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Goals Understand the Ricardian model of trade, in which trade is based on technological differences
Ricardian model Two goods: wine and cheese Two countries: H and F (*) MRTs are different for each country MRTs are constant (linear PPFs) Markets are competitive One productive resource: Labor[+] Labor is fixed in each country: cannot be exported Comparison between autarky (no trade) and trade Indifference curves are given but not explicitly drawn[+] All produced or producible productive wealth can beviewed as “stored” labor. Thus, given natural resources, laborcan be viewed as the sole resource.
Ricardian modelIn textbooks, the equation of the PPF for H is presented asfollows: L = aLC xC + aLW xWwhere aLC is the amount of labor required to produce oneunit of cheese, xC the amount of cheese produced, aLWthe amount of labor required to produce one unit of wine,and xW the amount of wine produced.The PPF equation for F will be similar but the variables willhave an asterisk (*). The a’s are called the “laborrequirements.”
ExampleConsider these two PPF equations: 100 = 2 xC + 4 xW 120 = 3 x*C + 3 x*WRearranging: xW = 25 – 0.5 xC x*W = 40 – x*Cwhich we’re more familiar with…This is to show you that you can always go (easily)from the textbook form of these equations to theform we learned in class.
Some points All is required for trade is CA. As long as the MRTs are not equal, the countries have a basis for trading. With equal MRTs, the basis for trade cannot be technology, i.e. resource requirement differences. (They may still trade on the basis of preference differences.) Without full employment, the model does not hold any longer as the MRTs are undefined. It highlights an important source of trade. Empirically: economists need to go and measure the effect of these difference in technology (MRTs) on observable trade. Results are mixed.