Wk 3: Tuesday, 9/2/2014

Today: Continue Thursdays 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 a
i
s and wages
Empirical test of the model (GDA McDougalls Study)
With 3 or More Goods
1. Compute (a
i
/a
i
*) 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, (*/), then
U.S. produces good if (a
i
/a
i
*) > (*/).
Three Additional Goods:
Shoes (S), Toys (T), Van (V)

a
i
a
i
* a
i
/a
i
* (*/)
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

* influenced by strength of demand for
products but also the average level of the
as

Consider data in next slide.
(*/)?
(
Mex
/
US
)
1/a
i
Mex
1/a
i
US

Increasing Mexico labor productivity (smaller a
Mex
)
Testing the Ricardo Model


How well does it predict trade patterns?

Consider famous test by GDA MacDougall
GDA MacDougalls 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
(a
UK
/a
US
) > 1

U.S. wages about 2x those in U.K.
(
US
/
UK
) 2
G.D.A. MacDougalls 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

a
uk
a
us

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.