Preview. Chapter 3. Labor Productivity and Comparative Advantage: The Ricardian Model

Transcription

1 hpter 3 Lbor roductivity nd omprtive Advntge: The Ricrdin Model review Opportunity costs nd comprtive dvntge roduction possibilities Reltive supply, reltive demnd & reltive prices Trde possibilities nd gins from trde ges nd trde Misconceptions bout comprtive dvntge Trnsporttion costs nd non-trded goods Empiricl evidence opyright 015 erson Eduction, Inc. All rights reserved. 3-1

2 Introduction Sources of differences cross countries tht led to gins from trde: The Ricrdin model (hpter 3) exmines differences in the productivity of lbor (due to differences in technology) between countries. The Heckscher-Ohlin model (hpter 5) exmines differences in lbor, lbor skills, physicl cpitl, lnd, or other fctors of production between countries. opyright 015 erson Eduction, Inc. All rights reserved. 3-3 Ricrdin Model Assumptions 1. Two countries: domestic nd foreign.. Two goods: wine nd cheese. 3. Lbor is the only resource needed for production. 4. Lbor productivity is constnt. 5. Lbor productivity vries cross countries due to differences in technology. 6. The supply of lbor in ech country is constnt. 7. Lbor mrkets re competitive. 8. orkers re mobile cross sectors. opyright 015 erson Eduction, Inc. All rights reserved. 3-4

3 omprtive Advntge Suppose tht the domestic country hs comprtive dvntge in cheese production: its opportunity cost of producing cheese is lower thn in the foreign country. L / L < L / L hen the domestic country increses cheese production, it reduces wine production less thn the foreign country does becuse the domestic unit lbor requirement of cheese production is low compred to tht of wine production. opyright 015 erson Eduction, Inc. All rights reserved. 3-5 omprtive Advntge Domestic country hs n bsolute dvntge in producing cheese if L < L needs less lbor to produce pound of cheese thn foreign country: unit lbor requirement for cheese production is lower thn in the foreign country. more efficient in producing cheese. Domestic country hs n bsolute dvntge in producing wine if L < L. opyright 015 erson Eduction, Inc. All rights reserved

4 omprtive Advntge Even country tht is the most (or lest) efficient producer of ll goods still cn benefit from trde. Even (rich, developed) country with n bsolute dvntge in both goods will hve comprtive dvntge in only one good the good where its bsolute dvntge is lrger. Even (poor, developing) country with n bsolute disdvntge in both goods will hve comprtive dvntge in producing something the good where its bsolute disdvntge is smller. opyright 015 erson Eduction, Inc. All rights reserved. 3-7 Numericl Exmple Unit lbor requirements (hours) heese (pounds) ine (gllons) Domestic L = 1 L = Foreign L = 8 L = 4 1 L L L L 8 4 opyright 015 erson Eduction, Inc. All rights reserved

5 Opportunity ost Exmple To produce n dditionl pound of cheese requires L hours of work. Ech hour devoted to cheese production could hve been used to produce certin mount of wine insted, equl to 1 hour/( L hours/gllon of wine) = (1/ L ) gllons of wine If 1 hour of lbor is moved to cheese production, tht dditionl hour of lbor could hve produced 1 hour/( hours/gllon of wine) = 1/ gllons of wine. opyright 015 erson Eduction, Inc. All rights reserved. 3-9 roduction ossibilities Frontier The production possibility frontier (F) of n economy shows the mximum mount of goods tht cn be produced for fixed mount of resources. If represents the quntity of cheese produced nd represents the quntity of wine produced, then the production possibility frontier of the domestic economy hs the eqution: L + L = L Totl mount of lbor resources Lbor required for ech unit of cheese production Totl units of cheese production Lbor required for ech unit of wine production Totl units of wine production opyright 015 erson Eduction, Inc. All rights reserved

6 roduction ossibilities Frontier F in lbor constrint form: L + L = L heese endpoint of F: if produce only cheese, L pounds when = 0. L ine endpoint of F: if produce only wine, L gllons when = 0. L opyright 015 erson Eduction, Inc. All rights reserved roduction ossibilities Frontier F in slope-intercept form: = L/ L ( L / L ) Slope of F equls ( L / L ) onstnt, so F is stright line. The opportunity cost of cheese production is: The quntity of wine production given up L / L Equl to the bsolute vlue of the slope of the F opyright 015 erson Eduction, Inc. All rights reserved

7 Fig. 3-1: Home s roduction ossibility Frontier opyright 015 erson Eduction, Inc. All rights reserved Exmple 3.1 Home F In the home country, producing one pound of cheese requires one unit of lbor, nd producing one gllon of wine requires two units of lbor. Home hs lbor supply of Find nd grph the Home F. L L L opyright 015 erson Eduction, Inc. All rights reserved

8 Exmple 3.1 Home F ht is the most cheese Home cn produce? L L pounds ht is the most wine Home cn produce? L L gllons opyright 015 erson Eduction, Inc. All rights reserved Exmple 3.1 Home F ht is the opportunity cost of cheese production for Home? L L 1 gllon of here does it pper in the F eqution? Absolute vlue of the slope wine opyright 015 erson Eduction, Inc. All rights reserved

9 Exmple 3.1 Home F 1500 ine (gllons) F slope -1/ heese (pounds) opyright 015 erson Eduction, Inc. All rights reserved Exercise 3.1 US F In the United Sttes, producing one unit of cheese requires 1 unit of lbor, while producing one unit of wine requires 4 units of lbor. US lbor supply is 600. Find nd grph the US F. Determine the US mximum cheese production. Determine the US mximum wine production. Find the US opportunity cost of cheese in terms of wine. here does it pper in the eqution describing the production possibilities frontier? opyright 015 erson Eduction, Inc. All rights reserved

10 Exercise Solutions 3.1 US F In the United Sttes, producing one unit of cheese requires 1 unit of lbor, while producing one unit of wine requires 4 units of lbor. US lbor supply is 600. Find nd grph the US F. L 4 L L opyright 015 erson Eduction, Inc. All rights reserved Exercise Solutions 3.1 US F Determine the US mximum cheese production. L L pounds Determine the US mximum wine production. 150 gllons opyright 015 erson Eduction, Inc. All rights reserved

11 Exercise Solutions 3.1 US F Find the US opportunity cost of cheese in terms of wine. L L 1 4 gllons of wine here does it pper in the eqution describing the production possibilities frontier? Absolute vlue of the slope opyright 015 erson Eduction, Inc. All rights reserved. 3-1 Exercise Solutions 3.1 US F 300 ine (gllons) 150 F slope=-1/ heese (pounds) opyright 015 erson Eduction, Inc. All rights reserved. 3-11

12 Fig. 3-: Foreign s roduction ossibility Frontier opyright 015 erson Eduction, Inc. All rights reserved. 3-3 Exmple 3. Foreign F In the foreign country, producing one pound of cheese requires eight units of lbor, nd producing one gllon of wine requires four units of lbor. Foreign hs lbor supply of Find nd grph the Foreign F. L 8 4 L L opyright 015 erson Eduction, Inc. All rights reserved

13 Exmple 3. Foreign F ht is the most cheese Foreign cn produce? L L pounds ht is the most wine Foreign cn produce? L L gllons opyright 015 erson Eduction, Inc. All rights reserved. 3-5 Exmple 3. Foreign F ht is the opportunity cost of cheese production for Foreign? L L gllons of wine ompre the slopes of the Home nd Foreign Fs. hich is fltter nd why? Home F is fltter thn Foreign s Home hs the smller opportunity cost of cheese 1/ <. opyright 015 erson Eduction, Inc. All rights reserved

14 Exmple 3. Foreign F 1500 ine (gllons) 0 F slope heese (pounds) opyright 015 erson Eduction, Inc. All rights reserved. 3-7 Exercise 3. Jpn F In Jpn, producing one unit of cheese requires 3 units of lbor, while producing one unit of wine requires units of lbor. Jpn s lbor supply is 600. Find nd grph Jpn s F. Determine Jpn s mximum cheese production. Determine Jpn s mximum wine production. Find Jpn s opportunity cost of cheese in terms of wine. ompre the slopes of US nd Jpn Fs. opyright 015 erson Eduction, Inc. All rights reserved

15 Exercise Solutions 3. Jpn F In Jpn, producing one unit of cheese requires 3 units of lbor, while producing one unit of wine requires units of lbor. Jpn s lbor supply is 600. Find nd grph Jpn s F. L 3 L L opyright 015 erson Eduction, Inc. All rights reserved. 3-9 Exercise Solutions 3. Jpn F Determine Jpn s mximum cheese production. L L pounds Determine Jpn s mximum wine production. 300 gllons opyright 015 erson Eduction, Inc. All rights reserved

16 Exercise Solutions 3. Jpn F Find Jpn s opportunity cost of cheese in terms of wine. L L 3 gllons of wine ompre the slopes of US nd Jpn Fs. US F is fltter due to US s lower opportunity cost of cheese in terms of wine compred to Jpn 1/4 < 3/. opyright 015 erson Eduction, Inc. All rights reserved Exercise Solutions 3. Jpn F 300 ine (gllons) 0 F slope=-3/ heese (pounds) opyright 015 erson Eduction, Inc. All rights reserved

17 roduction, rices nd ges Let be the price of cheese nd be the price of wine. ge equls vlue of the mrginl product of lbor ges of cheese mkers equl the mrket vlue of the cheese produced: w = / L ges of wine mkers equl the mrket vlue of the wine produced: w = / L orkers re ttrcted to whichever industry pys higher wge. opyright 015 erson Eduction, Inc. All rights reserved roduction, rices nd ges If / L > / L, workers will mke only cheese. The economy will specilize in cheese production if the price of cheese reltive to the price of wine exceeds the opportunity cost of producing cheese. If / L < / L, workers will mke only wine. The economy will specilize in wine production if the price of wine reltive to the price of cheese exceeds the opportunity cost of producing wine. opyright 015 erson Eduction, Inc. All rights reserved

18 roduction, rices nd ges If the domestic country wnts to consume both wine nd cheese (in the bsence of interntionl trde), reltive prices must djust so tht wges re equl in the wine nd cheese industries. hen the reltive price of good equls the opportunity cost of producing tht good / L = / L wges re equl cross sectors w = w opyright 015 erson Eduction, Inc. All rights reserved Reltive Supply nd Reltive Demnd ithout trde, reltive price of good equls the opportunity cost of producing tht good. Autrky reltive prices revel comprtive dvntge Home hs lower utrky reltive price of cheese due to hving the lower opportunity cost of producing cheese. A L L L L A opyright 015 erson Eduction, Inc. All rights reserved

19 Reltive Supply nd Reltive Demnd To see how ll countries cn benefit from trde, we clculte reltive prices when trde exists. The free trde reltive price of cheese to wine djusts to mke world reltive supply of cheese to wine equl world reltive demnd of cheese to wine. RD = RS opyright 015 erson Eduction, Inc. All rights reserved Reltive Supply nd Reltive Demnd orld reltive supply of cheese to wine is the quntity of cheese supplied by ll countries reltive to the quntity of wine supplied by ll countries t ech reltive price of cheese to wine. RS = ( + )/( + ) Usully increses s the reltive price of cheese increses, but will hve specil step shpe in this model. opyright 015 erson Eduction, Inc. All rights reserved

20 Reltive Supply If the reltive price of cheese to wine were to fll below Home s opportunity cost / < L / L < L / L Both countries would produce only wine, No cheese would be produced nywhere, nnot be n equilibrium opyright 015 erson Eduction, Inc. All rights reserved Reltive Supply hen the reltive price of cheese to wine equls Home s opportunity cost, / = L / L < L / L Domestic workers indifferent between producing wine or cheese Foreign workers produce only wine. opyright 015 erson Eduction, Inc. All rights reserved

21 Reltive Supply hen the reltive price of cheese is strictly in between the two opportunity costs L / L < c / < L / L Domestic workers produce only cheese, Foreign workers produce only wine. opyright 015 erson Eduction, Inc. All rights reserved Reltive Supply hen the reltive price of cheese to wine equls Foreign s opportunity cost L / L < L / L = / Foreign workers indifferent between producing wine or cheese, Domestic workers produce only cheese. opyright 015 erson Eduction, Inc. All rights reserved

22 Reltive Supply If the reltive price of cheese to wine were to rise bove Foreign s opportunity cost L / L < L / L < / Both countries would produce only cheese, No wine would be produced nywhere, nnot be n equilibrium. opyright 015 erson Eduction, Inc. All rights reserved Reltive Supply omplete speciliztion reltive supply is the vlue of world reltive supply when ech country produces only its comprtive dvntge good. ~ RS L L L L opyright 015 erson Eduction, Inc. All rights reserved. 3-44

23 Reltive Supply orld reltive supply is step function: First step L / L is Home opportunity cost of cheese Second step L / L is Foreign opportunity cost of cheese Jump occurs t complete speciliztion reltive supply opyright 015 erson Eduction, Inc. All rights reserved Reltive Demnd orld reltive demnd of cheese to wine is the quntity of cheese demnded in ll countries reltive to the quntity of wine demnded in ll countries t ech reltive price of cheese to wine RD = (D +D )/(D +D ). Usully consumers purchse less cheese nd more wine s reltive price of cheese to wine rises, so the reltive quntity of cheese demnded flls. opyright 015 erson Eduction, Inc. All rights reserved

24 Reltive Demnd A common specifiction for reltive demnd is to mke reltive demnd for cheese to wine proportionl to inverse of reltive price of cheese to wine. RD 1 opyright 015 erson Eduction, Inc. All rights reserved Fig. 3-3: orld Reltive Supply nd Demnd opyright 015 erson Eduction, Inc. All rights reserved

25 Reltive Supply nd Reltive Demnd ith common equilibrium long jump (such s #1), free trde reltive price of cheese is strictly in between the two opportunity costs L L L L opyright 015 erson Eduction, Inc. All rights reserved Reltive Supply nd Reltive Demnd However, depending on strength of reltive demnd for cheese, n equilibrium cn occur long either step, such s #. Free trde reltive price of cheese my equl Home or Foreign opportunity costs. opyright 015 erson Eduction, Inc. All rights reserved

26 Exmple 3.3 Reltive Supply nd Demnd Recll under complete speciliztion ccording to comprtive dvntge, Home produces 1000 pounds of cheese nd no wine. Foreign produces 1500 gllons of wine nd no cheese. Home s opportunity cost of cheese is 1/, nd Foreign s is. opyright 015 erson Eduction, Inc. All rights reserved Exmple 3.3 Reltive Supply nd Demnd ht reltive price of cheese to wine is required to hve Home produce both cheese nd wine (Home utrky price)? A L L 1 opyright 015 erson Eduction, Inc. All rights reserved

27 Exmple 3.3 Reltive Supply nd Demnd ht reltive price of cheese to wine is required to hve Foreign produce both cheese nd wine (Foreign utrky price)? A L L opyright 015 erson Eduction, Inc. All rights reserved Exmple 3.3 Reltive Supply nd Demnd ht is the world reltive supply of cheese to wine if ech country specilizes in its comprtive dvntge good? ~ RS opyright 015 erson Eduction, Inc. All rights reserved

28 Exmple 3.3 Reltive Supply nd Demnd onstruct nd grph world reltive supply nd reltive demnd RD = /. / RD = / RS 1/ </3 3/ /3 =/3 1/ >/3 opyright 015 erson Eduction, Inc. All rights reserved Exmple 3.3 Reltive Supply nd Demnd ht is the world reltive price of cheese to wine under free trde? ~ 1 RS 3 opyright 015 erson Eduction, Inc. All rights reserved

29 Exmple 3.3 Reltive Supply nd Demnd How does the world reltive price of cheese compre to wht existed in utrky in ech country? The free trde reltive price of cheese to wine is higher thn Home utrky price nd lower thn Foreign utrky price A 3 A 1 opyright 015 erson Eduction, Inc. All rights reserved Exmple 3.3 Reltive Supply nd Demnd Reltive price of cheese to wine RS RD Reltive quntity of cheese to wine opyright 015 erson Eduction, Inc. All rights reserved

30 Exercise 3.3 orld Equilibrium Find the reltive price of cheese to wine required to hve the United Sttes produce both cheese nd wine. Find the reltive price of cheese to wine required to hve Jpn produce both cheese nd wine. Find the world reltive supply of cheese to wine if both countries specilize in their comprtive dvntge good. opyright 015 erson Eduction, Inc. All rights reserved Exercise 3.3 orld Equilibrium onstruct nd grph world reltive supply nd demnd RD = /. Find the equilibrium reltive price of cheese to wine under free trde. ompre the free trde reltive price of cheese to ech country s utrky reltive price. opyright 015 erson Eduction, Inc. All rights reserved

31 Exercise Solutions 3.3 orld Equilibrium Find the reltive price of cheese to wine required to hve the United Sttes produce both cheese nd wine. A L L 1 4 opyright 015 erson Eduction, Inc. All rights reserved Exercise Solutions 3.3 orld Equilibrium Find the reltive price of cheese to wine required to hve Jpn produce both cheese nd wine. A L L 3 opyright 015 erson Eduction, Inc. All rights reserved

32 Exercise Solutions 3.3 orld Equilibrium Find the world reltive supply of cheese to wine if both countries specilize in their comprtive dvntge good. ~ RS opyright 015 erson Eduction, Inc. All rights reserved Exercise Solutions 3.3 orld Equilibrium onstruct nd grph world reltive supply nd demnd RD = /. / RD = / RS 1/4 4 < 1/ = 3/ /3 > opyright 015 erson Eduction, Inc. All rights reserved

33 Exercise Solutions 3.3 orld Equilibrium Find the equilibrium reltive price of cheese to wine under free trde. ~ 1 RS 1 opyright 015 erson Eduction, Inc. All rights reserved Exercise Solutions 3.3 orld Equilibrium ompre the free trde reltive price of cheese to ech country s utrky reltive price. The free trde reltive price of cheese to wine is higher thn US utrky price nd lower thn Jpn s utrky price. 3 A 1 A 1 4 opyright 015 erson Eduction, Inc. All rights reserved

34 Exercise Solutions orld RD & RS Reltive price of cheese to wine RS RD Reltive quntity of cheese to wine opyright 015 erson Eduction, Inc. All rights reserved orld roduction Efficiency orld production is efficient if it is not possible to increse the world production of cheese without reducing the world production of wine. Free trde equilibrium is efficient s t lest one country specilizes in its comprtive dvntge good Autrky is not - neither specilized opyright 015 erson Eduction, Inc. All rights reserved

35 Gins from Trde Gins from trde come from specilizing in production tht use resources most efficiently (comprtive dvntge good), nd using the income generted from tht production to buy the goods nd services tht countries desire. opyright 015 erson Eduction, Inc. All rights reserved Gins from Trde Domestic workers ern higher income from cheese production becuse the reltive price of cheese increses with trde. Foreign workers ern higher income from wine production becuse the reltive price of cheese decreses with trde (mking cheese cheper) nd the reltive price of wine increses with trde. opyright 015 erson Eduction, Inc. All rights reserved

36 Gins from Trde Think of trde s n indirect method of production or new technology tht converts cheese into wine or vice vers. ithout trde, country hs to llocte resources to produce ll of the goods tht it wnts to consume (utrky). ith trde, country cn specilize its production nd trde the products for the goods tht it wnts to consume. Allowing trde expnds consumption possibilities beyond production possibilities. opyright 015 erson Eduction, Inc. All rights reserved Gins from Trde If interntionl trde leds to reltive price of cheese to wine tht differs from Home s utrky price, then Home gins from trde. Similrly, if interntionl trde leds to reltive price of cheese to wine tht differs from Foreign s utrky price, then Foreign gins from trde. opyright 015 erson Eduction, Inc. All rights reserved

37 Gins from Trde Typiclly both countries gin from trde. ossible for one of the countries to not gin. If so, other country gins even more. At lest one country lwys gins since there re gins t the world level. If gin from trde, TF outside F. opyright 015 erson Eduction, Inc. All rights reserved Trde ossibilities Frontier The trde possibilities frontier (TF) of n economy shows the mximum mount of goods tht cn be consumed by trding the optiml production bundle t world prices under free trde. opyright 015 erson Eduction, Inc. All rights reserved

38 Trde ossibilities Frontier If D represents the quntity of cheese consumed nd D represents the quntity of wine consumed, then the trde possibility frontier of the domestic economy hs the eqution: D + D = + opyright 015 erson Eduction, Inc. All rights reserved Trde ossibilities Frontier Assuming complete speciliztion in cheese, Home trde possibilities frontier in income-expenditure form simplifies to D D opyright 015 erson Eduction, Inc. All rights reserved

39 Trde ossibilities Frontier Assuming complete speciliztion in wine, Foreign trde possibilities frontier in income-expenditure form simplifies to D D opyright 015 erson Eduction, Inc. All rights reserved Fig. 3-4: Trde Expnds onsumption ossibilities opyright 015 erson Eduction, Inc. All rights reserved

40 Exmple 3.4 Home nd Foreign TF Recll Home produces 1000 pounds of cheese nd no wine. Foreign produces 1500 gllons of wine nd no cheese. The free trde world reltive price of cheese is / = 3/. opyright 015 erson Eduction, Inc. All rights reserved Exmple 3.4 Home nd Foreign TF Find nd grph the Home TF. D D 3 3 D D D 1500 D 1500 opyright 015 erson Eduction, Inc. All rights reserved

41 Exmple 3.4 Home nd Foreign TF Find Home s mximum consumption of cheese nd mximum consumption of wine. D 1000, D 1500 ht is the slope of the Home TF nd its interprettion? Absolute vlue of slope is free trde reltive price To consume one pound of cheese, give up 1.5 gllon of wine on the world mrket opyright 015 erson Eduction, Inc. All rights reserved Exmple 3.4 Home nd Foreign TF 1500 ine (gllons) slope -3/ TF F slope -1/ heese (pounds) opyright 015 erson Eduction, Inc. All rights reserved

42 Exmple 3.4 Home nd Foreign TF Find nd grph the Foreign TF. 3 D D D D D D opyright 015 erson Eduction, Inc. All rights reserved Exmple 3.4 Home nd Foreign TF Find Foreign s mximum consumption of cheese nd mximum consumption of wine. D 1000, D 1500 ompre the slope of Home s nd Foreign s TFs. The sme becuse the countries fce the sme free trde reltive price of cheese. opyright 015 erson Eduction, Inc. All rights reserved

43 Exmple 3.4 Home nd Foreign TF 1500 ine (gllons) 0 F slope heese (pounds) slope -3/ TF opyright 015 erson Eduction, Inc. All rights reserved Exercise 3.4 US nd Jpn TF Find nd grph the US TF. Determine US mximum cheese consumption nd US mximum wine consumption. Find the slope of the US TF. ht does the slope of the US TF represent? opyright 015 erson Eduction, Inc. All rights reserved

44 Exercise 3.4 US nd Jpn TF Find nd grph Jpn s TF. Determine Jpn s mximum cheese consumption nd mximum wine consumption. Find the slope of Jpn s TF. ompre the slopes of US nd Jpn TFs. opyright 015 erson Eduction, Inc. All rights reserved Exercise Solutions 3.4 US & Jpn TF Find nd grph the US TF. D D 1 1 D D D 300 D 300 opyright 015 erson Eduction, Inc. All rights reserved

45 Exercise Solutions 3.4 US & Jpn TF Determine US mximum cheese consumption nd US mximum wine consumption. D 600, D 300 opyright 015 erson Eduction, Inc. All rights reserved Exercise Solutions 3.4 US & Jpn TF Find the slope of the US TF. Slope is -1/. ht does the slope of the US TF represent? Absolute vlue of slope is free trde reltive price give up 1/ gllon of wine to buy one pound of cheese on world mrket. opyright 015 erson Eduction, Inc. All rights reserved

46 Exercise Solutions US F & TF ine (gllons) F slope=-1/4 slope=-1/ TF heese (pounds) opyright 015 erson Eduction, Inc. All rights reserved Exercise Solutions 3.4 US & Jpn TF Find nd grph Jpn s TF. 1 D D D D D D 300 opyright 015 erson Eduction, Inc. All rights reserved

47 Exercise Solutions 3.4 US & Jpn TF Determine Jpn s mximum cheese consumption nd mximum wine consumption. D 600, D 300 opyright 015 erson Eduction, Inc. All rights reserved Exercise Solutions 3.4 US & Jpn TF Find the slope of Jpn s TF. Slope is -1/. ompre the slopes of US nd Jpn TFs. The sme becuse the countries fce the sme free trde reltive price of cheese. opyright 015 erson Eduction, Inc. All rights reserved

48 Exercise Solutions Jpn F & TF 300 ine (gllons) 0 F slope=-3/ heese (pounds) slope=-1/ TF opyright 015 erson Eduction, Inc. All rights reserved Trde ttern The trde pttern indictes the direction of trde; description of which countries import nd export which goods. Ech country exports its comprtive dvntge good. Home exports cheese nd imports wine. Foreign exports wine nd imports cheese. opyright 015 erson Eduction, Inc. All rights reserved

49 Three ossible Equilibri 1. Free trde reltive price cn equl Home utrky reltive price Home produces both goods, Foreign only wine Foreign gins, Home does not. Free trde reltive price cn equl Foreign utrky reltive price Foreign produces both goods, Home only cheese Home gins, Foreign does not opyright 015 erson Eduction, Inc. All rights reserved Three ossible Equilibri 3. Free trde reltive price cn be strictly in between utrky reltive prices Home produces only cheese, Foreign only wine (complete speciliztion ccording to comprtive dvntge) Both Home nd Foreign gin Home lwys exports cheese, Foreign lwys exports wine. opyright 015 erson Eduction, Inc. All rights reserved

50 Reltive ges Reltive wges re the wges of the domestic country reltive to the wges in the foreign country. roductivity (technologicl) differences determine wge differences in the Ricrdin model. A country with bsolute dvntge in producing good will enjoy higher wge in tht industry fter trde. Both countries hve cost dvntge in production. The cost of high wges cn be offset by high productivity. The cost of low productivity cn be offset by low wges. opyright 015 erson Eduction, Inc. All rights reserved ommon Misconceptions 1. Free trde is beneficil only if country is more productive thn foreign countries. Even n unproductive country benefits from free trde. The benefits of free trde do not depend on bsolute dvntge, rther they depend on comprtive dvntge: specilizing in industries tht use resources most efficiently. opyright 015 erson Eduction, Inc. All rights reserved

51 ommon Misconceptions. Free trde with countries tht py low wges hurts high wge countries. Not unfir competition: low wges reflect low productivity so production costs might not be low. onsumers benefit becuse they cn purchse goods more cheply (more wine in exchnge for cheese). roducers/workers benefit by erning higher income (by using resources more efficiently nd through higher prices/wges). opyright 015 erson Eduction, Inc. All rights reserved ommon Misconceptions 3. Free trde exploits less productive countries. hile lbor stndrds in some countries re less thn exemplry compred to estern stndrds, they re so with or without trde. Deeper poverty nd exploittion my result without exports. onsumers benefit from free trde by hving ccess to cheply (efficiently) produced goods. roducers/workers benefit from hving higher profits/wges higher compred to the lterntive. opyright 015 erson Eduction, Inc. All rights reserved

52 Trnsporttion osts nd Non-trded Goods The production speciliztion predicted by the Ricrdin model rrely hppens: 1. More thn one fctor of production reduces the tendency of speciliztion (chpter 4). rotectionism (chpter 8) 3. Trnsporttion costs reduce or prevent trde, which my cuse ech country to produce the sme good or service opyright 015 erson Eduction, Inc. All rights reserved Trnsporttion osts nd Non-trded Goods Non-trded goods nd services (e.g., hircuts nd uto repirs) exist due to high trnsporttion costs. ountries tend to spend lrge frction of ntionl income on non-trded goods nd services. This fct hs implictions for the grvity model nd for models tht consider how income trnsfers cross countries ffect trde. opyright 015 erson Eduction, Inc. All rights reserved

53 Empiricl Evidence Do countries export those goods in which their productivity is reltively high? The rtio of US to British exports in 1951 compred to the rtio of US to British lbor productivity in 6 mnufcturing industries suggests yes. At this time the US hd n bsolute dvntge in ll 6 industries, yet the rtio of exports ws low in the lest productive sectors of the US. opyright 015 erson Eduction, Inc. All rights reserved roductivity nd ges opyright 015 erson Eduction, Inc. All rights reserved

54 Do ges Reflect roductivity? Other evidence shows tht wges rise s productivity rises. In 000, South Kore s lbor productivity ws 35% of the US level nd its verge wges were bout 38% of US verge wges. After the Koren r, South Kore ws one of the poorest countries in the world, nd its lbor productivity ws very low. In 1975, verge wges in South Kore were still only 5% of US verge wges. opyright 015 erson Eduction, Inc. All rights reserved Fig. 3-6: roductivity nd Exports opyright 015 erson Eduction, Inc. All rights reserved

55 Empiricl Evidence ompre hinese output nd productivity with tht of Germny for vrious industries using 1995 dt. hinese productivity (output per worker) ws only 5 percent of Germny s on verge. In pprel, hinese productivity ws bout 0 percent of Germny s, creting strong comprtive dvntge in pprel for hin. opyright 015 erson Eduction, Inc. All rights reserved Empiricl Evidence The min implictions of the Ricrdin model re well supported by empiricl evidence: productivity differences ply n importnt role in interntionl trde comprtive dvntge (not bsolute dvntge) mtters for trde opyright 015 erson Eduction, Inc. All rights reserved

56 Tble 3-3: Bngldesh versus hin, 011 opyright 015 erson Eduction, Inc. All rights reserved Summry 1. Differences in the productivity of lbor cross countries generte comprtive dvntge.. A country hs comprtive dvntge in producing good when its opportunity cost of producing tht good is lower thn in other countries. opyright 015 erson Eduction, Inc. All rights reserved

57 Summry (cont.) 3. ountries export goods in which they hve comprtive dvntge - high productivity or low wges give countries cost dvntge. 4. ith trde, the reltive price settles in between wht the reltive prices were in ech country before trde. opyright 015 erson Eduction, Inc. All rights reserved Summry (cont.) 5. Trde benefits ll countries due to the reltive price of the exported good rising: income for workers who produce exports rises, nd imported goods become less expensive. 6. Empiricl evidence supports trde bsed on comprtive dvntge, lthough trnsporttion costs nd other fctors prevent complete speciliztion in production. opyright 015 erson Eduction, Inc. All rights reserved