Transcript International Trade and Comparative Advantage • Three reasons for trade : (1) Cross country differences in supply (different technologies, different industrial organization, etc.) (2) Cross.

International Trade and Comparative
Advantage
• Three reasons for trade :
(1) Cross country differences in supply (different
technologies, different industrial organization, etc.)
(2) Cross country differences in demand (difference
preferences)
(3) Exploiting Economies of Scale
Comparative Advantage:
The Ricardian Model
• Assumptions :
(1)
(2)
(3)
(4)
(5)
One factor
Differences in labor productivity across countries
Two goods
Two countries
Constant returns to scale
• Main idea :
Countries engage in trade because they are different from
each other in relative labor productivity.
The Ricardian Model
Two goods: W (wine), C (cheese)
Unit labor requirement (# of hours of labor
per one unit of output)
12 :
aLC , aLW
The Ricardian Model
Two goods: W (wine), C (cheese).
Unit labor requirements (# of hours of labor per
one unit of output): aLC , aLW
Production possibility frontiers:
aLC QC  aLW QW  L
QW
L / aLW
aLC / aLW
L / aLC
QC
aLC
aLW
= opportunity costs of producing one extra unit of C in
terms of output forgone in the W industry.
Wages, prices and output: PC , P
If
PC  aLCW  QC  0
PC  aLCW  QC  
PC  aLC W
PW  aLW W
PC  aLC W
PW  aLW W
An Equilibrium Price
Configuration
PC
aLC

PW
a LW
QC  0
QW  0
The Two Countries
L*
*
aLW
L
aLW
*
aLC
*
aLW
aLC
aLW
H
L
aLC
F
L*
*
aLC
*
*
aLC / aLW  aLC
/ aLW
Country H has a comparative advantage in the production of C.
Country F has a comparative advantage in the production of W.
Determining the Relative
PC / PW
Price:
P /P
C
W
3
aLC* / aLW*
aLC / aLW
2
1
RD’
L / a LC
*
L* / aLW
Relative Supply
RD”
RD = Relative Demand
QC  QC*
QW  QW*
Relative world
quantity of C
(in terms of W)
Point (1): H Completely specializes in C, Country F in W.
Point (2): F completely specializes in W, H produces both C & W.
Relative Wages
At 1:
PC '  aLC W '
*
PC ' aLW
W'
 ( )(
)
*
W ' PW ' aLC
PW '  a W '
*
LW
*
Factors terms
of trade
At 2:
Goods
terms of
trade
P  a LC W , ( P  a LW W )
2
C
2
2
W
2
*
PW2  a LW
W *2
2
2
C
2
W
*
LW
*
LW
P
a
a
W
(
)(
)
*2
W
P
a LC
a LW
Labor
productivity
ratio in the
export industries
Gains From Trade
We show that the Specialization in Production and Trade
are beneficial to both countries.
Assume that the equilibrium is at point (1).
(a) H can produce W directly: one hour produces 1 / aLW
Units of W.
(b) H can produce C , and then trade C for W: an “indirect”
method of production. One hour produces 1/ aLC units of
C to get through trade PC 1 units of W.
PW aLC
Thus, compare
1
aLW
But at point (1)
to
PC aLC

PW aLW
Therefore,
PC 1
1

aLW PW aLC
PC 1
PW aLC
aLC
PC

aLW PW
Since
1
1

( PC ' / PW ' ) 
aLC
aLW
H benefits
*
LC
*
LW
PC a

PW a
F can produce C directly: one hour
Or “indirectly”
1 PW
1
 *
*
aLW PC aLC
1
 *
a LC
1 PW
*
aLW PC