Comp Advantage (real wage increased in terms of imported good! specialise in good they have CA in increases consumption possibilities) Flashcards
Recall the ‘No trade model’ assumptions (4)
Identical tech and tastes
Same relative factor endowments
Constant RTS
No distortions
Which assumption do we relax for the Ricardian model?
Identical technology (since differences in tech drive changes in relative labour productivity)
So we assume differences in technology.
What does actually this mean?
Goods are produced with different amounts of labour
Ricardian model
5 Assumptions
Labour is the only factor
Labour productivity varies ACROSS countries, but labour productivity WITHIN the country is constant (rmb CRTS)
2 goods
Labour mobile between industries not countries
Competition allows workers to be paid a wage equal to what they produce, and allows them to work in the industry that pays the highest wage.
aLC and aLW: hours of labour to produce one unit
So high a means low productivity
L is total number of work hours available
Qc and Qw is quantity produced
What is the production possibility frontier? (PPF)
aLCQc + alwQw <=L
What is the opportunity cost of an additional cheese
aLC/aLW
Since an additional cheese requires aLC hours.
Which could’ve been used to produce 1/alw amount of wine.
How can we show the opportunity cost of cheese is the slope of the PPF (equation)
Qw = L/aLW - (aLC/aLW)Qc
What is wage expression for cheese and wine industry? (2)
Wc = Pc/aLC and Ww = Pw/aLW
Since mobile labour, they work where wages are higher.
Using this… If Pc/alc> Pw/alw , which good is produced
Cheese
Assuming convex (average>extremes) preferences,
In autarky what would consumers consume, and what happens to the market as a result?
C) What would the expression be?
Both wine and cheese
So relative prices must adjust so wages equal in both industries to ensure both goods are produced
C) Pc/Pw = aLc/aLw
(Relative price = opportunity cost)
Home country is more efficient in both wine and cheese production. What is this called?
B) hows it expressed
Absolute advantage (as lower unit labour requirements)
aLC < aLC and aLW < aLW
So a country can be more efficient in producing both goods (absolute advantage)
But, it will have a comparative advantage in ONLY ONE good unless..
Unless countries identical (aLc/aLw = aLc/aLw)
(So a country can have absolute advantage for both, but will only have comparative advantage in one)
What would PPFs look like graphically, say we assume:
aLC /aLW < aLC /aLW
Linear as CRS (no DMR since only one factor (labour)
And slope is opportunity cost. Since home has a lower opportunity cost, foreign PPF will be steeper (higher opportunity cost of cheese in terms of wine)
At autarky (no trade), will the relative price of cheese to wine be higher foreign or home?
B) Upon this, is it profitable to break autarky and sell cheese to foreign, and wine from foreign to home?
C) How do we find where relative prices settle
Foreign, as higher opportunity cost of cheese (steeper slope of alc/alw)
B) Yes, home should export cheese, and foreign should export wine
C) RICARDIAN MODEL - TRADE IS BASED OFF RELATIVE PRICES. As to where relative price settles… we need to find world relative supply
World relative supply of cheese expression
RS = Qc + Qc / Qw + Qw
(Quantity of h&f cheese / Q of h&f wine)
Pg 13:
When will:
A)no cheese be produced
B)home be indifferent to producing either, while foreign produces wine
C)Both countries specialise (whichever good they have a comparative advantage)
D)Home produces cheese, foreign is indifferent
E)No wine produced
A) Pc/Pw < aLc/aLw < a*Lc/aLw
(Since opp cost is greater than the rel price for both home and foreign)
B)
Pc/Pw = aLc/aLw < a*Lc/aLw
Home is indifferent (simple) but foreign opp cost of cheese is higher, so produce other good i.e wine
C) aLc/aLw < Pc/Pw < a*Lc/aLw
Since home has lower opp cost (produce cheese) and also lower than rel price, and foreign has higher opp cost for cheese that is above rel price so no point in producing so specialise in wine.
D) aLc/aLw < Pc/Pw = a*Lc/aLw
E) aLc/aLw < a*Lc/aLw < Pc/Pw
That shows relative supply in those scenarios.
Relative supply diagram pg 13
Y axis rel price of cheese Pc/Pw
X axis world supply Qc+Qc / Qw+Qw
Lower horizontal line marks alc/alw (home)
Top horizontal line marks alc/alw (foreign)
Vertical line is where both countries specialise entirely
What happens to relative demand of cheese if the relative price of cheese increases
demand less cheese and more wine, so relative QD of cheese falls!
What is this known as?
The substitution effect!! (Swapping wine for cheese since cheese becomes relatively more expensive in relation to wine
How to find the equilibrium relative price of cheese
b) intuition of the intersection
Where RD and RS curves intersect
B) Intersection is where both countries specialise. (Home only cheese foreign only wine)
(So relative prices determine amount produced, and relative prices are determined by RD & RS (INTERSECTION))
Scenario 2:
World relative price of cheese is equal to the opportunity cost of cheese at Home aLC /aLW, and less than opportunity cost of cheese in foreign
B0 Pg 16 graph
Pc/Pw = alc/alw < alc/alw
Ie home is indifferent in production. They don’t specialise in either. Foreign just producers wine
B) graph, relative demand line falls down to show
Pc/Pw=alc/alw line
So where do gains from trade come from?
Specialising in the good they have a comparative advantage in, and then using income generated to buy goods they desire.
In autarky no trade, what are real wages determined by?
Labour productivity
If we introduce trade what happens to real wages
Real wage is unchanged in terms of the exported goods, but rise in terms of the now cheaper imported goods.
(Makes sense since gains of trade come from the imported good being cheaper, rather than benefits from exporting)