Ricardian Model

Ricardian Model: compartative advantage

CHAPTER 3

Introduction

Countries engage in international trade for two basic reasons in accordance to Krugman et al (2018: 52) :

1. countries trade because they are different from each other
2. countries trade to achieve economies of scale in production

Comparative advantage

The abilty of an economy to produce a given good or service in a more efficent and economically competitive manner than another economy.

Ex: Roses v. Computers

To produce flowers for Valentine´s day in the US, heated greenhouses are needed, at great expense in terms of energy, capital investment, and other scarce resources. Those resources could be used to produce other goods, like computers. Inevitably, there is a tradeoff. The Opportunity cost´s concept describes such trade-offs as the number of computers that could have been produced with the resources used to produce a given number of roses.

Opportunity cost

• The potential benefit than an individual, investor o business misses out when choosing one alternative over another.
• For example, if you choose to spend your time sleeping the whole morning, the opportunity cost is the money you could have earned from working during that time.
• Opportunity cost helps individuals and organizations make informed decisions by weighing the costs and benefits of different choices and considering the value of the opportunities they are giving up.

Ex: Roses v. Computers

• Suppose the US grows 10 million roses for Valentine’s Day with resources that could have used to produce 100,000 computers. The opportunity cost of those 10 million roses is 100,000 computers.
• In Colombia, the same opportunity cost is less, because it is easier to produce flowers for February in Colombia considering that it is summer over there.
• Colombian workers are less efficient at making computers, which means that a given amount of resources used in computer production yields fewer computers in Colombia than in the US.
• So the trade-off in Colombia might be 10 million winter roses for only 30,000 computers.

• This difference in opportunity costs offers the possibility of a mutually beneficial rearrangement of world production. Let the United States stop growing winter roses and devote the resources this frees up to producing computers; meanwhile, let Colombia grow those roses instead, shifting the necessary resources out of its computer industry.

A one-factor economy

• There is only one production factor: Labor
• There are only two products: wine and chesse
• The unit of labor requirement can be expressed in hours to produce wine (aLW) or chesse (aLC), for example:
• 1 hour to produce a pound of chesse
• 2 hours to produce a gallon of wine

Prodction possibility frontier (PPF)

• If QW is the production of wine and QC its production of cheese, then the labor used in producing wine will be aLWQW, and the labor used in producing cheese will be aLCQC. The Production Possibility Frontier is determined by the limits on the economy’s resources—in this case, labor—. Because the economy’s total labor supply is L, the limits on production are defined by the inequality a:

Relative prices

• Suppose that it takes 1 hour of labor to produce a pound of cheese and 2 hours to produce a gallon of wine.
• The price of the cheese (Pc) is $4 a pound and the price of the wine (Pw) is $7 a gallon.
• If workers produce cheese, they can earn $4/hr. (considering there are no profits, workers receive the full value of their output). On the other hand, if workers produce wine, they will earn only $3.50/hr. because a $7 gallon of wine takes 2 hours to produce. So where the workers will work?

Relation of wages

• The hourly wage rate in chesse sector is: 𝑃𝑐/𝑎𝐿𝐶
• The hourly wage rate in wine sector is: 𝑃𝑤/𝑎𝐿𝑊
• Wages in the chesse sector will be higher if 𝑃𝐶/𝑃𝑊 >𝑎𝐿𝐶/𝑎𝐿𝑊
• Wages in the chesse sector will be higher if 𝑃𝐶/𝑃𝑊 <𝑎𝐿𝐶/𝑎𝐿𝑊
• Only when 𝑃𝐶/𝑃𝑊 =𝑎𝐿𝐶/𝑎𝐿𝑊 the both goods wil be produced.

Trade in a one factor world

• Suppose there are two countries: Home and Foreign.
• Home’s labor force will be L and Foreign´s labor force will be: L*
• Foreign’s unit labor requirements in wine and cheese will be denoted by: a*LW and a*LC
• Home will be more productive in chesse and less productive in wine if: 𝑎_𝐿𝐶/𝑎_𝐿𝑊 <〖𝑎∗〗_𝐿𝐶/〖𝑎∗〗_𝐿𝑊
• When one country can produce a unit of a good with less labor than another country, we say that the first country has an absolute advantage. In this case, Home has an absolute advantage in producing cheese.