Podcast
Questions and Answers
What does a high unit labor requirement indicate about productivity?
What does a high unit labor requirement indicate about productivity?
Which equation correctly represents the production possibility frontier (PPF)?
Which equation correctly represents the production possibility frontier (PPF)?
What occurs when the relative price of cheese falls below the opportunity cost of cheese in both countries?
What occurs when the relative price of cheese falls below the opportunity cost of cheese in both countries?
What situation arises when the relative price of cheese equals the opportunity cost of cheese in the home country?
What situation arises when the relative price of cheese equals the opportunity cost of cheese in the home country?
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How can comparative advantage in cheese production be determined?
How can comparative advantage in cheese production be determined?
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What happens to the world relative supply of cheese if the relative price of cheese rises above its opportunity cost in both countries?
What happens to the world relative supply of cheese if the relative price of cheese rises above its opportunity cost in both countries?
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If workers only produce cheese, what condition must hold true regarding the wages for cheese and wine?
If workers only produce cheese, what condition must hold true regarding the wages for cheese and wine?
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What can be inferred if the opportunity cost of producing cheese is lower in Home compared to Foreign?
What can be inferred if the opportunity cost of producing cheese is lower in Home compared to Foreign?
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What is the main cause of trade according to the Ricardian model?
What is the main cause of trade according to the Ricardian model?
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Which of the following is NOT one of the assumptions of the Ricardian model?
Which of the following is NOT one of the assumptions of the Ricardian model?
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In the context of trade, what does comparative advantage refer to?
In the context of trade, what does comparative advantage refer to?
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What is meant by 'gains from trade'?
What is meant by 'gains from trade'?
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Which of the following best describes economies of scale?
Which of the following best describes economies of scale?
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Study Notes
Theories of Trade
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Difference-based models: Focus on countries' varying labor skills, natural resources, and technology—yielding different productivity advantages.
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Economies of scale models: Emphasize efficiency gains from specialization, where countries specialize in certain products to benefit from larger-scale production.
Ricardian Model
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Trade driver: Differences in relative labor productivity across countries.
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Opportunity cost: The cost of foregoing producing one good because resources are dedicated to another good.
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Comparative advantage: Advantage in producing a good with a lower opportunity cost compared to other countries.
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Gains from trade: Increased production and consumption of goods compared to self-sufficiency.
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Assumptions:
- Labor is the only factor of production.
- Labor productivity differs across countries and is constant.
- Labor supply and quantity of goods are fixed.
- Only two goods are produced and consumed.
- Perfect competition, free entry/exit, and labor mobility.
- Two countries (Home and Foreign).
- No transportation costs.
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Production possibilities frontier (PPF): Represents the maximum output combinations using available resources.
- Defined by the amount of labor and unit labor requirements (lower unit labor requirement means higher productivity).
- Formula:
aLC * QC + aLW * QW = L(where L is total labor hours, aLC and aLW are unit labor requirements for cheese and wine, Q represents the quantities of each).
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Relative Prices and Opportunity Cost:
- Opportunity cost of cheese in terms of wine =
aLC / aLW. - Equilibrium occurs when wages for producing wine and cheese are equal, represented by
PC / aLC = PW / aLW, leading toPC / PW = aLC / aLW.
- Opportunity cost of cheese in terms of wine =
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Comparative Advantage Example:
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If Home has a lower opportunity cost for cheese production (
aLW/aLC < a*LW/a*LC), then Home will have a comparative advantage in producing cheese. This comparative advantage leads to beneficial trade. -
Relative Price and Trade:
- If Home’s relative price of cheese is lower its opportunity cost, thus exporting to foreign country is profitable.
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World Relative Supply (RS): The relationship between the relative quantities of cheese and wine supplied by all countries:
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RS Values: The world supply is affected by the price of cheese relative to the opportunity costs for both countries.
- If
PC / PWis lower than both home and foreign countries' opportunity cost of cheese production (comparative advantage), world supply is zero. - If
PC / PWis higher than both countries' opportunities cost, then the world supply is infinite. - If
PC / PWis equal to the opportunity cost of cheese in the home country, then the world relative supply (RS) is between 0 and infinity (in practice).
- If
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RS Values: The world supply is affected by the price of cheese relative to the opportunity costs for both countries.
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Description
This quiz explores the fundamental theories of trade, focusing on difference-based models and economies of scale. It delves into the Ricardian Model, emphasizing concepts like comparative advantage and opportunity cost. Test your understanding of how these theories explain international trade dynamics.
