REI Capítulo 1-I

CHAPTER 1
THE CLASSICAL AND NEOCLASSICAL THEORIES OF
INTERNATIONAL TRADE
1.1 The Ricardian model and comparative advantage
1.2 Extensions of the Ricardian model
1.3. The neo-classical model: Exchange and welfare
Trade between the countries:
-different (each one does something really well)
- Economies of scale are achived
Both represent gains. At the moment, we only see the first, and the
resulting trade is mutually beneficial.
1.1 The Ricardian model and comparative advantage
Concept of comparative advantage
Is trade beneficial? The key is that it minimizes the opportunity cost, as we shall
see. A very simple example to reason:
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EU: 1 car for every 10 carpets
Morocco: 1 car for every 20 carpets
They are worse making cars and best making carpets (for equal allocation of
resource)
What is the opportunity cost of cars/carpet / carpet/car in the EU and Morocco?:
UE 1c y 10 cp 2c
Marr 1c y 20 cp 40 cp 10 additional carpets
Thus, choice of specialization and trade
A country has a comparative advantage in the production of a good if the opportunity
cost in terms of other goods is less than that given in other countries. David Ricardo:
comparative advantage, early 19th
Two aspects of the Ricardian theory:
- (Very simple) arguments and models of general equilibrium
- Very common erroneous ideas
Ricardian model: the economics of a productive factor
Now L is not the same in each country
For the moment, just only one country, nothing to say about international trade.
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Restrictions:
- A productive factor: labour. Technology: L requirements (in hours) per
produced unit. L is the total supply of labour (limited resource, no change).
Two goods: wine and cheese (W) (C).
- Technical coefficients. It is important to stop to reason its meaning.
o a LC : hours to produce 1 kg of cheese
a LW : hours to produce one litre of wine
o How to interpret 1/a LC ?
Cheese production per hour worked. Total of cheese: L/ a LC
o a LC units: hours and 1/a LC : amount of cheese
o They not vary
- Competitive markets (including full labour mobility between sectors)
(PPF) production possibility frontier
Q C cheese production; Q W wine production
- a LC Q C : total amount of L used in making cheese
a LW Q W : total amount of L used in making wine
- Resources are limited: a Q Q Q + a V Q V L
- What would the be the productions "only cheese" and "only wine”?
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Q C = L/a LC
Q W = L/a LW
- What is and what it means a C /a W ? In what unit is measured?
Opportunity cost of cheese in terms of wine.
It coincides with the absolute value of the slope of the FPP
1 hour for 1 kg of cheese
2 hours for 1 litre of wine
Cost opportunity cheese/wine = ½
I have to make ½ liter of wine less in order to make 1 kg of cheese
QW
L/aLW
Slope: 1/2. Straight line when only one
factor: constant opportunity cost
L/aLC
QC
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A numerical example: a LC =1, a LW =2 y L=100. What is productivity in diferent
industries?
QW
L/aLW= 50
Slope: 1/2. Opportunity cost of cheese: ½ litre
of wine
QC
L/aLC= 100
Relative prices and supply
We know the production possibilities, but are they going to produce both goods?
We need relative prices (of each good depending on the other).
Perfect competition (there are no extraordinary profits).
So:
Wage = value of the marginal product
What means:
W C = P C /a LC
W W = P W /a LW
Why?
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Wage = value of what a worker can produce in an hour (price x quantity in an hour
1/a LC )
In addition, wages will be equal in the two sectors, why?: Suppose that in the cheese
sector wages are higher:
P C /a LC > P W /a LW
so
P C /P W > a LC /a LW (Oportunity cost of cheese in terms of wine)
Will work someone in wine? Is there wine production?
NO
So, both goods will be produced…
If P C /P W (relative prices)= a LC /a LW (opportunity costs)
Defining and reasoning in terms of opportunity costs and prices...
If the P C /P W price ratio is greater than the opportunity cost of the cheese in
relation to wine a LC /a LW , we produce just only cheese.
If there is no trade, our country will have to produce two goods, but does so only if
the relative price of cheese equals its opportunity cost.
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Trade in a world with a productive factor
Two countries
Foreign country is marked with * L*, a*LV y a*LQ
Let us assume, arbitrarily, that:
aLC/aLW < a*LC/a*LW
(relationship of unit requirements of job = opportunity cost)
(reduce less wine than abroad to have an additional unit of cheese)
Comparative advantage of our country in cheese and wine overseas
How would be a reasoning of absolute advantage?
Our country produces cheese with less work. aLC< a*LC
How would be the PPF from abroad?
Q*W
L*/a*LW
Higher slope (in absolute terms)
Opportunity cost of cheese in terms of wine, which in this country is higher
a LC /a LW < a*LC/a*LW
L*/a*LC
Q*C
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¿ What is the relationship between the relative prices in the two countries?
When there is no trade, (P C /P W = a LC /a LW ) < (P* C /P* W = a* LC /a* LW )
Are there incentives for international trade? Yes, we export cheese, they export wine,
until relative prices equalise. We demonstrate it right now.
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