Ricardian model of trade Flashcards
Why do countries trade?
- Comparative advantage
2. Economies of scale
Why are differences in opportunity costs significant?
It creates a possibility of comparative advantage.
What is the theory of the Ricardian model?
- Countries differ in terms of technology (labour productivity).
- Countries have mutual benefits from trading (gains from trade)
- Countries can achieve those gains by specialising in the production of the good in which they have comparative advantage in.
What are the assumptions of the Ricardian model?
- There are 2 goods
- There are 2 countries
- Perfect competition in goods and labour market
- Full factor mobility
- Only input is labour
- Constant returns to scale
- Technology is described in unit labour requirements that is inverse of labour productivity
What is production possibility frontier?
It is the maximum amount of goods that can be produced in an economy given it’s limited resources.
What is an opportunity cost?
It is an amount of a good that could have been produced instead of producing one additional unit of another good.
What is absolute advantage?
It is an advantage that a country has due to the smaller unit labour requirement it has in a particular good.
What is comparative advantage?
Comparative advantage is an advantage that a country has if it has a lower opportunity cost in a production of a good than another country.
What does absolute advantage depend on?
Unit labour requirements or aL.
What does comparative advantage depends on?
Opportunity costs or aL/ aW.
What happens if 1 country is specialised and the other one is not?
Only the specialised country gains from trade.
What are gains from trade?
Expanded consumption possibilities (production possibilities are not affected).
What explains production of one good in a country even if it does not have comparative advantage?
Differences in wages, especially how wages are low enough to compensate for the productivity disadvantage.
What is the difference between competitive and comparative advantages?
Competitive advantage is due to differences in price, comparative advantage is due to the differences in opportunity costs.
What is the only chnaged assumption between the Riicardian model and the Ricardian model with many goods?
Ricardian model with many goods assumes that there are more than 2 goods in the economy, namely from 1 to N.
