Chapter 3 (everything but emperical evidence)

Comparative advantage

the ability of one producer of a good (country) to produce at a lower opportunity cost than another producer (country) - this allows gain from trade

Gains from trade

the improvement in outcomes that occurs when producers specialize and trade goods instead of staying in autarky

By trading, countries can consume the other good they don't have a comparative advantage in cheaper than producing at home

Unit labour requirement

The amount of labour required to produce one unit of the good (aL_i)

aLi is the inverse of productivity. If a worker can produce 3 units of a good in one hour, the productivity is 3, but the aLi=1/3, as it takes 1/3 of an hour to produce of unit of the good

Opportunity Cost

The trade-off when producing one good instead of another

The units of labour required to produce one unit of a good in terms of the labour required to produce another good

Production possibilities

An economy has scarce resources and can only produce a finite amount of goods. If it produces one more unit of one good, it will have to give up an amount of units of another good.

Production Possibility Frontiers (PPF)

(in this example from the foreign perspective)

Total resources in a one factor economy

The total labour supply, given by L

The PPF equation (how to rearrange the PPF inequality )

The items in red are the calculations

When the PPF is linear

The opportunity cost of producing one good in terms of the other is constant

The slope of the PPF

The absolute value is equal to the opportunity cost

Relative price

The price of one good in terms of the price of the other good

free labour mobility

labour will shift to the industry that has the highest wage and the economy will specialise in that good

wages, w_i

Generally, the price of the good/the unit labour requirements
In autarky, wages=price of the good. there's no profit in autarky

The relationship between prices and production

The economy will specialise in the production of Good Y if the relative price of Good Y exceeds its opportunity cost in terms of good X. It will specialise in Good X if the if the relative price of Good Y is less than its opportunity cost of Good Y in terms of Good X

Prices in autarky

Absolute advantage

When one country produce a good with less labour than the other country
- simply compare the unit labour requirements of each good in both countries

Intersects on the axis of the PPF

If the country only produced one of the goods
L/aL_i and L/aL_x

General equilibrium analysis

Considers linkages between two markets (Comparative advantage models)

Relative Demand (RD)

Shows the demand for Good X in relation to Good Y

Relative Supply (RS)

The curve has steps and a vertical section.
Lower flatter section - Home can produce any amount of good with comparative advantage within constraints, but Foreign only produces the good they have a comparative advantage in

Vertical section - Between these two relative prices (OCs), both countries specialise (full utilisation)

Higher - Home produce only the goods they have a comparative advantage in; Foreign produces any amount of their good within their resource constraint

Equilibrium

Where RD=RS

Free trade and consumption

Relative wages

One will have to compare relative unit labour requirements and relative wages in order to figure out what country will produce what

e.g., if the relative wage is 3 times higher in one country but they are not 3 times more effective in producing the good, the other country will have the comparative advantage

Myth: Free trade is only beneficial if your country is strong enough to stand up to foreign competition

The idea of Ricardo's comparative advantage model is not absolute advantage, but specialising in the good that your country produces more efficiently than your trading country.

Pauper labour argument

An argument that builds on the notion that " Foreign competition is unfair and hurts other countries when it is based on low wages"

- comparative advantage → what are differences in efficiency? Can our country produce it cheaper than foreign or should we import and specialise in the good we can export at a higher price?

Comparative advantage with many goods

Trade with many goods

Compare the w/w* and the a*Li/aLi - Home will export the goods where w/w*

Relative Supply (Multigood)

Is determined by the relative size of labour forces L/L*
Vertical line

Relative Demand (Multigood)

Stepped curve
Whenever the relative wages, w/w*, Home's relative demand for labour will decrease (now more expensive) and demand for goods produced at home will decrease. Now relatively cheaper to produce at foreign.

Home will export the goods where w/w*

Flat section of the multigood model

The flat areas correspond to relative wages that equal the ratio of Home to Foreign productivity of the goods

Multigood Equilibrium

RD=RS
In the example RD=RS=3 - Home will produce everything to the left and Foreign everything to the right of the RS line

IF RD=RS is at a flat point, both countries will produce that one good and the other goods as stated above