains from specialization: China: shirts. It will produce 200 shirts more ! world output: + 150 shirts EU: cars. It will produce 10 cars more ! world output: + 5 cars
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Comparative advantage Table 2: comparative advantage. monthly output per worker. * shirts cars
China 400 20
EU 50 10
No absolute advantage. What if countries do get specialized in the same way as before? (Smith would point out an ambiguity) China: shirts. It will produce 400 shirts more ! world output: + 350 shirts EU: cars. It will produce 10 cars more ! world output:
10 cars
Are there gains from trade in this case?
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Comparative advantage Let’s go deeper into comparative advantage. What about opportunity costs? Oportunity cost of shirts: (i.e. how many cars you have to give up to produce 1 shirt) China: 20/400=1/20 Europe: 10/50=1/5 Analogously, opportunity cost of cars: (i.e. how many shirts you have to give up to produce 1 car) China: 400/20=20 Europe: 50/10=5
! It is convenient for China to give up car production and specialize in shirts. It is convenient for EU to give up shirt production and specialize in cars. E. ILIOPULOS (Paris 1)
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Reasons to trade: absolute vs comparative advantage
Absolute advantage: When a country has the best technology for producing a good, it has an absolute advantage in the production of that good. Absolute advantage is actually not a necessarily good explanation for trade patterns. Comparative advantage Comparative advantage is the primary explanation for trade among countries. A country has a comparative advantage in producing those goods that it produces best compared with how well it produces other goods.
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The Ricardian model: assumptions on PPF 1
Two countries: H, F
2
Two goods: X,Y
3
One only factor: labor
4
Two di¤erent technologies in H and F: the amount of good X and Y you can produce in each country is di¤erent.
5
No relative di¤erences in factor endowments: there exists one factor only.
6
CRS technology
7
No trade barriers nor other kind of distortions
8
Identical and homogeneous preferences
9
Labor is perfectly mobile within one country but does not cross borders (no migration)
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Production
Technology. proxy: technical coe¢ cient aL,x , aL,y ' labor quantity you need to produce one unit of X or Y One production factor only + CRS ! aL,x , aL,y constant.
1 1 ! aL,x , aL,y Marginal Productivity of Labor, MPL, (to produce good X and Y respectively) is constant. ∂Y ∂X MPLy = ∂L ;MPLx = ∂L . y x
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Production
Production functions: good X : good Y :
1 a L,x Lx 1 a L,y Ly
full employment: L¯ = Lx + Ly = aL,x X + aL,y Y X Y = + MPL,x MPL,y
(1)
perfect mobility ! one unique wage
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PPF in autharky Given all assumptions, PPF is linear: a L,x L¯ ¯ from (1),Y = aL,y a L,y X = (L) (MPL,y )
Slope PPF: MRT E. ILIOPULOS (Paris 1)
∂Y ∂X
=
a L,x a L,y
=
MPL ,y MPL ,x
X
MPL ,y MPL ,x
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PPF in autharky
Slope PPF: MRT
∂Y ∂X
=
a L,x a L,y
=
MPL ,y MPL ,x
∂X We know that w = px ∂L = px MPLx . Since labor is mobile across x ∂Y ∂X sectors: w = px ∂Lx = py ∂Ly
Thus:
px py
=
∂Y ∂L y
∂X / ∂L = x
MPL y MPL x
=
a L,x a L,y
= pha = MRT
! the slope of PPF re‡ects the comparative advantage of a country in autharky (the comparative advantage) ! the distance of PPF from the origin re‡ects the absolute advantage.
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Autharky in a two country world: H, F
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International trade
If p 6= p a , what happens to consumption and production? (1) How are prices determined in equilibrium? (2) What about wages? Are them equalized? (3)
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Autharky price vs int. trade price (1)
Let p ". Thus p x1 p y1
>
a L,x a L,y
!
p x1 a L,x
p x1 p y1
> p a = MRT
>
∂Y ∂X
=
p y1
a L,x a L,y
!
a L,y ∂X px ∂Lx =
1 1 ∂Y px aL,x = py aL,y . And wy = py ∂L ! y ¯ and Y=0. And consumption? wx > wy !! What happens? X=X
However, wx =
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Country H
careful with notation in graph: pa = MRT !! E. ILIOPULOS (Paris 1)
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Country H and country F
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Utility increases in both countries The pattern of trade is given by comparative advantage There is one only equilibrium price..which one?
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Equilibrium (2) Solving for international prices: the domestic export supply curve
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Solving for international prices: the foreign import demand curve
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Equilibrium with international trade
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Price determination in equilibrium: relative prices and quantities with complete specialization
careful with notation in graph: pa = MRT !
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Equilibrium
Why are relative demand curves identical? Same preferences, same demand What is the shape of the supply, in equilibrium? Complete specialization: pha < p < pfa What if a country is too small ( L is small) to supply goods for the whole world? Incomplete specialization. What happens to the price in this case? P ! to the autharky price of the large country. What if the domestic country is large?
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Incomplete specialization
L1h > Lh , the domestic country is large. F is small. H is incompletely specialized
= pha consumers in country H have no gains from trade. All gains go to consumers of country F. p
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World production
Ricardian equilibrium: R if both countries are completely specialized.
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Wages (3)
Does comparative advantage depend on wages di¤erential between countries? There is not an unique wage. Comparative advantage ! relative productivity!patterns of trade. Absolute advantage ! wages.
Productivity di¤erentials are at the roots of wage di¤erentials. Why?
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Productivity di¤erentials and wages h ; p h = w ah ! pxh = wh aLx h Ly y
wh p xh
=
1 h a Lx
;
wh p yh
=
1 h a Ly
With complete specialization(suppose H specializes in X, F in Y): pha < p < pfa . Substituting: h a Lx h a Ly
