International Trade - Theory and Policy, 2010a

The answer to some of these questions can be found by describing more carefully some of the features of
the model. In particular, we must describe the relationship between prices and wages. Using these
relationships, we can explain the impact of free trade on the price ratio and the effect of trade on the
distribution of income.
KEY TAKEAWAYS
In a two-country, two-good, one-factor Ricardian model, specialization in each country’s comparative
advantage good can raise world output of both goods.
An increase in world output given the same level of inputs is called an increase in world productive
efficiency.
By choosing an appropriate terms of trade, both countries can consume more of both goods relative to
autarky.
EXERCISE
1. Consider a Ricardian model with two countries, the United States and the EU, producing two
goods, soap bars and toothbrushes. Suppose the productivities are aLSUS = 2 soap bars per
worker, aLSE = 4 soap bars per worker, aLTUS = 8 toothbrushes per worker, and aLTE = 4
toothbrushes per worker. Assume the United States has 3,200 workers and the EU has 4,000
workers.
1. Plot the PPFs for both countries.
2. Determine how much each country would produce if it specialized in its comparative
advantage good.
3. Now choose a plausible autarky production point on each country’s PPF such that the world
output of each good is exceeded by the outputs determined in part b.
4. Determine a terms of trade between the two countries that will assure that both countries can
consume more of both goods after trade.
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