Chapter 2 Comparative Advantage Theory 1. David Ricardo David Ricardo 2. Ricardo’s Model...
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Chapter 2 Comparative Advantage Theory 1. David Ricardo 2. Ricardo’s Model 3. Summary
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Transcript of Chapter 2 Comparative Advantage Theory 1. David Ricardo David Ricardo 2. Ricardo’s Model...
Chapter 2Comparative Advantage
Theory
1. David Ricardo2. Ricardo’s Model3. Summary
Chapter 2David Ricardo
1772-18231. Son of a Jewish immigrant
stockbroker2. 3rd of 17 children3. Read WoN in 17994. Encouraged by James Mill5. Principles of Political
Economy 18176. Member of Parliament
1819-1823
Chapter 2
Ricardo’s Model
1. Basic Assumptions2. Basis of Trade3. Measurements of Comparative Ad
vantage
4. Pattern of Production and Trade 5. Effects of Trade
Chapter 2
Basic Assumptions Similar to AA Model Different presentation, same
meanings Goods are identical Perfect
Competition Perfect knowledge, no tariffs or
other trade barriers. No transaction costs
Chapter 2
Basis of Trade1.Differences in Technologies (in
relative term) Relative productivity Relative production cost Relative commodity price International Trade
2. Comparative Advantage
Chapter 2
A country is said to have a comparative advantage over another country in the production of a commodity if it can produce the commodity at a lower opportunity cost than the other country.
Comparative Advantage
Chapter 2
Comparative Advantage
Compares producers of a good according to their opportunity cost.
The producer who has the smaller opportunity cost of producing a good is said to have a comparative advantage in producing that good.
Chapter 2
Opportunity CostOpportunity Cost
Opportunity Cost of some decision is value of the next best alternative which you have to give up because of the decision
Opportunity Cost of some decision is value of the next best alternative which you have to give up because of the decision
–Opportunity cost is the most desired goods or services that are forgone in order to obtain something else.
Chapter 2Measurements of
Comparative Advantage(1)
1. Relative labor productivity of Product 1
If then China has a
comparative advantage in production of Product 1.
Q
Q
L
L
2
1
2
1
USChinaQ
Q
Q
Q
2
1
2
1
Chapter 2Measurements of
Comparative Advantage(2)
2. Relative input-requirement (physical cost) of Product 1
where aL1 is the input requirement in each unit
of output of Product 1
L
L
a
a
Q
LQ
L
1
2
2
1
2
1
Chapter 2Measurements of
Comparative Advantage(3)
3. Opportunity cost of Product 1:
The cost of an activity in terms of sacrificed next best alternative uses of the assets involved. Can also be formulated as “amount of product 2 we must give up to produce a unit of product 1” .——Marginal Rate of Technology Substitution (MRTS) of Product 1
2
1
2
1
Chapter 2Measurements of
Comparative Advantage(4)
4. Relative price of Product 1:
1
1
2
2
2
1
P Q
P Q
W L
W L
*
*
The four measurements of CA are the same in results.
Example
Chapter 2
A numerical example
Only a small changeAA model
Comparative Advantage
No Trade
Trade
Chapter 2Pattern of Production and
Trade
1. Each country should specialize in and export the Product in which it has a comparative advantage
2. in this case, China should
specialize in production of cloth and US should produce wheat.
Chapter 2
Effects of Trade
General equilibrium analysis: Graph Numerical
Summary for trade effects
Chapter 2General Equilibrium
Analysis(Graphs)
Trade
Triangle
QW
Export
25
5052
32
QC
China
Trade Triangle
Import50
100
ToT=1.52
E
P
C
O 50
55
68
48
QC
QW
US
100
110 ToT=1.51.1
E
P
C
O
Export
Import
?
Chapter 2
The Standard of Welfare
Attentions: In the analysis of general equilibrium, the standard index measuring welfare is CIC, not the absolute consumptions of products. So the rise of the consumptions of both products can prove the gains of trade, but the gains of trade need not be the rise of the consumptions of both products.
Chapter 2General equilibrium analysis （ Nu
merical ）P=Produce;C=ConsumerLabor be used equally on the production of C&WExchange Rate must between 1.1~2
Chapter 2
Exchange Rate
China exchange 100 unit Cloth for Wheat not less than 50 unit, or else produce Wheat itself；USA exchange 100 unit Wheat for Cloth not less than 110 Unit, or else produce Cloth itself；So the exchange rate of Cloth/Wheat must between 1.1 (=110/100) and 2 (=100/50)。
Chapter 2
Tradable ZoneQC
QWO
2.0
1.1
not tradable
for China
not tradable
for USA
tradable for both
Chapter 2General equilibrium analysis
（ Numerical ）
Gains ：
China consume 52 Cloth and 32 Wheat. If produce itself, it has to input 116L (= 52×1 ＋ 32×2) ， so save 16L ；
USA consume 48 Cloth and 68 Wheat. If produce itself, it has to input 111.6L (=48×0.91 ＋ 68×1), so save 11.6L 。
Chapter 2Summary for trade
effects1. To Price:
the relative Price of export ( which has comparative advantage) goes up
2. Work division: Each country specializes in the
Product in which it has a comparative advantage
3. Welfare: Each country is better off(consume
more or produce frugally)
Chapter 2
Summary Interdependence and trade
allow countries to enjoy a greater quantity and variety of goods and services.
The gains from trade are based on comparative advantage, not absolute advantage.
Comparative advantage applies to countries as well as to people.
Chapter 2
Should Tiger Woods Mow His Own Lawn?
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