3. Ricardo

Question 1

List the assumptions of the Ricardian Model

Answer 1

1. There is a single factor of production, labor, which is intersectorally mobile (that is all workers are equally good at producing either wine or cheese); the total labor endowment is fixed.
2. There are two goods (wine and cheese).
3. There is perfect competition (meaning everyone in the economy is a price taker).
4. There are constant returns to scale (meaning if inputs are increased by a certain % then outputs will increase by that same %; implies a positive, linear relationship between input and output).

Question 2

Define the Doctrine of Comparative Advantage.

Answer 2

In free trade, a country always exports the good in which it has a comparative advantage.

Question 3

Write the equation for Constant Returns to Scale

Answer 3

Alw * Qw = Lw Alc * Qc = Lc

Question 4

Write out the equation for the opportunity cost of cheese in terms of wine.

Answer 4

Alc / Alw

Question 5

Write out the equation for finding the relative price of cheese in terms of wine.

Answer 5

Pc / Pw

Question 6

When would producing more cheese be profitable? (algebraically)

Answer 6

It is profitable if Pc/Pw is greater than Alc/ Alw.

Question 7

When a firm decides to produces more cheese, what is the equation for finding the lost to sales of wine?

Answer 7

Pw * Alc / Alw

Question 8

Firms specialize in cheese production if:

Answer 8

Pc/Pw > Alc/Alw

Question 9

Fims specialize in wine production if:

Answer 9

Pc/Pw < Alc / Alw

Question 10

Firms are willing to produce either cheese or wine if:

Answer 10

Pc/Pw = Alc / Alw

Question 11

What is the equation for the Economy-wide resource constraint?

Answer 11

L = Lw + Lc L = Alw(Qw) + Alc(Qc)

Question 12

What does the PPF tell us?

Answer 12

The PPF tells us all the combinations of Qc and Qw that the economy is capable of producing.

Question 13

What is the absolute value of slope of the PPF?

Answer 13

The Absolute value of slope of the PPF is the cost of cheese (x axis) in terms of wine (y axis).

Question 14

What is the equation for the Production Possibilities Frontier?

Answer 14

Qw = (L/Alw) - (Alc/Alw) * Qc

Question 15

Home has an absolute advantage in cheese if:

Answer 15

Alc < Alc*

Question 16

Home has an absolute advantage in wine if:

Answer 16

Alw < Alw*

Question 17

Home has a comparative advantage in cheese if:

Answer 17

Alc/Alw < Alc*/Alw*

The steeper the slope of your PPF, the steeper you opportunity cost. If the Home country has a comparative advantage in cheese, then it has a flatter PPF.

Question 18

How do we know that the free trade relative price lies in between the two opportunity costs?

Answer 18

• If Pc/Pw < Alc/Alw < Alc*/ Alw* then both countries would be specialized in wine (i.e., a world without cheese)
• If Alc/ Alw < Alc* / Alw* < Pc/Pw, then both countries would specialize in cheese (i.e., a world without wine).
• If consumers demand both goods, then prices would adjust until each good is produced somewhere.

Question 20

How do you determine the free trade equilibrium relative price of cheese?

Answer 20

The free trade equilibrium relative price of cheese is determined by world supply and demand for cheese relative to wine.

Question 21

What are the quations for World Relative Supply and World Relative Demand?

Answer 21

• World Relative Supply = (Qc + Qc*)/ (Qw + Qw*)
• World Relative Demand = (Dc + Dc*)/ (Dw + Dw*)

Question 22

Draw and lable the World Relative Supply and Demand Curves

Answer 22

Question 23

Do countries gain from trade?

Answer 23

• Free trade expands consumption possibilities.
• Free trade increases real wages.

Question 24

What are three equations for calculating GDP?

Answer 24

1. GDP = wL (national income)
2. GDP = PcQc + PwQw (value of final output)
3. GDP = PcDc + PwDw (national expenditure)
4. PcQc + PwQw = wL = PcDc + PwDw

Question 25

Write the equation for finding real wage in terms of wine.

Answer 25

w/Pw

Question 26

Write the equation for finding real wage in terms of cheese.

Answer 26

w / Pc

Question 27

In autarky, how can price be calcuated?

Answer 27

w(Alw) = Pw

Question 29

Draw and label the CONSUMPTIONS Possibilities frontier

Answer 29

Question 30

When wine is on the y axis and cheese is on the x axis, what is the slope of the consumption possibilities frontier?

Answer 30

the slope is equal to -(Pc/Pw)

Question 31

Define a country’s terms of trade.

Answer 31

A country’s terms of trade is defined as the relative price of its exports in terms of its imports. (e.g. if the home country exports cheese, then its terms of trade is Pc/Pw.).

Question 32

An increase in a country’s terms of trade ___________ (increases or decreases) its consumption possibilities.

Question 33

When will Home export good x in terms of w?

Answer 33

Home exports any good X if:

• (w)Alx < W*(Alx)*
• (w/w*) < (Alx*)/Alx)
• That is,

Question 34

How is a country’s terms of trade affected by a shift in world demand in favor of a country’s export good (cheese)?

Answer 34

Causes an increase in your terms of trade as the relative price of cheese increases. ANd will decrease the terms of trade of the country that exports wine.

Question 35

How is a country’s terms of trade affected by an increase in a country’s labor endowment?

Answer 35

If L increases, then the vertical part of the RS curve will shift right and the terms of trade will go down as production increases because the relative price will go down. Home real wages will go down because the price of the export good goes down as production increases.

Question 36

How is a country’s terms of trade affected by an improvement in foreign technology?

Answer 36

The improvement in technology for the foreign country will mean that it will take fewer workers to produce the export good (wine). This means that the virticle part of the RS curve will shift to the left.

Question 37

How do you find the comparative advantage if there are more than two goods?

Answer 37

Home exports any good X if w(Alx) < w*(Alx*) or (w/w*) < (Alx*/Alx). If the home wage relative to the foreign wage is less than the home productivity relative to the foreign productivity in good X. If home country’s productivity is greater than foreign in good X, then home has the comparative advantage of that good.