Ricardian Model Flashcards
What is the simplest form of the Ricardo model?
CE model with two countries (R and F), two output goods (x and y), and one input (L) supplied inelastically
How can comparative advantage be represented graphically for two countries with constant returns to labour in both goods?
Under autarky each country can only produce on their own PPF but with trade the total PPF allows for optimal production with more of both goods at its kinks which is a Pareto-improvement
Domestic PPFs will be lower than the trade line starting from the good in which the country has a comparative advantage with slope -px/py
How is production organised when trade is possible?
Comparative advantage means each country should produce only the good in which they have a lower opportunity cost (the good in which they have a comparative advantage) and then they can trade it
It is not possible for a country to have a comparative advantage in both goods so trade will always be beneficial unless the countries are identical
How can comparative advantage be explained in terms of production technologies?
Trade effectively adds a production technology (transforming domestic good into imported good through trade so there are more production possibilities)
How can comparative advantage be explained in terms of exchange rates?
Trade is beneficial when the return to labour in some good is lower than the exchange rate in terms of that good as the producer can trade more of the other good for that good than they could produce
What would happen in CE under autarky?
The optimal iso-profit line would coincide with the constant returns PPF so profit = 0 and consumption will be at the point where the IC is tangent to the PPF which coincides with the PPF
What would happen in CE if trade were possible but not migration?
The price of each good must be the same between countries otherwise no producer would sell in the lower-priced market, but wage may differ
In equilibrium the price ratio must be between |MRT| in each country otherwise there would be no production of one good which is incompatible with equilibrium
Each country will only produce the good in which they have a comparative advantage and wages will adjust to make profit zero and prices adjust so the aggregate bundle is shared in such a way that all consumers have same |MRS| = price ratio
If one country has an absolute advantage in both goods, they will have a higher eqm wage
What are some limitations of the Ricardian model?
Cannot analyse changes in income distribution between owners of different factors (Heckscher-Ohlin model suggests sometimes workers worse off under trade compared to autarky while capitalists better off) but could be argued that SWT suggests free trade should still be used
Doesn’t take account of dynamic effects (predictable or unpredictable changing relative prices) but this should be taken care of entrepreneurs provided they have access to working capital markets
