Chapter 2: Ricardian Model Given your recent exposure to the Ricardian model, an
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Chapter 2: Ricardian Model Given your recent exposure to the Ricardian model, answer the following questions a. b. 5. Can one country have comparative advantage in all goods? Why or why not? Suppose it has been determined that a country has comparative advantage in the production of Adamantium and a comparative disadvantage in vibranium, 1. Does the Ricardian model predict that the wages in the Vibranium industry will increase? Why or why not? Does the Ricardian model predict partial specialization in the Vibraniunm industry? Why or why not? 6. Consider the following table. Country A Country B MPL of wheat 8 MPL of cloth a. Which country has an absolute advantage in wheat production? Why? b. Which country has an absolute advantage in cloth production? Why? c. Which country has a comparative advantage in wheat production? (Show why) d. Which country has a comparative advantage in cloth production? (show why) e. In what range must the international relative price of wheat fall? Why? 20 4.Explanation / Answer
The Ricardian theory of international trade predicts that trade between countries take place due to the comparative advantage in the cost production. A country will specialize in the production of those commodities in which it has a comparative advantage and import those commodities in which it has a comparative disadvantage in cost of production. It means that a country will export that item in which it has comparative advantage and gain from international trade and import those item which it has a comparative disadvantage.
The gain from trade can be measure in absolute and in comparative terms. The absolute advantage can be measured in terms of physical quantity of labour embodied while the comparative advantage is measured in terms of the exchange rate between the commodities. For example there are two countries A and B producing wheat and cloth. The MPL for wheat in country A is 5 and in country B it is 8 and the MPL for cloth in country A is 20 and in country B is 4. Therefore the country A has an absolute advantage in the production of cloth and B has a absolute advantage in the production of wheat. With a given amount of labour the country A can produce larger amount of cloth than B while country B can produce a larger amount of wheat than A. This is absolute advantage of production. But the comparative advantage is measured in terms of the domestic exchange ratio between the two commodities. The country A has a comparative advantage in production if it can get a larger amount of cloth in exchange of a given amount of wheat. Similarly country B has comparative advantage in production Wheat if it can get larger amount of wheat in exchange of a given amount of cloth.
The basic assumptions of the model are:
1. The model is based on two countries and two commodities.
2. Labour is the only factor of production and the value of commodity is calculated in terms of the amount of labour power.
3. Constant returns to scale in production function.
3. Labour is mobile domestically but completely immobile between countries.
4. No transport cost.
5. Free trade takes place between the countries.
6. Full employment of labour.
a. Since Ricardian model is based on the assumption of full employment of labour and as it is a two commodity model, a the country cannot have comparative advantage in the production of all goods. Since full employment exists, transferring labour from one production to another increase the wage and comparative advantage decreases. Thus a country will not have comparative advantage in all the goods.
b (i) In a situation of full employment if the country try to increase the production in Vibranium industry it has to hire more labours from the Adamantium industry. This will naturally raise the wage rate in Vibranium industry.
(ii) The Ricardian model states that partial specialization in comparative disadvantage theory reduces the gain from international trade. If the resources are transferred from high advantage industry to low advantage industry, the wage rate increase and the transfer of labour where it has high productivity to the area where it has lower productivity reduce the benefit of comparative advantage in production. As there is perfect mobility of labour partial specialization is possible but it limits the gain from trade.
6. a. Country B has an absolute advantage in the production of wheat where the MPL of wheat is higher than in country A.
b. Country A has an absolute advantage in the production of clothe since the MPL of cloth is higher in country A than in B.
c. The domestic exchange ratio between wheat and cloth in country A is 1:4 and in country B is 2:1. In country A for 4 units of cloth it can get 1 unit of wheat, but in country B for 1 unit of cloth it can get 2 units of wheat. It means that country B has a comparative advantage in the production of wheat.
d. The domestic exchange ratio between wheat and cloth in country A is 1:4 and in country B is 2:1 For every one unit of wheat it can get 4 units of cloth in country A. But in country B for every 2 units of wheat it can get only 1 unit of cloth. Here country A has a comparative advantage in the production of cloth as it gets more units of cloth while exchanging wheat with cloth.
e. If country B stop the production of cloth and specialize in the production of wheat.
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