International Economics: Ricardian Model

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Introduction to International Economics

• Group work precedes lecture-discussion.
• Group work must be face-to-face.
• Rotate roles; facilitator & documentor.
• Peer-grading is used to prevent free-riding.
• Innovations from students are welcome.
• Instructor should be informed of learning/personal issues.
• The class is a community of learners.
• Grading:
  • 33% Group work: Peer-grading to prevent free-riding.
  • Grade based on participation level.
  • 33% Midterms and 33% Finals

Chapter 3: Labor Productivity and Comparative Advantage: The Ricardian Model

• Trade is a path to peace
• Markets/trade is beneficial.
• Premises of trade: diversity and scale economies which lead to price differences and arbitrage.
• Comparative advantage is lower for goods/services one doesn't specialize in.
• Ricardian model is based on technology, productivity.
• Labor is cost, determines price, whole economy.
• Efficiency of labor depends on tech
• More efficient tech means less labor required
• Unit labor requirement represents inverse of productivity.
• Less input results in more productive/output.
• Key elements in model include a and Land
• In autarky, for both products to be produced, wages between industries.
• Wage is price/unit labor requirement
• For trade, relative prices must differ from relative a₁

Chapter 4: Specific Factors Model

• Asks: Why does trade create winners and losers?
• Reality: land and capital are stuck in certain sectors.
• Political economy of trade: country gains in general, but there are losers and the losses which are not fully compensated.
• Created by Paul Samuelson & Ronald Jones.
• There are 3 Factors: labor (mobile), capital (specific), land (specific).
• Labor moves to highest wages
• Trade shifts production: comparative advantage industries expand and others shrink
• Winners are capital owners in expanding sectors and losers are capital & landowners in shrinking sectors.
• Assumptions:
  • 2 goods (typically, manufactures and agri)
  • 3 factors (L, K, land)
  • perfect competition, CRS
  • Manufactures (labor and capital)
  • Agri (labor and land)
  • Labor can move between sectors
  • Land and capital are both sticky factors
• Questions:
  • What are the production possibilities given resources and technology?
• Returns to factors of production have major impact
• Trade shifts relative prices of goods affecting labor returns.
• Tool kit to understand is begin with characteristics of each product (typified by production function)
• What makes opportunity costs rise?
  • PPF slope = opportunity cost of product A in terms of product B.
  • Low marginal returns = high opportunity cost
• Ricardian: how much labor to produce 1 unit of output is relevant.
• Opportunity cost is slope of PPF = MPL(A)/ MPL(B)
• The Ricardian-Viner states that slopes are at each point in PPF
• Value produced by an additional hour Price is X MPL = marginal cost of L = W

Factors Proportions and Trade

• Ricardian:
  • Differences in labor productivities (same endowments)
  • Only one technology for producing a good
• Heckscher-Ohlin:
  • Differences in endowments (same labor productivities)
  • Technology could be labor-saving or capital-saving,
  • called the factors proportion theory
• 2 countries, 2 goods, 2 factors (2X2X2.)
• Free factor mobility (no sticky sectors!)
• Countries have different relative endowments
• Production uses factors with different relative intensity
• Cloth is labor-intensive Food is capital-intensive
• Same technology used to produces two goods are identical across countries
• Same tastes (homothetic preferences)
• A sector is 'labor intensive' if it requires more labor per unit of capital compared to the other sector
• Wage is described as a payment to Labor while rental rate is payment to K
• Ratio of rental rate/wage is important to know
• Tech allows different combinations of L & K to make cloth / food

Stolper-Samuelson Theorem

• If relative price of good increases, then the income of factor used intensively in the production of that good increases, while the factor income of the other factor decreases.
• Factors:
  • Change in relative prices will change income distribution!!
  • Trade hurts one and benefits the other.
  • raise real income of workers and lower real income of K owners

Factor Price Equalization

• Unlike Ricardian, HO model predicts FPE
• Free trade equalizes relative prices
• Link of prices factor prices so FPE
• Trade raises demand of good produced by relatively abundant factors, indirectly increasing demand of these factors, raising the prices (and incomes) of relatively abundant factors
• There is a tendency towards FPE

Comparative vs Competitive Advantage

• Applications are trade relationships, effects of growth, policy and global market shifts on terms of trade & welfare
• Export-biased growth and its effects are worth noting.
• Immiserizing growth in developing countries are important to consider.
• Tariffs and Export subsidies may play a role
• Impact of US trade policies today