Ricardain Model and Comparative Advantage! Chayun Tantivasadakarn! Faculty of Economics, Thammasat University!

Transcription

1 Ricardain Model and Comparative Advantage! Chayun Tantivasadakarn! Faculty of Economics, Thammasat University! 1

2 Outline! Assumption Production Possibility Curves Autarky equilibrium Comparative advantage Free trade equilibrium The Balassa Index Empirical Tests 2

3 No trade conditions! 2 countries with! Identical technology! Identical resource endowments! Identical preferences! Constant returns to scale technology! Perfect competition in all sectors! Adam Smith s absolute advantage and Ricardian model emphasize on differences in technology! 3

4 Ricardian Model and Comparative Advantage! Use the same set of assumption as Adam Smith s! Production functions:! where a and b are marginal product of labor! Labor requirements are:! 4

5 Ricardian Model and Comparative Advantage! Full employment requires that labor demand = supply! where L and L * are the respective labor supply.! Example:" " X" " Y" Labor supply! Home"" " a = 8" b = 4" L = 160! Foreign" a * = 1" b * = 2" L * = 160! This information allows us to construct the Production Possibility Curve for each country! 5

6 Ricardian Model and Comparative Advantage! Y! 80! MRT = - a * /b * = - 0.5! L/b = 160/4! = 40! MRT = - a/b = -2! Home PPC! L/a = 160/8 = 20! Foreign PPC! 160! X! 6

7 Ricardian Model and Comparative Advantage! Why should the MRT equals to a/b?! Each firm that produce X maximizes profit! This gives w = VMP = ap X or P X = w/a = wa.! Similarly P Y = w/b = wb.! Since MRT = MC X /MC Y, perfect competition implies! 7

8 Ricardian Model and Comparative Advantage! 40! Y! Home PPC! A! MRT = MRS = P X /P Y = a/b = 2! 20! IC! X 1! Autarky or no-trade equilibrium! Equilibrium occurs at the tangency between IC and PPC or when MRT = MRS = P X /P Y.! Note: if all goods are consumed in the equilibrium, preferences play no role on determining the equilibrium price ratio.! Before trade: Home price P X /P Y = 2, Foreign price P * X /P * Y = 0.5.! 8

9 Comparative Advantage! MRT = P X /P Y = 2 implies that to get one more unit of X Home needs to give up 2 units of Y.! The opportunity cost of X in terms of Y in Home country equals to 2.! Similarly P * X/P * Y = 0.5 implies that the opportunity cost of X in terms of Y in foreign country equals to 0.5.! Foreign has comparative advantage in X and should specialize and export X.! With two goods, Home must have comparative advantage in Y and should specialize and export Y.! 9

10 Gains from trade! 40! Y! Home! IC 1! (P X /P Y ) A = 2! 80! Y *! (P * X /P* Y )A = 0.5! Foreign! IC * 1! E! A! IC 2! E *! A *! IC * 2! 20! X! (P X /P Y ) W = 1! Trade expand the Consumption Possibility Frontier.! H can export and gain from trade even it has no absolute advantage in any good.! 160! X *! 10!

11 Gains from trade! Suppose after trade the world equilibrium price ratio (P X /P Y ) W = 1.! Further assuming that P W = 16 = P X W Y. Since H exports Y and w = VMP implies that P W Y = wb, H s wage rate = P W / b = 16/4 = 4.! Y Similarly, since F exports X and P W = w X * a *, F s wage rate = P W X/ a * = 16/1 = 16.! The country with the higher absolute advantage (F) has a higher wage after trade. However, both countries gain from trade.! 11

12 Free trade equilibrium! There are several ways to solve for free trade equilibrium:! World PPC! World Relative Supply and Demand! Offer curves! 12

13 World PPC! L/b! Y! L/b+ L * /b *! A! H! a * /b *! World PPC is the outer envelope of the aggregation of H s and F s PPCs.! Point A + A * is inside the World PPC. This implies gains from trade.! If H specializes in Y and F specializes in B! X, the world will be A+A *! at point B which is preferred to point A + A *.! L/a! L/a+ L * /a *! a/b! X! 13!

14 World PPC: Three possible outcomes! a * /b *! IC 1! F! E 1! IC / 2! E 2! E 3! H! H! IC // 3! X 1! L * /a *! L/a+ L * /a *! a/b! 14!

15 World Relative Supply and Demand! P X /P Y! a/b! S X! If P X /P Y < a * /b *, X = 0.! If P X /P Y = a * /b *, X varies from 0 to L * /a *.! If a * /b * < P X /P Y < a/b, X is fixed at L * /a *.! a * /b *! If P X /P Y = a/b, X varies from L * /a * to L * /a * + L/a.! 0! L * /a *! L * /a * + L/a! X! 15!

16 World Relative Supply and Demand! P X /P Y! a/b! a * /b *! S 1! 0! D 1! E 3! E 2! D 3! E 1! D 2! If P X /P Y < a * /b *, H and F specialize in Y.! If P X /P Y = a * /b *, H specializes in Y, F diversifies and may produce up to L * /a *.! If a * /b * < P X /P Y < a/b, no change in X; Each specializes in its com. adv.! L * /a *! L * /a * + L/a! X! If P X /P Y = a/b, F specializes in X, H diversifies.! 16!

17 Offer curves! Y *! (P X /P Y ) W = 1! (P * X /P* Y )A = 0.5! IC * 1! A *! Imports of Y! Offer curves! IC * 2! The offer curve is the curve that trace the equilibrium points as the world price changes.! Exports of X! X *! 17!

18 Offer curves! X *! Y! Exports of Y from H! Imports of X! To H! 0 H! Exports of X! from F! IC * 2! A! (P X /P Y ) A = 2! E = E *! Imports of Y! from F! A *! IC 2! IC 1! IC * 1! X! (P * X/P * Y) A = 0.5! (P X /P Y ) W = 1! 0 F! Y *! 18!

19 Measuring trade advantages: the Balassa index I! How do you determine a country s strong export sectors? Most often used: Balassa index or Revealed Comparative Advantage (RCA)! If RCA A j If RCA A j > 1, country j has a comparative advantage in j.! < 1, country j has a comparative disadvantage in j.! 19

20 Calculation of RCA!! 2003, Billion Baht Thailand! World! Export of computer! 340! 37323! Export of clothes! 115! 9038! Total export! 3326! ! 20

21 Empirical Evidence on the Ricardian Model! Productivity and Exports! 21

22 What are the main ideas of Ricardian Model?! What are the draw back of the model?! Review:! General equilibrium, Edgeworth Box Diagram, PPC.! Home work! 22