Please sit in groups of 5

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Please sit in groups of 5
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Today Wednesday

• Wrap up chapter 2
• Start Chapter 3, comparative advantage
• introduce David Ricardo
• introduce concept of comparative advantage
• show gains from trade with comparative advantage
• in labour savings
• on graph with ppf and consumption
• list assumptions needed for classical model of
  trade

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Using the sheets handed out

• Please sit in groups.
• Complete YOU DO from last class and homework. You
  have about 7 minutes in which to do this.
• If you have questions consult your group members.
• Hand in one copy per group. Please include all
  names of people in group. Thanks.

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Chapter 3

• David Ricardo and Comparative Advantage

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David Ricardo

• A stock broker, member of parliament and
  brilliant economic thinker
• He read The Wealth of Nations while on holiday
  in 1790 and studied political economy from then
  on.

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Some Terminology

• Autarky
• no trade
• example autarky price ratio in country relative
  prices in the country when the country does not
  trade.
• Terms of trade
• price of exports over price of imports
• Complete specialization
• each country only produces one good, buys other
  good(s) through imports

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Comparative Advantage

• This theory reinforces Adam Smith in showing that
  countries can gain from trade.
• IDEA Even if one country is absolutely better at
  producing all goods and services than its trading
  partners, it can gain from trading with them.

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Comparative Advantage

• A country has a comparative advantage in the
  production of a good if it is better at producing
  that good in comparison to its ability to produce
  another good
• better means using comparatively less labour in
  that good relative to its trading partners.
• to determine comparative advantage requires 4
  numbers we compare the value of 2 ratios
  (fractions)

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Ricardo and Trade

• Trade can benefit all countries by making goods
  cheaper for consumers and by allowing more goods
  to be produced by all countries.
• His example corn production and wine production
  between England and Portugal

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Labour requirement

• Portugal needs less hours to produce both goods.
  (Wine 80 compared to 120)(Cloth 80 compared to
  100)
• Portugal therefore has an absolute advantage in
  the production of both goods

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Labour requirement

• For comparative advantage, we must look at all
  four labour requirements at the same time! The
  lowest relative requirement tells you who has
  comparative advantage in which good.

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Labour requirement

• 80/120 lt 90/100 Portugal produced wine
  comparatively more productively than it produces
  cloth, in relation to England. Portugal has a
  comparative advantage in the production of wine.
• 80 is the hrs/bbl for Portugal for wine.

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Comparative Advantage

• If 80/120 lt 90/100 then we can be sure that
• 100/90 lt 120/80 (this is the inverse of the
  above.
• Therefore, England has a comparative advantage in
  the production of corn

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Labour requirement

• For comparative advantage, we must look at all
  four labour requirements at the same time!
• Recall 80/120 lt 90/100 Portugal produced wine
  comparatively more productively than it produces
  cloth, in relation to England, therefore

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Labour requirement

• According to classical trade theory, Portugal
  should produce only Wine,
• England should produce only Cloth
• Both countries can trade and gain.

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Gains from Trade

• Ricardo used a different method to discuss gains
  from trade than we did in the last chapter.
• He argued that, as long as a country could SAVE
  time or buy more of a good by trading, there is a
  gain.
• He did not bother with the total production of
  the country, but illustrated gains from the
  production of one unit.

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Gains from trade continued

• In example.
• England needs 100 hours to produce one yd of
  cloth
• England needs 120 hours to produce one bbl of
  wine
• But Portugal can produce wine using less hours
  than cloth.
• Assume Pc/Pw 1/1 with trade
• (NOTE this is easy assumption, not always price
  ratio!)

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Gains from trade continued

• England can use 120 hours to produce one bbl of
  wine itself (producing wine directly)
• OR
• England can use 100 hours to produce a yard of
  cloth which it can sell for one bbl of wine (he
  called this indirectly producing wine)

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Gains from trade continued

• By producing cloth and trading, England saves 20
  hours for each unit of wine consumed.
• These 20 hours can be used to produce more cloth,
  either for consumption or trade.

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You do

• Which country has comparative advantage in
  cameras?
• Which country has a comparative advantage in
  t-shirts?
• What would be the price ratio in autarky?
• What would be a possible price ratio with trade?

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You do

• Which country has comparative advantage in
  cameras?
• Which country has a comparative advantage in
  t-shirts?
• Which country has comparative advantage in
  cameras?
• Which country has a comparative advantage in
  t-shirts?
• What would be the price ratio in autarky?
• What would be a possible price ratio with trade?

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You do

• Which country has comparative advantage in
  cameras?
• Which country has a comparative advantage in
  t-shirts?
• Which country has comparative advantage in
  cameras?
• Which country has a comparative advantage in
  t-shirts?
• What would be the price ratio in autarky?
• What would be a possible price ratio with trade?

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What do we learn from these questions?
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Gains from trade (if time permits)

• Look at examples 1, 2 and 3.
• I will put terms of trade on the board.
• Determine how much time each country can save by
  producing the good in which it has a comparative
  advantage and trading for the other good.
  Determine this time saving if the country does
  this for 1 million units of the good.