Ricardian Model: Trade, PPF, and Tariffs

Ricardian Model

Unit Labour Req.  Pears(Ib).  Oranges(Ib)

Home                  4h (aLp).         3h (aLo)

Foreign.              6h (aLp*).        1h (alp*)

Absolute Advantage - country takes less time to produce goods?

Home -> pears // Foreign -> oranges

Comparative Advantage - lower opportunity cost 

- Home has a C.Adv in pears production as its opp. cost of pears production is lower than foreign country - will specialize in pears

PPF (grafico) - (aLp · Qp) + (aLo · Qo) <= L

4Qp + 3Qo <= L (Qp = 300 & Qo=400)

Maximum home pears production is 300 and oranges 400

Slope = opp. cost - the opp. cost of pear is how many pounds of oranges Home must stop producing in order to make one more pound of pear

Absence of Trade - relative price of pears in terms of orange (Pp/Po)

- Table of opp. cost (Pp/Po) -> (aLp / aLo) -> 4/3 = 1.332

Home -> 1 Ib of pears = 1.332 Ib of oranges

Foreign -> 1 Ib of pears = 6 Ib oranges 

In case of absence of trade, I will need to produce both goods because the external market won't provide it to me, all I produce is all I consume and I want to consume both goods. I figure out that the opp. cost of producing pears is the oranges that I will not produce

Relative Prices Change in Terms of Trade

- In terms of trade it will be profitable to buy pears from Home to Foreign, because pears be relatively cheaper at home.

The relative price of pears to oranges will be higher in foreign than in home, since foreign has the opp. cost of pears

If countries open to trade, will be profitable as the relative price, 2,  is within the relative supply range. Both parties are going to be almost equally advantageous.

Pp* /Po* > pp/Po --> 6 >1.332      (2)

Grafico /_   (eje vertical 6 i 1.3 -> lineas discontinuas horizontales // lincea continua vertical (1u)

(6 high - no demand) (6-1.3 trade) (1.3 low no supply)

PPF t/nt - is the production possibilities frontier. Country's resources not change with T or NT

CPF nt - in the absence of trade, the CPF is limited by how much the country can produce

CPF t - when there is trade they can specialize in the good they produce more efficiently. Home reserve all its resources to produce pears, so the max it can produce is 300. And then he could trade all the 300Ib pears for maximum production of foreign 600 Ib oranges. Thanks to the trade, Home can consume 600Ib of oranges which could have not produced by itself.

Trade Policy

Home import demand curve: MD = D-S

Foreign export supply curve: XS* =  S*-D*

Absence price equal MD or XS to 0 (pa i pa*)

-  Equilibrium Free Trade -> MD = XS* (Pw)

-80+80P = 160 - 80P -> Pw = 1.5

Qw -> MD (Pw=1.5) = 160- 80·1.5 = 40

(Ahora dibujar gráfico) -> (1.5, 40) (2,0) (0,40)

-   Tariff : 0.7$. -> Pt = Pt* + t

t: difference between Pt and Pt* = 0.7

Pt: home price with tariff

Pt* foreign price with tariff

MD(Pt) = 160-80pt. // XS(Pt*)= -80+80Pt*

Transform -> MD(Pt*) = 160-80( Pt* + 0.7) = Pt* = 1.15

Pt = 0.7 + 1.15 = 1.85

Volume of trade: Qt -> MD(Pt = 1.85) = 160-80 · 1.85= 12 

  -  Quantity of X supplied and demanded in each country: 

D y S de home 

_Shome(pw =1.5)= x //_Shome (pt =1.85) =

_Dhome(pt =1.85)= x //_Dhome(pw =1.5) =

(Hacer dibujo (a,b,c,d,e) y calcularlas 

A: producer surplus change

- (a + b + c+ d) consumer surplus change 

C + E: government revenue change

E - (b+d) : net impact of the tariff

b- producer efficiency loss

d- consumer efficiency loss

e- terms of trade (tariff lowers the foreign price, allowing home to buy its imports cheaper)

If the terms of trade gains exceed the efficiency loss, the national welfare will increase under a tariff, at the expenses of foreign countries

World Net Impact: -b-d-f