Wk 3: Tuesday, 9/2/2014

Today: Continue Thursday’s Lecture Graph of the Ricardo Model

• Production Possibility Frontier, slope• Diagonal Demand• Autarky Equilibrium• Opening up to Trade and Specialization• Trade Triangle• Gains from Trade & Consumption Possibilities Set

Thursday• More realism: Ricardo Model and MANY goods• Relationship between ai’s and wages• Empirical test of the model (GDA McDougall’s Study)

With 3 or More Goods

1. Compute (ai/ai*) for each good and order from highest to lowest.

2. The U.S. will have a comparative advantage in product with the highest ratio and disadvantage in good with lowest ratio.

3. AND, if you have knowledge of the wage in U.S. relative to wage in Mexico, (ω*/ω), then U.S. produces good if (ai/ai*) > (ω*/ω).

Three Additional Goods: Shoes (S), Toys (T), Van (V)

ai ai* ai /ai* (ω*/ω) 4 hrs: 1 C 1.0 hrs: 1 C 4 2 hrs: 1 W 1.5 hrs: 1 W 1.33 6 hrs: 1 S 3.0 hrs: 1 S 2 3 hrs: 1 T 1.0 hrs: 1 T 3 3 hrs: 1 V 2.5 hrs: 1 V 1.2

WHAT determines

ω* influenced by strength of demand for products but also the average level of the a’s

Consider data in next slide.

(ω*/ω)?

(ωMex/ωUS)

1/aiMex

1/aiUS

Increasing Mexico labor productivity (smaller aMex)

Testing the Ricardo Model

How well does it predict trade patterns?

Consider famous test by GDA MacDougall

GDA MacDougall’s 1954 Study

•Data for U.K. and U.S. exports to third countries shortly after WWII U.S. Exports to i / U.K Exports to i

•U.S. industry ABSOLUTELY more productive in all 13 industries for which data was available (aUK/aUS) > 1

•U.S. wages about 2x those in U.K. (ωUS/ωUK) ≈ 2

G.D.A. MacDougall’s 1951 Data

U.S. Exports to Output per Third Market U.S. Worker (Market Share)

Industry ------------------- -------------------- U.K. Exports to Output per Third Market U.K. Worker (Market Share) Pig Iron 3.6 5.1 Motor Cars 3.1 4.3 Machinery 2.7 1.5 Glass Containers 2.4 3.5 Paper 2.2 1.0 Cigarettes 1.7 .47 Leather Footwear 1.4 .32 Hosiery 1.8 .30 Cotton Spinning 1.5 .11 Beer 2.0 .056 Cement 1.1 .091 Wool 1.35 .004 Apparel 1.25 .044

auk auk

aus aus

Conclusion

This simple theory has impressive empirical support.

Trade patterns between countries are determined to a significant degree by relative differences in their labor productivities.

Next Tuesday

• Ricardo Model says nothing about income distribution effects, but trade is highly controversial since creates losers.

• Complete specialization is unrealistic. Rarely are trade effects so dramatic in terms of destroying large swaths of the economy.

• New Model of Trade that does address these and other issues.