Ricardian Model. Mercantilism: 17 th and 18 th Century. Adam Smith s Absolute Income Hypothesis, End of 18 th Century: Major Shift in Paradigm

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1 Mercntilism: th nd th Century Ricrdin Model lesson in Comprtive dvntge Trde ws considered s Zero-Sum Gme It ws viewed mens to ccumulte Gold & Silver Exports were encourged Imports were discourged End of th Century: Mjor Shift in rdigm Dvid Hume,, It is not the quntity of Gold & Silver tht ntion holds tht mtter, rther it is the qulity of goods & services tht the gold nd silver cn uy. dm Smith s solute Income Hypothesis, Trde is not zero-sum gme oth economies cn enefit if ech specilizes in the product in which it hs solute dvntge. country is sid to hve solute dvntge in the product which cn e produced t lower lor cost compred to its trding prtners. solute dvntge or Hour Requirement Wine Cheese Englnd ortugl The numer in the tle shows the mount of lor hours needed to produce ech unit of the product in question. Englnd hs solute dvntge in Wine ortugl hs solute dvntge in Cheese Exmple : roduction of Wine nd Cheese The numer in the tle shows the mount of lor hours needed to produce ech unit of the product in question. Wine Cheese Englnd ortugl Who hs solute dvntge in Wine? Who hs solute dvntge in Cheese? Cn these countries enefit from trde nd speciliztion?

2 Dvid Ricrdo, : Theory of Comprtive dvntge The direction of Trde nd Speciliztion should not e determined on the sis of solute cost ut should depend on comprtive cost or opportunity cost. country is sid to hve comprtive dvntge in the commodity which cn e produced in tht country t lower opportunity cost. Exmple : roduction of Wine nd Cheese The numer in the tle shows the mount of lor hours needed to produce ech unit of the product in question. Wine Cheese Englnd ch ½ wi ortugl ch ¼ wi In Englnd, Wine Cheese & Cheese ½ Wine In ortugl, Wine ¼ Cheese & Cheese ¼ Wine Interntionl Exchnge Rte, Wine Cheese Ricrdin Model: Forml Exposition Simplifying ssumptions:. erfect Competition previls oth in the product nd fctor mrket.. Ech Country hs fixed endowment of resources. Resources re internlly moile ut cn not move interntionlly.. Fixed technology nd only one input () needed for the production of the goods in question. Constnt Returns to Scle previls.. There is zero trnsporttion cost nd product produced re homogeneous. Country Country In Country : The Opportunity cost of / ½ In : The Opportunity cost of / Country Country Totl or in Country The resource Constrint tht the country fces is,-. +. Country Country Totl or in Country Given this supply, wht is the mximum mount of country cn produce?

3 Country : roduction ossiility Frontier (F) / / The eqution of the F is,-. +. The solute vlue of the slope of the F: d d Opportunity Cost of Mrginl Rte of Trnsformtion (MRT) ets now look t the reltive price of the two products. Under erfect Competition:.w.w So the reltive price of the two products will e. w. w The eqution of the F is,-. +. The solute vlue of the slope of the F: d d Opportunity Cost of Mrginl Rte of Trnsformtion (MRT) Country : roduction & Consumption in utrky / / Country Country Totl or in The resource Constrint tht the country fces is,-. +.

4 Country Country Totl or in Given this supply, wht is the mximum mount of country cn produce? : roduction & Consumption under utrky / / For : The eqution of the F is,-. +. The solute vlue of the slope of the F: d d Opportunity Cost of Mrginl Rte of Trnsformtion (MRT) Direction of Trde nd Speciliztion: If, ( / )<( / ), s hs een shown in our numericl exmple, then Country should completely specilize in the production of. If the ove is true then, y construction it will lso e true tht, ( / )<( / ), nd should completely specilize in the production of. The interntionl price rtio hs to e etween the two domestic price rtios. In other words,- < tt tt < Int rice Rtio Country : Free Trde Equilirium / Imports Trde Tringle Exports /

5 : Free Trde Equilirium / Exports Imports / Trde Tringle Figure : Wht Does Country Gin from Exchnge? / * Slope ( / ) tt U U () Gins from Exchnge p / Figure : Wht Does Country Gin from Exchnge nd Speciliztion? Figure : Wht Does Country Gin from Exchnge nd Speciliztion? c / / c / U * Slope ( / ) tt U U U p U * U Slope ( / ) tt p / () Gins from Exchnge * U U Slope ( / ) tt p / () Gins from Exchnge nd Speciliztion () Gins from Exchnge nd Speciliztion / Figure : Domestic Mrkets for Goods nd in utrky under Constnt ( / ) S ( / ) ( / ) S Figure : Domestic Mrket for Good in utrky under Constnt ( ) / S ( / ) D Demnd for D * * ( / ) () Mrket in ( / ) () Mrket in ( / ) S S ( / ) D Demnd for ( / ) * * D * D () Mrket in (c) Mrket in (d) Mrket in

6 Figure : Domestic Mrket for Good in utrky under Constnt ( / ) ( / ) S Figure c: Domestic Mrket for Good in utrky under Constnt ( / ) ( / ) S Demnd for D * Demnd for D * () Mrket in (c) Mrket in Figure d: Domestic Mrket for Good in utrky under Constnt ( / ) S ( / ) ( ) / ) tt Figure : Interntionl Mrkets for Goods nd under Constnt ( / ) ( / ) ( / ) ( / ) tt ( / ) ( / Demnd for ( / ) Demnd for D * (d) Mrket in tt () Mrket Trde in tt () Mrket Trde in Figure : Does Reltive or roductivity Relly ffect Export erformnce? Tle : Vlue-dded per Hour Worked In Mnufcturing, - (U.S.) rewr Output per Worker, U.S.:U.K. Tin cns ig iron Woolen eer nd Clothing worsted Mrgrine. Coke inoleum Cotton Hosiery Cigrettes Ryon Ryon yrn Footwer cloth Cement.. Mchinery Wireless Motor Glss crs per continers.. Quntity of Exports, U.S.:U.K.,