The Ricardian model focuses on comparative advantage

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The RS curve is a step with flat sections and linked by a vertical section. There is no supply of cloth if the world price drops below aLc/aLw (in this case 0,5). Home will specialise in the production of widgets whenever Pc/Pw < aLc/aLw. Similarly, Foreign will specialise in widgets production whenever Pc/Pw > aLc*/aLw*. Assumption: aLc/aLw < aLc*/aLw*. So at relative prices of cloth below aLc/aLw, there will be no world cloth production. When the relative prices of cloth, Pc/Pw, is exactly aLc/aLw, workers in Home can earn exactly the same amount making either cloth or widgets. So Home will be willing to supply any relative amount of the two goods, producing a flat section to the supply curve. For any relative price of cloth between aLc/aLw and aLc*/aLw* the relative supply of cloth is (L/aLc)/(L*/aLw*) (in this case 0,5). At Pc/Pw = aLc*/aLw*, Foreign workers are indifferent between producing cloth and widgets. Thus we again have a flat section of the supply curve. Finally, for Pc/Pw > aLc*/aLw*, both Home and Foreign workers are indifferent between producing cloth and widgets. There will be no widget production, so that the relative supply of cloth will become infinite.


aLc/aLw = 0,5 < aLc*/aLw* = 2

Trade equilibrium 2 > Pc/Pw > 0,5


The Ricardian model focuses on comparative advantage. In a Ricardian model, countries specialize in producing what they produce best. Countries will export goods that their labor produces relatively efficiently and import goods that their labor produces relatively inefficiently. Trade benefits can be shown by: Instead of producing a good for itself, a country can produce another good and trade it for the desired good. Whenever a good is imported it must be true that this indirect "production" requires less labor than direct production. Unlike other models, the Ricardian framework predicts that countries will fully specialize instead of producing a broad array of goods. So in this case Home will specialise in cloth production and Foreign in widget production. Than Home will export cloth and import widgets and Foreign will export widgets and import cloth. Home and Foreign gain: producers of cloth in Home and widgets in Foreign (higher world relative prices for their exports) and consumers of widgets in Home and cloth in Foreign (lower world relative prices for their consumption of imported goods).

Question 12

Export-biased growth: If point c is the production point with trade, then Alabania has a comparative advantage in good B. Therefore from the shape of the new PPF (as compared with the original one) it is clearly an export-biased growth.

Export-biased growth tends to worsen a growing country's terms of trade, to the benefit of the rest of the world. The ceteris paribus (from question a) would tend to worsen Albania's terms of trade. The terms of trade effect would, again ceteris paribus, worsen its real income.

Import-biased growth: When Albania discovers that the relative price of A equals twice the price of B, it knows that it has a comparative advantage in A. Therefore Albania would produce at production point b.

Import-biased growth tends to improve a growing country's terms of trade at the rest of the world's expense. The ceteris paribus (from question c) would tend to improve Albania's terms of trade. The terms of trade effect would, again ceteris paribus, improve its real income.

If Albania is a small country it cannot affect its terms of trade and therefore there is no effect in the real income.

Question 13

Country R would export F. This is consistent with the H-O model. The country which is relatively capital abundant exports the product which is relatively capital intensive. This is consistent with the Heckscher-Ohlin model.

The terms of trade would settle somewhere between the two autarky relative prices on the PC/PF axis. The relative wages (w/r) will be lower than the highest and higher than the lowest on the vertical axis above and they will become equal. This is consistent with the Heckscher-Ohlin model.

In an idealized model international trade would actually lead to equalization of the prices of factors such as labor and capital between countries. In reality, complete factor-prize equalization is not observed because of wide differences in resources, barriers of trade, and international differences in technology.

The point of production with trade will be above point 5. The country will be shifting its production composition to be more heavily weighted in labor intensive good, C. Within each industry, the production technique will be more capital intensive, since with the rising relative wage, the optimal point of production will involve sliding around the isoquants in the direction of saving on the now relatively more expensive labor.

Question 14

In the absence of trade supply and demand must be equal. Therefore this country produces 60 widgets.

Consumer surplus: 0,5*(6*60) = 180

Producer surplus : 0,5*(6*60) = 180

With free trade and no tariffs the quantity is: 100-10 = 90

With a specific tariff of 3 Pounds per unit the quantity imported is: 80-40=40

Free Trade:

Consumer surplus: 0,5*( 11*100) = 550

Producer surplus: 0,5*(1x10) = 5

With tariff:

Consumer surplus: 0,5*(8*80) = 320

Producer surplus: 0,5*(4*40) = 80

Consumer surplus due to tariff: 320-550 = -230 (loss)

Producer surplus due to tariff: 80-5 = 75 (gain)

The prohibitive tariff is 5 Pounds per unit, because at this level the price at home would be equal to the price at home in autarky.

Question 15

Although there are many who draw precisely this lesson from the ʺ East Asian Miracleʺ of the past half-century, such a conclusion does not necessarily follow logically. Though the four HPAEs are very successful in their economic as well as in their export sector growth, they varied among themselves significantly in the degree and way with which they forswear protectionist policies. Definitely export-promotion policies can distort relative prices to the same extent as import protectionist policies, and hence can lead to the same waste and misallocation of national resources. Some economists argued that the reasons of rapid economic growth in general and rapid growth in export sectors of HPAEs were high saving and investment rates. Further almost all of the HPAEs have experienced rapid growth in education, leading to high literacy and numeracy rates important for a productive labor force.

Question 16

Airbus will produce and Boeing will not because Airbus are the first in the market. If Boing also decides to produce, both will make losses. Therefore Boing will not enter the market.

Only Airbus will produce as it knows that the subsidy would not be sufficiently large to lure Boeing to also enter the market.