Chapter 3: Ricardian Model
Labor Requirement
- # hours to produce 1 unit of a good - inverse of productivity - higher labor requirement = less productivity
Relative Productivity
- #A/#B per hour (better formula) - OR # hours to make A/ # hours to make B per 1 good - inverse of labor requirement - Opportunity Cost (Opp cost of 1 A = #b/#a)
Relative Price
- Good price of A in terms of B (Pa/Pb) OR price of B in terms of A (Pb/Pa) 1. If (Pa/Pb) < (#A1/#B1) < (#A2/#B2), no supply of A b/c relative price A is less than OC of A for both countries, 1 and 2 specialize in B 2. If (Pa/Pb) = (#A1/#B1) < (#A2/#B2), 1 doesn't specialize and is indifferent, 2 specializes in B b/c OC of A in terms of B > relative price of A 3. If (#A1/#B1) < (Pa/Pb) < (#A2/#B2), 1 specializes in A b/c OC of A in terms of B is < relative price of A, 2 specializes in B b/c OC of A in terms of B > relative price of A
Relative Demand
- amount of A consumers willing/able to buy/amount of B consumers willing/able to buy for given price - decreasing function - RD(good A) =[Qad1 + Qad2]/[Qbd1 + Qbd2] - function of Pa/Pb
Relative Supply
- amount of A producers willing/able to produce / amount of B producers willing/able to produce at given price - RS (good A) = [Qas1 + Qas2] / [Qbs1 + Qbs2 OR [L1/#A1] / [L2/#B2]
Absolute Advantage
- country produces MOST of a good
Consumption Function
- function showing consumption of 2 goods within a country, represents budget line and expected utility - w/o trade = PPF - w/ trade generally > PPF - if specializing in A, additional B gained and additional A kept if trading
Indirect Production
- idea that when trading, country can "produce" good for which they receive - Import Q > Q produced w/o trade if Pa/Pb > #A1/#B1 - can get more B than would have produced w/o specialization - import good B b/c price of B in terms of A < cost of B in terms of A
Terms of Trade
- ratio of index of all country's export prices to index of all import prices - Pexp/Pimp - shows range in which countries will trade/specialize or are indifferent
Indifference Curve
- set of combinations leaving consumers equally well off - downward sloping b/c decreasing marginal utility of good - each prefers more of both than less - each gets flatter as it moves closer to horizon line (X line) - draw tangent to PPF and CF at same point... reveals how utility may be increased - tangent to PPF = equilibrium
Wage Rate
- wages of workers in per hour (can also do per good with a different formula) = Price Good A/ Number of Hours to make Good A - When Pa/#a = Pb/#b, workers indifferent b/c wage is same and work in either a or b - When Pa/#a > Pb/#b, workers specialize in A b/c relative wages higher in a - When Pa/#a < Pb/#b, workers specialize in B b/c relative wages higher in b
Comparative Advantage
- when country can produce good in RELATIVELY more efficiency than another country - CA when country's OC of a good is greater than the OC of another country
Ricardian Model
Economic model in which 2 countries produce 2 homogenous goods with 1 factor of production that has differing productivity (opportunity costs not equal) Assumptions 1. Differences in labor productivity (opportunity costs are ≠) 2. Perfect competition so no profits, workers have maximizing behavior, labor perfectly mobile within country 3. Market determines resource allocation 4. Start = closed, End = open then compare Conclusions 1. Countries trade because they have differing productivities which leads to comparative advantages 2. Net gains... no explicit distribution effects 3. Convergence of relative prices
PPF
Production Possibilities Frontier - shows what country may produce and consume based on... 1. Opportunity cost (Ricardian) - slope = constant = opp cost of good - Axes: y = Qb, x = Qa 2. Combinations of factor of production (HO and SF) - slope ≠ constant - Axes: y = Qb, x = Qa
Cost Advantage
- When a country can pay less for good than its productivity is worth (ie: relative wage of the good < productivity of that good in that country)