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1、Slides prepared by Thomas BishopCopyright 2009 Pearson Addison-Wesley.All rights reserved.Chapter 3Labor Productivity and Comparative Advantage:The Ricardian ModelPreviewOpportunity costs and comparative advantageA one factor Ricardian modelProduction possibilities Gains from tradeWages and tradeMis
2、conceptions about comparative advantageTransportation costs and non-traded goodsEmpirical evidence2Copyright 2009 Pearson Addison-Wesley.All rights reserved.IntroductionTheories of why trade occurs can be grouped into three categories:Market size and distance between markets determine how much count
3、ries buy and sell.These transactions benefit both buyers and sellers.Differences in labor,labor skills,physical capital,natural resources,and technology create productive advantages for countries.Economies of scale(a larger scale is more efficient)create productive advantages for countries.3Copyrigh
4、t 2009 Pearson Addison-Wesley.All rights reserved.Introduction(cont.)The Ricardian model(chapter 3)says differences in the productivity of labor between countries cause productive differences,leading to gains from trade.Differences in productivity are usually explained by differences in technology.T
5、he Heckscher-Ohlin model(chapter 4)says differences in labor,labor skills,physical capital,land,or other factors of production between countries cause productive differences,leading to gains from trade.4Copyright 2009 Pearson Addison-Wesley.All rights reserved.Comparative Advantage and Opportunity C
6、ostThe Ricardian model uses the concepts of opportunity cost and comparative advantage.The opportunity cost of producing something measures the cost of not being able to produce something else because resources have already been used.5Copyright 2009 Pearson Addison-Wesley.All rights reserved.Compara
7、tive Advantage and Opportunity Cost(cont.)Patrick Buchannan,(1996)A country faces opportunity costs when it employs resources to produce goods and services.For example,a limited number of workers could be employed to produce either roses or computers.The opportunity cost of producing computers is th
8、e amount of roses not produced.The opportunity cost of producing roses is the amount of computers not produced.A country faces a trade off:how many computers or roses should it produce with the limited resources that it has?6Copyright 2009 Pearson Addison-Wesley.All rights reserved.Comparative Advan
9、tage and Opportunity Cost(cont.)Suppose that in the U.S.10 million roses could be produced with the same resources that could produce 100,000 computers.Suppose that in Ecuador 10 million roses could be produced with the same resources that could produce 30,000 computers.Workers in Ecuador would be l
10、ess productive than those in the U.S.in manufacturing computers.Quick quiz:what is the opportunity cost for Ecuador if it decides to produce roses?7Copyright 2009 Pearson Addison-Wesley.All rights reserved.Comparative Advantage and Opportunity Cost(cont.)Ecuador has a lower opportunity cost of produ
11、cing roses.Ecuador can produce 10 million roses,compared to 30,000 computers that it could otherwise produce.The US can produce 10 million roses,compared to 100,000 computers that it could otherwise produce.8Copyright 2009 Pearson Addison-Wesley.All rights reserved.Comparative Advantage and Opportun
12、ity Cost(cont.)The US has a lower opportunity cost of producing computers.Ecuador can produce 30,000 computers,compared to 10 million roses that it could otherwise produce.The US can produce 100,000 computers,compared to 10 million roses that it could otherwise produce.The US can produce 30,000 comp
13、uters,compared to 3.3 million roses that it could otherwise produce.9Copyright 2009 Pearson Addison-Wesley.All rights reserved.Comparative Advantage and Opportunity Cost(cont.)A country has a comparative advantage in producing a good if the opportunity cost of producing that good is lower in the cou
14、ntry than it is in other countries.A country with a comparative advantage in producing a good uses its resources most efficiently when it produces that good compared to producing other goods.10Copyright 2009 Pearson Addison-Wesley.All rights reserved.Comparative Advantage and Opportunity Cost(cont.)
15、The U.S.has a comparative advantage in computer production:it uses its resources more efficiently in producing computers compared to other uses.Ecuador has a comparative advantage in rose production:it uses its resources more efficiently in producing roses compared to other uses.Suppose initially th
16、at Ecuador produces computers and the U.S.produces roses,and that both countries want to consume computers and roses.Can both countries be made better off?11Copyright 2009 Pearson Addison-Wesley.All rights reserved.Comparative Advantage and TradeMillions of RosesThousands of ComputersU.S.-10+100Ecua
17、dor+10-30Total0+7012Copyright 2009 Pearson Addison-Wesley.All rights reserved.Comparative Advantage and Trade(cont.)In this simple example,we see that when countries specialize in production in which they have a comparative advantage,more goods and services can be produced and consumed.Initially bot
18、h countries could only consume 10 million roses and 30 thousand computers.If they produce goods in which they had a comparative advantage,they could still consume 10 million roses,but could consume 100,000 30,000=70,000 more computers.13Copyright 2009 Pearson Addison-Wesley.All rights reserved.A One
19、 Factor Ricardian ModelThe simple example with roses and computers explains the intuition behind the Ricardian model.We formalize these ideas by constructing a slightly more complex one factor Ricardian model using the following simplifying assumptions:14Copyright 2009 Pearson Addison-Wesley.All rig
20、hts reserved.A One Factor Ricardian Model(cont.)1.Labor services are the only resource important for production.2.Labor productivity varies across countries,usually due to differences in technology,but labor productivity in each country is constant across time.3.The supply of labor services in each
21、country is constant.4.Only two goods are important for production and consumption:wine and cheese.5.Competition allows workers to be paid a“competitive”wage,a function of their productivity and the price of the good that they can sell,and allows them to work in the industry that pays the highest wag
22、e.6.Only two countries are modeled:domestic and foreign.15Copyright 2009 Pearson Addison-Wesley.All rights reserved.A One Factor Ricardian Model(cont.)Because labor productivity is constant,define a unit labor requirement as the constant number of hours of labor required to produce one unit of outpu
23、t.aLW is the unit labor requirement for wine in the domestic country.For example,if aLW=2,then it takes 2 hours of labor to produce one liter of wine in the domestic country.aLC is the unit labor requirement for cheese in the domestic country.For example,if aLC=1,then it takes 1 hour of labor to pro
24、duce one kg of cheese in the domestic country.A high unit labor requirement means low labor productivity.16Copyright 2009 Pearson Addison-Wesley.All rights reserved.A One Factor Ricardian Model(cont.)Because the supply of labor is constant,denote the total number of labor hours worked in the domesti
25、c country as a constant number L.17Copyright 2009 Pearson Addison-Wesley.All rights reserved.Production PossibilitiesThe production possibility frontier(PPF)of an economy shows the maximum amount of a goods that can be produced for a fixed amount of resources.If QC represents the quantity of cheese
26、produced and QW represents the quantity of wine produced,then the production possibility frontier of the domestic economy has the equation:aLCQC+aLWQW=LTotal units of wine productionLabor required for each unit of cheese productionTotal units of cheese productionLabor required for each unit of wine
27、productionTotal amount of labor resources18Copyright 2009 Pearson Addison-Wesley.All rights reserved.Fig.3-1:Homes Production Possibility Frontier 19Copyright 2009 Pearson Addison-Wesley.All rights reserved.Production Possibilities(cont.)aLCQC+aLWQW=LQC=L/aLC when QW=0QW=L/aLW when QC=0QW=L/aLW (aLC
28、/aLW)QC:the equation for the PPF,with a slope equal to (aLC/aLW)When the economy uses all of its resources,the opportunity cost of cheese production is the quantity of wine that is given up(reduced)as QC increases:(aLC/aLW)When the economy uses all of its resources,the opportunity cost is equal to t
29、he absolute value of the slope of the PPF,and it is constant when unit labor requirements are constant.20Copyright 2009 Pearson Addison-Wesley.All rights reserved.Production Possibilities(cont.)To produce an additional kg of cheese requires aLC hours of work.Each hour devoted to cheese production co
30、uld have been used to produce a certain amount of wine instead,equal to1 hour/(aLW hours/liter of wine)=(1/aLW)liter of wineFor example,if 1 hour is moved to cheese production,that additional hour of labor could have produced 1 hour/(2 hours/liter of wine)=1/2 liter of wine.The trade-off is the incr
31、eased amount of cheese relative to the decreased amount of wine:aLC/aLW.21Copyright 2009 Pearson Addison-Wesley.All rights reserved.Production Possibilities(cont.)In general,the amount of the domestic economys production is defined by aLCQC+aLWQW LThis describes what an economy can produce,but to de
32、termine what the economy does produce,we must determine the prices of goods.22Copyright 2009 Pearson Addison-Wesley.All rights reserved.Production,Prices and WagesLet PC be the price of cheese and PW be the price of wine.Because of competition,hourly wages of cheese makers are equal to the market va
33、lue of the cheese produced in an hour:PC/aLChourly wages of wine makers are equal to the market value of the wine produced in an hour:PW/aLWBecause workers like high wages,they will work in the industry that pays a higher hourly wage.23Copyright 2009 Pearson Addison-Wesley.All rights reserved.Produc
34、tion,Prices and Wages(cont.)If PC/aLC PW/aLW workers will make only cheese.If PC/PW aLC/aLW workers will only make cheese.The economy will specialize in cheese production if the price of cheese relative to the price of wine exceeds the opportunity cost of producing cheese.If PC/aLC PW/aLW workers wi
35、ll make only wine.If PC/PW aLW/aLC workers will only make wine.The economy will specialize in wine production if the price of wine relative to the price of cheese exceeds the opportunity cost of producing wine.24Copyright 2009 Pearson Addison-Wesley.All rights reserved.Production,Prices and Wages(co
36、nt.)If the domestic country wants to consume both wine and cheese(in the absence of international trade),relative prices must adjust so that wages are equal in the wine and cheese industries.If PC/aLC=PW/aLW workers will have no incentive to work solely in the cheese industry or the wine industry,so
37、 that production of both goods can occur.PC/PW=aLC/aLW Production(and consumption)of both goods occurs when the relative price of a good equals the opportunity cost of producing that good.25Copyright 2009 Pearson Addison-Wesley.All rights reserved.Trade in the Ricardian ModelSuppose that the domesti
38、c country has a comparative advantage in cheese production:its opportunity cost of producing cheese is lower than it is in the foreign country.aLC/aLW a*LC/a*LW where“*”notates foreign country variablesWhen the domestic country increases cheese production,it reduces wine production less than the for
39、eign country would because the domestic unit labor requirement of cheese production is low compared to that of wine production.26Copyright 2009 Pearson Addison-Wesley.All rights reserved.Trade in the Ricardian Model(cont.)Suppose the domestic country is more efficient in wine and cheese production.I
40、t has an absolute advantage in all production:its unit labor requirements for wine and cheese production are lower than those in the foreign country:aLC a*LC and aLW a*LWA country can be more efficient in producing both goods,but it will have a comparative advantage in only one goodthe good that use
41、s resources most efficiently compared to alternative production.27Copyright 2009 Pearson Addison-Wesley.All rights reserved.Trade in the Ricardian Model(cont.)Even if a country is the most(or least)efficient producer of all goods,it still can benefit from trade.To see how all countries can benefit f
42、rom trade,we calculate relative prices when trade exists.Without trade,the relative price of a good equals the opportunity cost of producing that good.To calculate relative prices with trade,we first calculate relative quantities of world production:(QC+Q*C)/(QW+Q*W)28Copyright 2009 Pearson Addison-
43、Wesley.All rights reserved.Relative Supply and Relative DemandNext we consider relative supply of cheese:the quantity of cheese supplied by all countries relative to the quantity of wine supplied by all countries at each price of cheese relative to the price of wine,Pc/PW.29Copyright 2009 Pearson Ad
44、dison-Wesley.All rights reserved.Relative Supply and Relative Demand(cont.)aLC/aLWa*LC/a*LWRSRelative priceof cheese,PC/PWRelative quantityof cheese,QC+Q*C QW+Q*WL/aLCL*/a*LW30Copyright 2009 Pearson Addison-Wesley.All rights reserved.Relative Supply and Relative Demand(cont.)There is no supply of ch
45、eese if the relative price of cheese falls below aLC/aLW.Why?because the domestic country will specialize in wine production whenever PC/PW aLC/aLW And we assumed that aLC/aLW Pc/PW aLC/aLW,domestic workers specialize in cheese production because they can earn higher wages,but foreign workers will s
46、till produce only wine.When a*LC/a*LW =PC/PW,foreign workers will be indifferent between producing wine or cheese,but domestic workers will still produce only cheese.There is no supply of wine if the relative price of cheese rises above a*LC/a*LW 32Copyright 2009 Pearson Addison-Wesley.All rights re
47、served.Relative Supply and Relative Demand(cont.)Relative demand of cheese is the quantity of cheese demanded in all countries relative to the quantity of wine demanded in all countries at each price of cheese relative to the price of wine,PC/PW.As the price of cheese relative to the price of wine r
48、ises,consumers in all countries will tend to purchase less cheese and more wine so that the relative quantity of cheese demanded falls.33Copyright 2009 Pearson Addison-Wesley.All rights reserved.Relative Supply and Relative Demand(cont.)RD1aLC/aLWa*LC/a*LWRSRelative priceof cheese,PC/PWRelative quan
49、tityof cheese,QC+Q*C QW+Q*WL/aLCL*/a*LW34Copyright 2009 Pearson Addison-Wesley.All rights reserved.Fig.3-3:World Relative Supply and Demand35Copyright 2009 Pearson Addison-Wesley.All rights reserved.Gains From TradeGains from trade come from specializing in the type of production which uses resource
50、s most efficiently,and using the income generated from that production to buy the goods and services that countries desire.where“using resources most efficiently”means producing a good in which a country has a comparative advantage.Domestic workers earn a higher income from cheese production because