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Trade and Technology: The Ricardian Model Flashcards

1
Q

What is the Ricardian Model?

A
  • Ricardian model is named after David Ricardo,

* He explained that countries can gain from free trade by exporting the goods in which they have comparative advantage

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2
Q

What are the components of the Ricardian Model environment?

A
  1. two Goods
  2. two Countries
  3. one input factor
  4. Identical preferences across countries
  5. Free trade
  6. Balanced trade
  7. Technology is different across countries
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3
Q

What are the first 3 components environment grouped together as?

A

2X2X1 Model

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4
Q

Explain the first 2 components environment?

A
  • 1- Two goods- X&Y also described as two industries e.g. wheat & cloth
    1. two Countries: Home and Foreign (F can be considered rest of the world)
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5
Q

Explain the 3rd environment component

A

•3. one input factor: labour

  • Labour is fully employed.
  • Labour is perfectly mobile across Goods (can move from X to Y Industries without training ),
  • but NOT mobile across countries (No international migration).
  • Total labour can be different across countries (This does not affect our analysis of trade pattern)
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6
Q

Explain the components 4-6 of the model

A
  1. Identical preferences across countries
    e.g. consumers in two countries are equally satisfied with 4 units of X and 5 units of Y so ICs are the same
  2. Free trade
    No tariffs or non-tariff barriers, or any transportation cost and etc.
  3. Balanced trade
    The value of exports is equal to the value of imports.
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7
Q

Explain the 7th component of the environment

A
    1. Technology is different across countries
  • most important in Ricardian-driving force for international trade
  • Tech indicates productivity of labour e.g. output per worker (due to labour being only input factor)
  • Output per worker is constant so equal to the marginal product of labour
  • Tech also different across industries= 4 technologies(2 industries, 2 countries)
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8
Q

What is an absolute advantage and example?

A

When a country has the best technology for producing a good e.g. Netherlands and Germany known for high quality manufactured goods

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9
Q

What is absolute advantage (AA) determined by in the Ricardian Model?

A

• Technology-Output per worker (larger=AA) when comparing country to country in an industry NOT industry-industry of one country
e.g. 4 > 1, Country H has AA in X;
2 < 3, Country F has AA in Y

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10
Q

How is the trade pattern determined by AA?

A
  • Trade pattern can be determined when one country has AA in one product and the other country has AA in the other product
  • every country exports the product it has AA in
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11
Q

What is the issue with determining the pattern of trade using AA?

A
  • When one country has AA in both industries AA is NOT useful to determine the pattern of trade
  • so Comparative Advantage is used
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12
Q

What is Comparative Advantage (CA)?

A

A country has a CA in producing those goods that it produces best compared with how well it produces other goods e.g. relatively more difficult to produce wine than cloth in England so would have a CA in producing cloth compared to Portugal having a CA in wine

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13
Q

What is the production possibility frontier(PPF)?

A

Various combinations of goods that are produced with all resources and efficient technology

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14
Q

Explain the PPF?

A
  • Increasing the production of one industry must decrease the production in another industry
  • Output per worker is constant so PPF is linear
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15
Q

What is opportunity cost?

A
  • OC of X is the units of Y forgone to produce one unit of X

* Absolute Value of Slope of PPF as OC of X (horizontal axis).

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16
Q

What is the calculation for the OC of X and vice versa for Y

A

output per worker for Y/output per worker for X

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17
Q

How is the comparative advantage decided?

A

• By comparing the OCs between countries in one industry with the lower OC signalling CA
e.g
Country H has lower OC in X so has CA
Country F has lower OC in Y so has CA

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18
Q

What is autarky equlibrium?

A

Where the PPF for the country is at tangency with a IC where there is no trade.

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19
Q

What is the PPF in autarky?

A
  • It acts as the income budget of the country, all combinations beyond PPF are not affordable
  • Only points on the PPF are efficient production
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20
Q

What is an indifference curve?

A
  • Various combinations of goods that are indifferent to consumers. Higher IC= higher utility and welfare.
  • Downward sloping because of marginal rates of substitution
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21
Q

Explain the autarky equilibrium point

A
  • PPF and IC at tangency

* The point is where the country produces and consumes, i.e. Production point=Consumption point internally with no trade

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22
Q

What is the relative price?

A

The amount of one good that has to be given up to obtain another good. e.g. relative price of wheat=1/2 so extra 1 wheat means 1/2 yard cloth has to be given up

23
Q

At the equilibrium, what is the relative price of X (horizontal axis) equal to? and why

A

The absolute value of the slope of PPF
• Wages are equal in two industries, i.e. X and Y
• In Ricardian model, firms are under perfect competition

24
Q

Explain relative prices in autarky in terms of equal wages

A

• Wages are equal in two industries, i.e. X and Y. The reason is:
• labour is mobile across industries. If X industry has higher wage than Y industry, labour moves to the industry X (moves out of industry Y), increasing
labour supply of industry X (decreasing labour supply of Y).
• the wage in industry X decreases (wage in industry Y increases).
• In the end, wages are equal between two industries and labour stop moving between industries

25
Explain relative prices in autarky in terms of perfect competition? and equation (see derivation on learn for full understanding)
the price of X (Y) is equal to the marginal cost of X (Y) | PX/PY= output per worker for Y/output per worker for X = |slope|
26
If the relative price of X in H is 1/2 and 1 in F, what happens when the two countries open to trade and equation?
(PX/PY)H < (PX/PY)F This suggests that X is relatively expensive in Country F than in Country H. Therefore, Country H can sell (export) X to Country F
27
How is the trade pattern determined?
(1) We expect that country exports the product it has CA. (2) The country imports the product it has comparative disadvantage in. (3) CA determines trade pattern!!!! If one country has AA in both goods, it is CA that determines the trade pattern. (4) Mechanism? form OC to relative prices CA determining the trade pattern can be understood by looking at the (relative) prices of products
28
What is world price determined by?
Determined by the world market demand and | supply
29
What is world price?
Is the price of a good in which home and foreign countries will choose to buy or sell products
30
What does the world price need to be for free trade equilibrium?
* Needs to be between autarky relative prices in order for e.g. H to want to sell and F to want to buy * Lower than autarky prices will mean H&;F would both want to import as cheap prices so no trade * Higher than autarky prices= both H&F would want to export as the price for their products is high
31
What the equation for what world price should be if exogenously given?
(Px/Py)h < (Px/Py)w < (Px/Py)f
32
What is specialisation?
In free trade, a country that only produces a certain product e.g. Country H specializes in X
33
Explain specialisation
* In free-trade- country exports a certain product so has to produce more of it * so product point moves (specialises) along PPF until it reaches a point where it only produces one product * move from autarky equilibrium (A) to complete specialisation (B)
34
What is consumption in free trade equilibrium?
How much of each product is consumed by each country at the point on on a new PPF (world price line) and new IC
35
Explain consumption
* Because of the opportunity to trade, the budget (PPF) is now relaxed * new budget in free trade is the world price line * This crosses the specialization point with the slope: the absolute value of the slope is the world price. * Tangent point between world price line and IC is the consumption point in free trade
36
Explain the world price line
* New PPF in trade | * Gradient is between the gradient of H and F PPFs reflecting world price being between autarky prices
37
Where is the free trade equilibrium?
* The tangent point between new budget (world price line) and IC * tangent point is the consumption point in free trade
38
Explain the trade triangles in trade equilibrium
* Country H’s export of X is equal to country F’s import of X * ) Country F’s export of Y is equal to country H’s import of Y * Two trade triangles should be the same * ∆BCD = ∆C∗B∗D
39
what are the different elements/ combinations of the trade triangle
* Country H consumes less X than it produces. The export of X is denoted as BD. * Country F consumes more X than it produces. The import of X is denoted as C∗D∗ * BD = C∗D∗ * Country F consumes less Y than it produces. The export of Y is denoted as B∗D∗ * I Country H consumes more Y than it produces. The import of Y is denoted as CD. * CD = B∗D∗
40
What are the trade gains from free trade?
* Both countries are better off because both countries have arrived at higher ICs so greater utility/welfare * This consumption point is not attainable in autarky * In free trade, both countries have larger (at least equal) real wages in a given industry
41
What are the basic steps to work out free trade equilibrium?
1. Work out autarky equilibrium 2. CA=OC=slope=relative price 3. Specialisation & complete specialisation 4. World (relative) price 5. Work out exports and imports -> trade triangle 6. Trade gains-both countries should be better off
42
What is an argument of wages across countries?
* Argument that high wage countries cannot trade with low wage countries but.. * Ricardian model shows high wage countries can compete with low wage countries
43
What is the equation for the wage in autarky?
w(AUT) = PX × output per worker for X = PY × output per worker for Y • Equation rearranged from equation of Px • Marginal costs=marginal revenue in perfect competition
44
What is the real wage? and equation in autarky?
• nominal wage divided by price, i.e. the purchasing power of nominal wage. •Aut^(w/PX)H = output per worker for X = 4 note: swap X for Y or H for F depending on industry and country
45
What is the relationship between AA and real wage in autarky and free trade?
the country with AA in a product will have a larger real wage e.g Aut^(w/PX)H >Aut^(w/PX)F • AA determines real wage because workers are more efficient • In free trade, the country with AA will still have larger real wages than the other country DRAW EQUATIONS ON REVISION CARDS
46
Explain the real wages in free trade and equations
• The real wages for the industry that the country specialises in will be the same as in autarky • Real wages for the industry that a country imports should be related to the world relative price • FT^(w/PY)H =(PX × output per worker for X)/PY =output per worker for X ×(PX/PY)W
47
What are the trade gains from free trade in terms of real wages?
• In free trade, both countries have larger (at least equal) real wages in a given industry • Same for countries you export but more in inustries you import • Higher in import industries than in autarky because you pay cheaper foreign prices so purchasing power increases e.g. •AUT^(w/PX)H =FT^(w/PX)H • AUT^(w/PY)H < FT^(w/PY)H
48
Why are empirical tests difficult for Ricardian model?
* The model is just too simple: 2 x2 x1; 2 goods, 2 countries, 1 factor-not realistic in real world * Specialization-doesn’t appear to be true in the data-most countries produce a bit of everything
49
What did the early empirical tests focus on in Ricardian?
* Model suggest high productive goods tend to have higher net exports. * Early studies test the relationship between labour productivity and net exports
50
What is the first empirical test of the Ricardian model?
MacDougall in 1951 Looked at labour productivity and export data for US and UK (MAY NEED TO ADD)
51
What did Macdougall's focus on? and why?
•looked at the exports from UK/US to the rest of the world instaed of bilateral trade •Tariffs between US and UK varied widely but Tariffs set by the world to US and UK are similar so impact of tariffs could be discounted
52
What did Macdougalls's findings show?
In industries US (UK) had comparative advantage, US sold more than UK into the world. True in 20 industries out of 25!
53
In the industries that the US had CA why did it not capture the whole export market?
* due to product differentiation: In the same industry, two countries produce different products: * e.g. a US car is not identical to a UK car. * Even if US car is cheaper, some consumers in the world market may still prefer the British car.
54
What is a real-life example of real wages increasing with international trade
China and India wages and standard of living have increased

International economics (7 decks)

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