The Ricardian Model of Trade and Non-Traded Goods Consider the U.S. in the examp

Question

The Ricardian Model of Trade and Non-Traded Goods Consider the U.S. in the example we discussed in class where the U.S. had a comparative advantage in the production of guns (therefore producing and exporting guns while importing butter). As a reminder, here are the unit input requirements for the U.S. from the class lecture notes: 3. ,, aLG 0.5 0.125 We also showed that perfect competition would drive profits down to zero which would result in the following condition to hold in both markets (but here just shown for guns) Suppose the U.S. produces a non-traded good labeled Z (which you can think of as haircuts), and the U.S. requires 0.75 workers to make one unit of good Z. Using the above relationship between wages, prices and the unit input requirement, what must be the relative price of good Z in terms of guns (i.e. Pz / PG) in the U.S? a) b) Typically, productivity in the traded sector good increases more quickly than productivity in the non-traded sector. If aug falls to 0.1, what has happened to labor productivity in guns? What does the increase in labor productivity in guns do to the relative price of Z (assuming no increase in labor productivity in Z)? c) d) Assuming developed countries (like the U.S.) have faster labor productivity growth than developed countries, what do the results of this problem imply about the price level of goods in developed countries vs. developing countries? This is known as the Balassa-Samuelson effect.

Explanation / Answer

Ricardian mannequin Assumptions
The trendy variation of the Ricardian mannequin assumes that there are two nations, producing two items, utilizing one component of creation, commonly labor. The mannequin is a basic equilibrium model where all markets (i.E., goods and explanations) are perfectly aggressive. The items produced are assumed to be homogeneous across nations and organizations within an industry. Items will also be costlessly shipped between countries (i.E., there are not any transportation fees). Labor is homogeneous inside a country however may have exceptional productivities across international locations. This implies that the creation technological know-how is assumed to fluctuate across countries. Labor is costlessly mobile throughout industries within a nation but is motionless across nations. Full employment of labor can also be assumed. Shoppers (the people) are assumed to maximise utility subject to an earnings constraint.
Below you will discover a extra complete description of each and every assumption along with a mathematical formula of the mannequin.
Excellent competition
ideal competition in all markets implies that the next stipulations are assumed to keep.
A) Many corporations produce output in each enterprise such that every organization is just too small for its output decisions to affect the market price. This implies that after choosing output to maximise revenue each and every company takes the cost as given or exogenous.
B) corporations prefer output to maximise revenue. The rule of thumb used by flawlessly competitive firms is to pick that output level which equalizes the price with the marginal price. That is, set P = MC.
C) Output is homogeneous across all businesses. Which means that items are same in all of their characteristics such that a customer would in finding merchandise from exclusive companies indistinguishable. We could also say that items from distinct businesses are excellent substitutes for all patrons.
D) Free entry and exit of firms in line with earnings. Positive revenue sends a sign to the relaxation of the financial system and new corporations enter the industry. Bad profit (losses) leads present firms to exit, separately, out of the industry. Consequently, ultimately fiscal profit is pushed to zero within the enterprise.
E) ideal knowledge. All corporations have the integral information to maximize revenue, to establish the confident profit and negative revenue industries, etc.
Two international locations
The case of two international locations is used to simplify the model evaluation. Let one country be the U.S., the opposite France *. Word, something related exclusively to France* within the model will be marked with an asterisk (or in some areas we will distinguish nations by way of color). The 2 countries are assumed to fluctuate simplest with respect to the creation technological know-how.
Two goods
Two items are produced with the aid of each countries. We assume a barter economic system. This means that there is no cash used to make transactions. Rather, for exchange to occur, items need to be traded for other goods. Accordingly we'd like as a minimum two items in the mannequin. Let the 2 produced items be wine and cheese.
One component of creation
Labor is the one component of production used to produce each and every of the goods. The element is homogeneous and might freely transfer between industries.
Utility Maximization / Demand
In Ricardo's customary presentation of the mannequin he targeted solely on the deliver part. Only later did John Stuart Mill introduce demand into the model. Because much will also be discovered with Ricardo's incomplete mannequin we proceed at first with out formally specifying demand or utility functions. Later we will use the combination utility specification outlined below to depict an equilibrium within the model.
When wanted we will be able to assume that aggregate utility may also be represented by using a function of the form U = CCCW the place CC and CW are the mixture portions of cheese and wine consumed in the country. This operate is chosen considering that it has residences that make it convenient to depict an equilibrium. The main feature is that the function is homothetic. This suggests that the country consumes wine and cheese within the same fixed percentage, at given price s, despite income. If two international locations share the same homothetic preferences, then when the countries share the equal costs, as they are going to in free exchange, they're going to additionally eat wine and cheese in the same proportion.
Basic Equilibrium
The Ricardian model is a common equilibrium mannequin. Which means that it describes a complete round drift of cash in exchange for items and services. As a result, the sale of items and offerings generates income to the organizations which in flip is used to pay for the element offerings (wages to workers on this case) utilized in production. The element income (wages) is used, in flip, to purchase the items and offerings produced through the businesses. This generates revenue to the businesses and the cycle repeats again. A "general equilibrium" arises when costs of items, services and factors are reminiscent of to equalize give and demand in all markets simultaneously.
Production
The construction services under symbolize enterprise construction, not organization creation. The industry contains many small corporations in mild of the idea of ultimate competitors.

Transportation costs
The mannequin assumes that goods can be transported between countries at no cost. This assumption simplifies the exposition of the mannequin. If transport expenses were incorporated, it may be shown that the key outcome of the model should still obtain.
Exogenous and Endogenous Variables
In describing any model it is constantly priceless to hold monitor of which variables are exogenous and which are endogenous.
Exogenous variables are these variables in a mannequin that are determined by means of processes that aren't described within the model itself. When describing and solving a mannequin, exogenous variables are taken as constant parameters whose values are recognized. They're variables over which the retailers inside the mannequin have no manipulate.
Within the Ricardian model the parameters ( L, a LC, aLW ) are exogenous. The corresponding starred variables are exogenous in the different nation.
Endogenous variables are those variables decided when the model is solved. For this reason finding the way to a model way fixing for the values of the endogenous variables. Sellers in the model can control or impact the endogenous variables via their actions.
In the Ricardian model the variables ( L C, L W, QC , QW ) are endogenous. Likewise the corresponding starred variables are endogenous in the different nation.

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