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Trade and Technology: The Ricardian Model
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

Questions to Consider

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1. What are reasons for countries to trade?
2. Willthecountrythatisbestatproducingagood always export it?
3. How can countries compete with low-wage exporters, like China?
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

Introduction
• Table 2-1 shows that the U.S. imported 366,089 snowboards from 19 countries in 2018 that were worth more than $28 million.
• This pattern raises a question: With all the manufacturing capability in the United States, why does it purchase snowboards from these countries at all instead of producing them domestically?
U.S. Imports of Snowboards, 2018
Value of Imports ($ thousands)
Quantity of Snowboards (thousands)
Average Price ($/board)
United Arab Emirates
Switzerland
Netherlands

All other countries
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

Why do Countries Trade?
• Click at the link below and enter your versions • https://padlet.com/vladimirtyazhelnikov/oh22fph46zd7e67e
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

Introduction
• Reasonscountriestradegoodswitheachother
– Differences in the technology used in each country (i.e., differences in each country’s ability to manufacture products)
– Differences in the total amount of resources (including labor, capital, and land) found in each country
– Differences in the costs of offshoring (i.e., producing the various parts of a good in different countries and then assembling them into the finished product in a final location)
– The proximity of countries to each other (i.e., how close they are to one another). The closer countries are, the lower the costs of transportation.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

Introduction
• Inthischapter,wefocusontechnology differences across countries as an explanation for trade, called the Ricardian model.
– The Ricardian model explains how the level of a country’s technology affects its trade pattern.
– It also explains the concept of comparative advantage and why it works as an explanation for trade patterns.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

1) Reasons for Trade (part 1)
• Proximity
– The closer countries are, the lower the costs of transportation. For example, the largest trading partner of many European countries is another European country.
• Resources
– Geography includes natural resources, as well as labor resources and capital. A country’s resources are often collectively called its factors of production, the land, labor, and capital used to produce goods and services.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

1) Reasons for Trade (part 2)
• AbsoluteAdvantage
– When a country has the best technology for producing a good, it has an absolute advantage in the production of that good.
– Absolute advantage is not a good explanation for trade patterns.
• ComparativeAdvantage
– Instead, comparative advantage is the primary explanation
for trade among countries.
– A country has comparative advantage in producing those goods that it produces best compared with how well it produces other goods.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

and Mercantilism
• Mercantilists believed that exporting was good because it generated gold and importing was bad because it drained gold from the national treasury.
• Mercantilists were in favor of high tariffs to ensure high exports and low imports.
• Ricardo showed that countries could benefit from international trade without having to use tariffs.
• Many of today’s major international institutions around the world were founded at least in part on the idea that free trade between countries brings gains for all trading partners.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

2) Ricardian Model of Trade (part 1)
The Home Country
• TodevelopaRicardianmodeloftrade,wewill use an example with two goods:
– Wheat and other grains are major exports of the United States and Europe.
– Many types of cloth are imported into these countries.
– For simplicity, we will ignore the role of land and capital and suppose that both goods are produced with labor alone.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

2) Ricardian Model of Trade (part 2)
The Home Country
• Weassumethatlaboristheonlyresourceused to produce goods. The marginal product of labor (MPL) is the extra output obtained by using one more unit of labor.
– In Home, one worker produces 4 bushels of wheat, so MPLW = 4.
– Alternatively, one worker can produce 2 yards of cloth, so MPLC = 2.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

2) Ricardian Model of Trade (part 3)
The Home Country
• HomeProductionPossibilitiesFrontier
– We can graph Home’s production possibilities frontier (PPF) using the marginal products for wheat and cloth.
– The slope of the PPF is also the opportunity cost of wheat, the amount of cloth that must be given up to obtain one more unit of wheat.
– If Home had 25 workers and all were employed in wheat, Home could produce 100 bushels. If all were employed in cloth, they could produce 50 yards.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

2) Ricardian Model of Trade (part 4)
The Home Country
• Home Production Possibilities Frontier
– The Home PPF is a straight line between 50 yards of cloth and 100 bushels of wheat.
– The slope of the PPF equals the negative of the opportunity cost of wheat. Equivalently, the magnitude of the slope can be expressed as the ratio of the marginal products of labor for the two goods.
FIGURE 2-1
SlopeofPPF=− 50 =−𝑀𝑃𝐿! 1𝐿2 =−𝑀𝑃𝐿! =−1 1 0 0 𝑀 𝑃 𝐿 ” 1 𝐿3 𝑀 𝑃 𝐿 ” 2
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

2) Ricardian Model of Trade (part 5)
The Home Country
• HomeIndifferenceCurve
– We will represent demand in the home economy using indifference curves that have the following properties:
– All points on an indifference curve have the same level of utility.
– Points on higher indifference curves have higher utility.
– Each indifference curve shows the combinations of two goods, such as wheat and cloth, that a person or economy can consume and be equally satisfied.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

2) Ricardian Model of Trade (part 6)
FIGURE 2-2
The Home Country
• Home Indifference Curve
– Points A and B lie on the same indifference curve and give the Home consumers the level of utility U1.
– The highest level of Home utility on the PPF is obtained at point A, which is the no-trade equilibrium.
– Point D is also on the PPF but would give lower utility.
– Point C represents a higher utility level but is off of the PPF, so it is not attainable in the absence of international trade.
Home Equilibrium with No Trade
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

2) Ricardian Model of Trade (part 7)
The Home Country • Home Equilibrium
– In the absence of international trade, the production possibilities frontier acts like a budget constraint for the country, and with perfectly competitive markets, the economy will produce at the point f highest utility subject to the limits imposed by its PPF.
– The point of highest utility is at point A in Figure 2-2, where Home consumes 25 yards of cloth and 50 bushels of wheat.
– We will refer to point A as the “no-trade” or the “pre- trade” equilibrium for Home.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

2) Ricardian Model of Trade (part 8)
The Home Country
• OpportunityCostandPrices
– The slope of the PPF reflects the opportunity cost of producing one more bushel of wheat.
– Under perfect competition the opportunity cost of wheat should also equal the relative price of wheat.
– Price reflects the opportunity cost of a good.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

2) Ricardian Model of Trade (part 9)
The Home Country • Wages
– In competitive markets, firms hire workers up to the point at which the hourly wage equals the value of one more hour of production.
– The value of one more hour of labor equals the amount of goods produced in that hour (MPL) times the price of the good.
– Labor will be hired up to the point where wage equals P • MPL for each industry.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

2) Ricardian Model of Trade (part 10)
The Home Country • Wages
– Use the equality of the wage across industries to obtain the following equation:
PW •MPLW =PC •MPLC
– Rearranging terms, we see that
PW /PC = MPLC /MPLW
– The right-hand side of the equation is the slope of the production possibilities frontier (the opportunity cost of one more bushel of wheat).
– The left-hand side of the equation is the relative price of wheat.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

2) Ricardian Model of Trade (part 11)
• TheForeignCountry
– Assume a Foreign worker can produce 1 bushel of wheat
or 1 yard of cloth.
MPL*W = 1, MPL*C = 1
– Assume there are 100 workers available in Foreign.
– If all workers were employed in wheat, they could produce 100 bushels.
– If all workers were employed in cloth, they could produce 100 yards.
– It is worth noting that Home has absolute advantage in both goods but will export only one, as explained later.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

2) Ricardian Model of Trade (part 12)
The Foreign Country
• The Foreign Production Possibilities Frontier
– The Foreign PPF is a straight line between 100
yards of cloth and 100 bushels of wheat.
– The slope of the PPF equals the negative of the opportunity cost of wheat.
– The opportunity cost is the amount of cloth that must be given up (1 yard) to obtain 1 more bushel of wheat.
FIGURE 2-3
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

2) Ricardian Model of Trade (part 13)
• The Foreign Country
• Comparative Advantage
– A country has a comparative advantage in a good when it has a lower opportunity cost of producing than another country.
– By looking at the chart we can see that Foreign has a comparative advantage in producing cloth. Home has a comparative advantage in producing wheat.
Cloth (1 Yard)
Wheat (1 Bushel)
2 Bushels of Wheat
1⁄2 Yard of Cloth
1 Bushel of Wheat
1 Yard of Cloth
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

2) Ricardian Model of Trade (part 14)
The Foreign Country
• Comparative Advantage
– The highest level of Foreign utility on the PPF is obtained at point A*, which is the no-trade equilibrium.
FIGURE 2-4
Foreign Equilibrium with No Trade
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

Application: Comparative Advantage in Apparel, Textiles, and Wheat
This table presents sales per employee for the apparel and textile industries in the United States and China, as well as bushels per hour in producing wheat. The United States has an absolute advantage in all of these products. But China has a lower opportunity cost and a comparative advantage in producing textiles and apparel.
Apparel, Textiles, and Wheat in the United States and China
United States
Absolute Advantage
Sales/Employee
Sales/Employee
U.S./China Ratio
Bushels/Worker
Bushels/Worker
U.S./China Ratio
Comparative Advantage: United States
Comparative Advantage: China
Opportunity cost of apparel
Opportunity cost of textiles
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

3) Determining the Pattern of International Trade (part 1)
• InternationalTradeEquilibrium
– What happens when goods are traded between
Home and Foreign? We will see:
– That a country’s no-trade relative price determines which product it will export and which it will import
– The no-trade relative price equals its opportunity cost of production
– The pattern of exports and imports will be determined by the opportunity costs of production in each country—their comparative advantage
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

3) Determining the Pattern of International Trade (part 2)
• InternationalTradeEquilibrium
– Examining each country’s no-trade relative price, we can determine which product it will export and which it will import.
– The relative price of cloth in Foreign is PC /PW = 1.
– The relative price of cloth in Home is PC /PW = 2.
– Therefore, Foreign would want to export cloth to Home if they can make it for $1 and export it for more than $1.
– Home will export wheat, and Foreign will export cloth.
– Both countries export the good for which they have the comparative advantage.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

3) Determining the Pattern of International Trade (part 3)
• InternationalTradeEquilibrium
– The two countries are in an international trade equilibrium when the relative price of wheat is the same in the two countries.
– To fully understand the international trade equilibrium, we are interested in two issues:
– Determining the relative price of wheat (or cloth) in the trade equilibrium
– Seeing how the shift from the no-trade equilibrium to the trade equilibrium affects production and consumption in both Home and Foreign
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

3) Determining the Pattern of International Trade (part 4)
• InternationalTradeEquilibrium
– The relative price of wheat in the trade equilibrium will
be between the no-trade price in the two countries.
– For now assume that the free-trade price of PW /PC is
!” (between the price of #! in Home and 1 in Foreign).
– We can now take this price and see how trade
changes production and consumption in each country.
– The world price line shows the range of consumption possibilities that a country can achieve by specializing in one good and engaging in international trade.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

3) Determining the Pattern of International Trade (part 5)
FIGURE 2-5 (1 of 3)
International Trade Equilibrium
• ChangeinProduction and Consumption
– With a world relative price of wheat of !”, Home production will occur at point B.
Home Equilibrium with Trade
in exchange for !” yard of cloth.
– Through international trade, Home is able to export each bushel of wheat it produces
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

3) Determining the Pattern of International Trade (part 6)
FIGURE 2-5 (2 of 3)
International Trade Equilibrium
• ChangeinProduction and Consumption
– As wheat is exported, Home moves up the world price line BC. Home consumption occurs at point C, at the tangent intersection with indifference curve U2, since this is the highest possible utility curve on the world price line.
Home Equilibrium with Trade
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

3) Determining the Pattern of International Trade (part 7)
FIGURE 2-5 (3 of 3)
International Trade Equilibrium
• Change in Production and Consumption
– Given these levels of production and consumption, we can see that total exports are 60 bushels of wheat in exchange for imports of 40 yards of cloth and also that Home consumes 10 fewer bushels of wheat and 15 more yards of cloth relative to its pre-trade levels.
Home Equilibrium with Trade
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

3) Determining the Pattern of International Trade (part 8)
FIGURE 2-5 (revisited)
International Trade Equilibrium
• International Trade
– Home obtains a higher utility
with international trade than in the absence of trade (U2 is higher than U1).
– The finding that Home’s utility increases with trade is our first demonstration of the gains from trade.
Home Equilibrium with Trade
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

3) Determining the Pattern of International Trade (part 9)
FIGURE 2-6 (1 of 2)
International Trade Equilibrium
• PatternsofTradeand Gains from Trade
– With a world relative price of wheat of !”, Foreign
production will occur at point B*.
Foreign Equilibrium with Trade
exchange for 1 bushel of wheat, moving down the world price line.
– Through international trade, Foreign is able to
export !” yard of cloth in
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

3) Determining the Pattern of International Trade (part 10)
FIGURE 2-6 (2 of 2)
International Trade Equilibrium
• Patterns of Trade and Gains from Trade
– Foreign consumption occurs at point C*, and total exports are 40 yards of cloth in exchange for imports of 60 bushels of wheat. Relative to its pre-trade wheat and cloth * consumption (point A ), Foreign consumes 10 more bushels of wheat and 10 more yards of cloth.
Foreign Equilibrium with Trade
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

3) Determining the Pattern of International Trade (part 11)
• InternationalTradeEquilibrium
• PatternsofTradeandGainsfromTrade
– Each country is exporting the good for which it has the comparative advantage.
• This confirms that the pattern of trade is determined by comparative advantage.
– This is the first lesson of the Ricardian model.
– There are gains from trade for both countries. – This is the second lesson of the Ricardian model.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

3) Determining the Pattern of International Trade (part 12)
• SolvingforWagesAcrossCountries 𝑴𝑷𝑳𝒘 = 𝟒 𝐛𝐮𝐬𝐡𝐞𝐥𝐬 𝐨𝐟 𝐰𝐡𝐞𝐚𝐭
Home Wage = ! 𝒐𝒓
𝑷 4 .𝑴𝑷𝑳 = 𝟖 𝐲𝐚𝐫𝐝𝐨𝐟𝐜𝐥𝐨𝐭𝐡
Absolute Advantage
– As our example shows, wages are determined by absolute advantage. In contrast, the pattern of trade in the Ricardian model is determined by comparative advantage.
𝐅𝐨𝐫𝐞𝐢𝐠𝐧 𝐖𝐚𝐠𝐞 =
(𝑷∗𝑪4𝑷∗𝑾) A 𝑴𝑷𝑳∗𝑪 = 𝟑𝟐 𝐛𝐮𝐬𝐡𝐞𝐥𝐬 𝐨𝐟 𝐰𝐡𝐞𝐚𝐭
𝑴𝑷𝑳𝑪 = 𝟏 𝐲𝐚𝐫𝐝 𝐨𝐟 𝐜𝐥𝐨𝐭𝐡
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

Application: Labor Productivity and Wages (part 1)
FIGURE 2-7
Labor Productivity and Wages, 2012 Labor productivity is measured by value-added per hour of work and can be compared with the wages paid in manufacturing in various countries.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

Application: Labor Productivity and Wages (part 2)
FIGURE 2-8
• Thetrendsinlabor productivity and real wages in manufacturing can also be graphed over time.
• Thegeneralupward movement in labor productivity is matched by upward movements in wages, as predicted by the Ricardian model.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor

Application: Labor Productivity and Wages (part 3)
FIGURE 2-9
• The trends in labor productivity and real wages are shown for the business sector, including the production of goods and services, in the United States.
• When the real wage is measured relative to the business sector prices, then its growth is similar to labor productivit

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