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Comparative Advantage (Ricardian Model) by mmw12015

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									                     FREC 410
 International Ag. Trade & Marketing

                                                                      Comparative Advantage
                                                                         (Ricardian Model)
                Dr. Titus Awokuse
                207 Townsend Hall
            Tel: 302-831-1323; Fax: 302-831-6243
                       kuse@udel.edu
http://www.udel.edu/FREC/Awokuse/FREC410_webpage.htm
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 Comparative Advantage                                         Principle of Comparative Advantage
 !   David Ricardo proposed the theory of C.A.
                                                           !   Gains from trade if:
 Ricardian “Law” of Comp. Advantage:                       !   A nation exports goods in which it has greatest C.A.
 A country has C.A. in the production a good if            !   A nation imports goods in which it has the least C.A.
   the Opportunity Cost (OC) or the Marginal
   Cost (MC) of producing that good in terms of
   other goods is lower in that country than in
   other countries.



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Opportunity Cost                                              Computers or Roses
!   Trade-offs/Choices:                                     Choice:
    Cost of what you choose to have in terms of             1 million Roses OR 10,000 Computers
    what you _______________                                  " O.C.   of 1 mil. Roses is 10,000 Computers
!   Fresh Roses in February                                   " O.C.   of 10,000 Computers is 1 mil. Roses
        " Grown   in greenhouses at high cost                 " O.C.  of producing Roses (in terms of computers)
        " Cheaper   thru int’l trade with S. America            in S.America will be less than in USA
        " Opportunity   cost of imports: some US jobs
                                                              Differences in O.C offers basis for mutually
                                                               __________ trade among nations

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    What’s Basis for Trade?                                  Comparative Advantage
                                                             Main Assumptions of Ricardian Model:
                                                             ! 2 countries – 2 commodities – 1 Factor of prodn
    !   Differences in relative prices (i.e. O.C)            ! Constant __________________
        reflects each nation’s C.A. and forms the            ! Perfect mobility of resources w/in nations, but
        basis for trade                                        immobility between nations
                                                             ! Zero transportation cost
                                                             ! Perfect competition prevails in all factor and
                                                                   product ________
                                                             ! Consumer tastes and preferences is ignored
                                                                " Focus only on production side, not
                                                                  consumption
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 Implications of Assumptions
                                                          Comparative Advantage
!   Complete specialization of both nations in the
    product in which they have a C.A.                     Basis for Trade?
!   Only the potential range of ______________            ! Differences in relative prices (i.e. O.C)

    can be determined – not specific terms of trade         reflects each nation’s C.A. and
                                                            ______________________________
    (TOT)
!   Production levels can be determined, but not
    the level of trade or consumption of either of the
    two commodities


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One Factor Economy                                            Unit Labor Requirement

!   Labor is the ONLY factor of production                !   Definition:
!   Labor productivity is expressed in terms of:          !   Is the # of hours of labor required to produce a
    unit labor requirement
                                                              gallon of wine (or pound of cheese)
!   Differences in labor productivity is viewed as
    basis for comparative advantage
                                                          !   Example:
!   Assume                                                    Wine:   1 hour of labor per gallon (aLW)
    " 2 countries: US and France
                                                              Cheese: 2 hours of labor per pound (aLC)
    " 2 commodities: Wine and Cheese
    " One factor of production – Labor Only
       ! _______________________
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Production Possibilities                                        Production Possibilities Frontier
Frontier (PPF)                                              !   PPF is a straight line if: only one Factor
                                                                " Wine and Chesse production: QW ; QC
!   Scarce resources implies trade-offs:                    !   PPF line equation: aLW QW + aLC QC = L
     " can produce more W if less C is produced
!   _______ shows the various possible
    combination of the 2 commodities that can be
    produced




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     Comparative Advantage: Review                      Opportunity Cost: Review
                                                        !   Since PPF is a straight line:
What is the Ricardian “Law” of Comparative                  " O.C of a gallon of wine in terms of cheese
 Advantage?                                                   is constant

                                                        !   Recall: O.C of Cheese is the # of gallons of
What is the basis for trade?                                Wine the economy give up to produce an
                                                            extra pound of cheese
                                                             " O.C. of C is: aLC/ aLW
                                                                ! 1 lb. of C cost: aLC person-hours

                                                                ! 1 gal. of W cost: aLW person-hours


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        Opportunity Cost
                                                          Who Trades in What?
    !   EXAMPLE:
    !   Let 1 lb. of C cost: aLC = 1
    !   Let 1 gal. of W cost: aLW = 2                     !     The ratio of the unit labor req. determines
    !   Then, O.C. of C is: aLC/ aLW =1/2                       who has ________________________
    !   Then, O.C. of W is: aLW/ aLC = 2
                                                                   " Countrywith lower unit labor req. in producing
                                                                    a commodity has comparative advantage in
                                                                    that commodity



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                                                              Who Trades in What?
        Who Trades in What?
                                                              Numerical Example
!   Ratio of the unit labor req (Same as Opport.                        Cheese    Wine           O.C.C            O.C.w
    Cost):                                                    US                             aLC/aLW = 1/2   aLW/ aLC = 2
                                                                       aLC = 1   aLW = 2
    aLC(us)/aLW(us) < aLC(France) /aLW(France)                France                         aLC/aLW = 6/3   aLW/ aLC = 3/6
                                                                       aLC = 6   aLW = 3

!   Comparative Advantage:                                !   US has lower unit labor req.
    " US    more productive in C than France                   " Higher   labor productivity
                                                          !   Relative price of C (Pc/Pw):
         ! US   has C.A. in production and export of C
                                                               " Range    b/w O.C. of C in both nations
    " France     more productive in W than US
                                                          !   US specialize in production and export of C
    " France     has C.A. in production and __________    !   France specialize in production and export of W

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Conclusion…
!   One Factor Economy - Labor only
!   Differences in _____________________ is viewed
    as basis for comparative advantage
!   This is only a partial explanation
    " Other  basis for trade (ignored by Ricardo’s model) is
      differences in countries resource endowments
    " E.g. Canada X lumber to US not b/c of higher
      productivity but b/c they have more forest land per capita
    " Weakness:     Exclusion of role of resource endowment
    "    We can improve Ricardian Model by allowing for other
        factors such as (K, land, and mineral resources)

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