Labor Productivity and Comparative Advantage: The Ricardian Model Flashcards
Why do countries trade with each other?
- Because they are different from each other (different competences and resources)
- To capitalize on large-scale production and specialization
Opportunity costs
Reason for opportunity cost of production: not being able to produce something else with the resources used.
How much of a good you need to give up in order to produce the other one
Opportunity cost is constant because the unit labor requirements are both constant
Absolute value of the slope of the PPF
Comparative advantage
A country has a comparative advantage in producing a good if the opportunity cost of producing that good is lower in the country than in other countries.
The Concept of Comparative Advantage
When countries specialize in production in which they have a comparative advantage, more goods and services can be produced and consumed.
One-factor Ricardian model
Two countries: home and foreign.
– Labor is the only factor of production.
– Labor productivity varies across countries due to differences in technology, but labor productivity in each country is constant.
– The supply of labor in each country is constant.
– Competition allows workers to be paid a wage equal to the value of what they produce (only one factor exists in the model, labour), and allows them to work in the industry that pays the highest wage.
Unit labor requirement
Indicates the constant number of hours of labor required to produce one unit of output
Labor productivity
How much output one hour of labor creates
A high unit labor requirement means
Low labor productivity.
Labor supply
Total amount of labor resources − the number of hours worked
Production possibility frontier
Shows the maximum amount of goods that can be produced for a fixed amount of resources.
What actually is produced depends on
Prices
Production depends on
Wages earned which depend on relative prices
Relative Prices and Supply
Workers will choose to work in the industry that pays the higher wage
If the price of cheese relative to the price of wine equals the opportunity cost of producing cheese…
Wage in cheese will equal the wage in wine, so workers will be willing to make both wine and cheese
If the home country wants to consume both wine and cheese (in the absence of international trade)…
Relative prices must adjust so that wages are equal in the wine and cheese industries
Production (and consumption) of both goods occurs when…
Relative price of a good equals the opportunity cost of producing that good
Comparative advantage determines the…
Pattern of trade
