Chapter 5 TECHNOLOGY AND PRODUCTIVITY: THE RICARDIAN TRADE MODEL

The next few chapters focus on different models of production and their implications for international trade. The Ricardian model is the simplest of these models, and yet it captures essential aspects of trade between the technologically advanced countries and the developing nations. In the Ricardian model, labor is the only factor required to produce final goods. The productivity of labor in its different uses determines production costs, and differences in production costs across countries determine the pattern of trade. Countries concentrate their production in the industries in which costs are relatively low at home and import those goods which are relatively costly to produce at home. Comparative advantage, not absolute advantage, is what matters. An important implication of the Ricardian model is that small countries tend to completely specialize in producing those goods in which they possess a comparative advantage. Because wages depend on labor productivity, and productivity varies across countries, wages differ across countries. In a Ricardian setting, the price of a non-traded good is determined by its production technology and the wage rate, and the wage rate is determined in turn by the prices and production technologies of traded goods. International trade is the link through which productivity shocks in one country are transmitted to its trading partners. A productivity gain in one country can spill over to the trading partners; the gains may be distributed evenly, or skewed in favor of either the home country or the trading partners.

SHORT-ANSWER QUESTIONS
1. True or False: (a) (b) Comparative, not absolute, advantage determines the pattern of trade. Even if the home country has an absolute advantage in producing all commodities over the foreign country, the home country can gain from trading with the foreign country. If the home country has an absolute advantage in producing all commodities over the foreign country, then the wage rate must be higher in the home country. If the home country is completely specialized in food, this means that the foreign country is completely specialized in clothing. If the foreign country requires less labor than the home country to produce a unit of food, we say that the foreign country has a comparative advantage in food production.

(c)

(d) (e)

2.

When countries desire both goods, autarky prices are determined by (a) (b) (c) supply conditions only. demand conditions only. both supply and demand conditions.

3.

If two countries trade, and if they are both specialized in production, then world prices are determined by (a) (b) (c) supply conditions only. demand conditions only. both supply and demand conditions.

When answering the following questions, assume that the home country is specialized in clothing and that producers take world prices as given. 4. If the productivity of labor in clothing doubles in the home country: (a) (b) (c) the wage rate is halved. the wage rate doubles. the wage rate is unchanged.

5.

If the domestic labor supply doubles in a small open economy, (a) (b) (c) the wage rate is halved. the wage rate doubles. the wage rate is unchanged.

6.

If the price of clothing doubles, (a) (b) (c) the wage rate is halved. the wage rate doubles. the wage rate is unchanged.

7.

Assuming that the home country is specialized in clothing and the foreign country is specialized in food, derive from the competitive profit conditions the expression for the ratio of the two countries' wage rates.

8.

Show algebraically why, given world prices px = $10 and py = $5 and labor coefficients aLx = 3 and aLy = 6, the home country cannot produce both x and y.

9.

Suppose the home country is specialized in food and the foreign country is specialized in clothing. If clothing is twice as expensive as food, and foreign labor is twice as productive in both goods as home labor, what can you conclude about the ratio of home to foreign wages?

10.

Suppose the home country has the labor coefficients aLC = 3 and aLF = 2. (a) (b) Can we say that the home country has a comparative advantage in one of the goods? Suppose that we are given the additional information that a*LC=4. Does the home country have a comparative advantage in clothing? Does the home country have an absolute advantage in clothing? Finally, we are given the information that a*LF = 5. What does this tell us about the pattern of trade? Given the home country's absolute advantage in both industries, explain why the home country does not export both goods to the foreign country where labor is less productive.

(c) (d)

PROBLEMS
1. Absolute versus Comparative Advantage: Suppose that in the United States four man-hours are required to produce each unit of clothing and each unit of food. In Canada, one man-hour is required for each unit of clothing and two man-hours are required for a unit of food. (a) (b) (c) Which country has an absolute advantage in each good? Which country has a comparative advantage in each good? Assuming that each country has 40 man-hours of labor available for production, draw the production possibilities frontiers for each country. (Put food on the vertical axis.) What do the slopes of these frontiers indicate? Draw the world production possibilities frontier. What does its slope indicate? If consumers in both countries have Leontief preferences, consuming clothing and food in the fixed proportion of one-to-one, what is the trade pattern? If the labor force of the United States increases by a factor of 20, will anything happen to the trade pattern?

(d) (e)

(f)

2.

Commodity Prices and Factoral Terms of Trade: Suppose the labor coefficients in the food and clothing industries are as follows: aLC = 4 aLF = 8 a*LC = 10 a*LF = 5

Suppose also that the home country has 16 units of labor and the foreign country has 30. Draw the production possibilities frontier for each country and calculate each country's autarky prices. (b) Draw the world production possibilities frontier. What must the world relative price of food in terms of clothing be in order for both countries to specialize in food? In clothing? Over what range of prices will countries specialize in the good in which each has a comparative advantage? (c) Suppose the world price ratio is equal to 1. Calculate the relative wages, w/w*. (d) Now suppose there is an increase in world demand for clothing so that the relative price of clothing rises to 3 / 2. What happens to the relative wage between the home and the foreign country? Consumption Possibilities, Production Possibilities, and Trade: (a)

3.

The production possibilities frontiers for the home and foreign countries are drawn below. Is it possible for the two countries to consume at C and C* and still remain within their budget constraints?

4.

Comparing the Models: Define an increase in demand for clothing as a shift in the indifference curves toward the clothing axis. This is illustrated below as a shift from curve A to curve B.

(a)

Consider first an endowment economy with an allocation of food and clothing shown by point E and the indifference curve A. Given our definition of a "demand shock," suppose there is an increase in demand for clothing. What happens to the relative (autarky) price of clothing? What happens to the supply of clothing?

(b)

Now suppose the economy has a bowed out production possibilities frontier. What happens to the relative price of clothing when demand for clothing increases? What happens to the supply of clothing?

(c)

Finally consider a Ricardian model of production. Now what happens to the relative price of clothing when demand for clothing increases? What happens to the supply of clothing?

(d)

Since we know that autarky prices determine the pattern of trade, in what sense are the endowment model and the Ricardian model "extreme cases"? (Hint: Think about the role of demand and supply in determining autarky prices.)

5.

Technology, the Export Pattern and Non-Traded Goods: A small Caribbean island nation with Ricardian-type technology has an agricultural sector dominated by the production of rice (a nontraded good for domestic consumption) and sugar (which it exports in order to import manufactured products). Large deposits of bauxite are suddenly discovered on the island. The

discovery revolutionizes the country's export sector, as labor is now 10% more productive in the extraction of aluminum than in sugar production. (a) What will happen in the export sector as a result of this discovery? Draw the country's production possibilities frontier both before and after the discovery. (Put tradable goods on the vertical axis, nontradables on the horizontal.) What happens to the production of sugar? What happens to the production of rice? In answering this question, think about the income and substitution effects involved. What is likely to happen if demand for rice is elastic? If it is inelastic?

(b)

6.

Technology and the Pattern of Trade: Suppose clothing and food are available on world markets at prices $10 per unit of clothing and $24 per unit of food. It takes 2 hours of labor to produce a unit of clothing at home and 8 hours of labor to produce a unit of food at home. A third commodity, shelter, requires 100 hours of labor to produce and must be provided locally since costs of transporting the good internationally are prohibitive. Assume that these labor cost-per-unit-output figures are invariant to the scale of output. (a) (b) (c) What is the trade pattern, and what is the price of shelter? Answer part (a) if technical progress at home has lowered the cost of producing food to 6 hours of labor per unit. Answer part (a) if home technical progress has further lowered the cost of producing food to 4 hours of labor.

7.

Multiple Traded Goods: The home country produces two goods, x and y, and trades with the foreign country, which is specialized in z. Consumers in each country demand all three goods. The country makes a discovery that improves its technology in producing x. Assuming that the price of y is unchanged, what happens to the price of z if x and z are close substitutes? If they are complements? (Goods x and z are complements if a reduction in the price of x causes consumption of z to go up.)

8.

International Wage Comparisons:

This table of wage rates in different countries was published in The Wall Street Journal. In view of what you have learned from the Ricardian model of production, how would you respond to the following comments?

(a) (b)

(c) (d) (e)

The high cost of hiring production workers in the United States has undermined its competitive position in world markets. The high wages in the United States compared to those found abroad are due to labor unions forcing their levels above what would be implied by labor's productivity in a competitive Ricardian world. The increase in Japanese wages implies that Japan is losing its competitive edge in world markets. The low wages in Britain are an indication that British workers are being underpaid. Allowing the importation of goods from countries with lower wages is unfair to American workers.

9.

The Missing Link: Suppose there are two countries in the world, each producing two commodities (manufactured goods and services) with two types of labor (skilled and unskilled). The production of a unit of the manufactured good requires two hours of skilled labor or one hour of unskilled labor, while the production of a unit of services requires one hour of skilled labor or two hours of unskilled labor. The home country has 200 hours of skilled labor and 100 hours of unskilled labor available for production. The foreign country has a labor force of the same size, but has only 100 hours of skilled labor and 200 hours of unskilled labor. (a) On a diagram with output of manufactured goods on the vertical axis and output of services on the horizontal axis, draw in the production possibility frontiers for both countries. Assuming consumers in both countries wish to consume one unit of manufactured goods for every unit of services, what is the pattern of trade? What is the relationship between a country's endowment of labor to its export good? What is the nature of specialization in this model? To be more specific, are countries specialized in production or are workers specialized or does specialization occur at both levels?

(b) (c) (d)