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Trade and Technology: The Ricardian Model - Faculty

Trade and Technology: The Ricardian Model - Faculty

Trade:

Trade: Equilibrium prices International Commercial Policy The Ricardian Model Remember that under autarky a country’s relative prices reflect its opportunity cost. In particular, P C /P W = a LC / a LW and P* C /P* W = a* LC /a* LW . Remember also that we assumed that Home has a comparative advantage in cheese production which implies that a LC /a LW < a* LC /a* LW . Hence, under autarky it must be that P C /P W < P* C /P* W so that cheese is relatively cheaper at Home. 30


Trade: Equilibrium prices (cont.) International Commercial Policy The Ricardian Model Of course, prices must be equalized under free trade to rule out arbitrage opportunities, P C = P* C and P* W = P W , so that P C /P W = P* C /P* W . This implies that, relative to autarky, P C /P W must rise and/or P* C /P* W must fall. To find out what happens exactly, it is instructive to consider again the relative demand and relative supply curves. However, we now have to consider world relative demand and world relative supply. 31


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