Topic 2: The Ricardian Model Flashcards
What does Ax & Ay mean in the Ricardian model?
The amount of labour required to produce good X, and good Y respectively.
Show how in the Ricardian model, the zero-profit condition leads to the determination of price in autarky.
ACX = AXw
For zero profits,
pXqX - TCX = 0
pX - ACX = 0
pX = ACX = AXw
pX= AXw
(when good X is being produced, when it is not PX < AXw)
Show how relative prices are related to production costs in the Ricardian model under autarky.
pX/pY = aXw/aYw
pX/pY = aX/aY
When PX/PY < AX/AY, what will the relative production of the two goods be?
There will be no production of good X, and full capacity production of good Y.
Show the supply curve for cotton (with the other good being rice) for one country.
This follows, as when the price is under pC/pR, no cotton will be produced.
In addition, after all labour is devoted to cotton, no more can be supplied, no matter how high the price.
Calculate the relative prices in Autarky from the following table of labour requirements.
Where are the comparative advantages for these countries?
AU: PC/PR = 50/100 = 1/2
CHN: PC/PR = 25/25 = 1
Australia has a comparative advantage in coal. (It costs 1/2 a unit of rice, compared to China’s 1 unit relative cost.)
China has a comparative advantage in rice (It costs 1 unit of coal, compared to Australia’s two unit relative cost.)
Draw a diagram showing the world supply of coal, in a Ricardian model where:
- Australia has the comparative advantage in coal, and can produce 2 units at full production, and has an opportunity cost of 1/2 units of rice.
- China can produce 4 units of coal max, and has an opportunity cost of 1 unit of rice.
Outline the situation in this trade equilibrium.
- The world price is between the two countries autarky prices.
- Both countries produce only the goods they specialize in.
- Both countries import some amount of the good they do not specialize in.
- Both countries gain from trade.
Outline the situation in this trading equilibrium.
- The world price is at china’s autarky price.
- Both China produces both goods.
- Australia only produces coal.
- Australia is better of relatively than when the world price was between the two countries Autarky levels.
- China has not gained by trade in this case. But it ain’t worse off.
How are relative wages between countries determined in the Ricardian model, when both countries specialize?
Consider Australia and China, who specialize in coal and rice respectively.
P*C = WAUAC
WAU = P*C /AC
WCH = P*R /AR
so:
WAU/ WCH = P*CAR / P*RAC
How can relative wages be calculated in the Ricardian model with a no specialization trade equilibrium?
Consider Australia and China, who have a comparative advantage in coal and rice respectively.
Lets say both countries are producing coal.
p*C = ACAU WAU= ACCH WCH
WAU/WCH = ACCH/ACAU
How can real wages be caculated?
Divide it by one of the two goods.
WAU/P*C = P*C / ACP*C = 1 / AC
Real wage in terms of coal is just productivity of a worker.
In terms of the other good.
WAU/P*R = 1/AC X P*C/P*R
Can real wages ever fall when a country opens to trade in the Ricardian model?
Nope.
Why do we only care about comparative advantage, not absolute advantage - why would we import from a country that is bad at making things?
Use the following table of labour requirements as an example.
Because the crappier countries will have lower wages. The workers might as well do something, so you have them doing the thing they are comparatively better at.
China is better at everything here, but lets consider what would happen if it specialized, and produced only rice (it’s comparative advantage).
From zero profits, P*R = ARCHWCH
China is better off with a low import price P*C, < ACCHWCH (China’s Aut. Coal Price).
ACAUWAU < ACCHWCH
WAU/WCH < ACCH/ACAU
As r.h.s. is less then one (China has absolute advantage), it follows that wages in Australia must be lower, for China to gain from trade.
What are some issues with the Ricardian model?
- Homogeneous labour.
- No industry size effect.
- Only one input.
- No trade costs.
