W2 - Comparative Advantage - Ricardo

when does a country have comparative advantage

lower OC than competitors

unit labour requirement (2)

number of hours to produce one unit

high = low productivity

unit labour symbol

a

who has ABSOLOUTE advantage

portugal

what does Ricardian model seek to prove?

There are gains from specilaisation and trade liberalisation leads to price convergence

what determines how much a country can produce

labour endowment and technology

slope of PPF is equal to (3)

opportunity cost of producing one good relative to another good

ratio of unit labour requirements

how much of x you must sacrifice for y

Formula for production possibility of a good (Q)

Q = L/ax

labour hours formula

awQw + acQc

opportunity cost of x formula

ax/ay

Who has comparative advantage in each good

ax/ay

ac/aw

2/3

1/2

for every sweater produced UK gives up 2/3 wine bottles

for every sweater produced Portugal gives up ½ a bottle of wine

Portugal has comparative advantage in sweaters

how do you tell who has comparitive advantage in producing a good

whoever has lower opportunity cost

if the opportunity cost for cloth relative to wine is ac/aw = 2/3, to produce one sweater, how much wine must they sacrifice

2/3 of a bottle

if a firm wants to produce +50x, how much of y must they sacrifice

50(x/y)

50 (2/3)

50 × 0.66

when will a country be happy to produce and export a good

explain then give formula

if the price at which they sell it is lower than the price at which they sell

pc/pw > ac/aw

what is the relative price of cloth in terms of wine

explain then formula

the amount of wine that can be exchanged for cloth

pc/pw

relative cost (same as opportunity cost)

ac/aw

if pc/pw > ac/aw who exports what

everyone will produce cloth and no one will produce wine due to no profits

assumption of relative price model

price of good is equal to its unit labour requirement

if the price of cloth increases relative to its cost (unit labour requriement) what happens to the quantity produced

supply more cloth instead of wine

why does world supply of cloth relative to wine jump

world supply jumps when prices exceed the opportunity cost, so Q increases

jump is where UK enters the market as they have a higher opportunity cost

maximum cloth production possibility formula

L/ac

why is RS curve initially flat

because portugal can produce at any Q it likes until it reaches maximum quantity based on labour endowement

what happens at equilibrium between world supply, demand and price

price is between different auturky prices so as specialisation takes place prices converge

why do prices converge in case of portugal

because world supply expands beyond portugal and other countries enter market and demand forces prices to converge

why would relative demand curve be low at RD’

UK’s relative price of cloth is below cost so they only produce wine and Portugal has monopoly in cloth

what happens to consumption when countries specialialise and engage in global trade?

consumption possibilites expand beyond production possibility frontier as countries can engage with cheaper world price of cloth Q = L/ax

EVAL of comparative advantage model (2)

Hausmann: developing countries should, and do, diversify rather than specialise

Does not model inequality or protectionism

Labour is only input