ECON 340 LECTURE 4 HOMEWORK 3 QUESTIONS ANSWERED CORRECTLY LATEST UPDATE 2026

ECON 340 LECTURE 4 HOMEWORK 3 QUESTIONS ANSWERED CORRECTLY LATEST UPDATE 2026 The Ricardian model outlines the first basic reason for trade we will study: - Answers technology differences Ricardian Model Setup - Answers -Two countries, Home and Foreign -Two goods cloth c and food f -Demand Dc and Df (as before) -Each good is produced using one factor: labor L with constant returns to scale. -In autarky and trade, countries must decide on the allocation labor to the production of goods. Workers move freely between industries. -All markets are competitive so that wine and cloth producers take prices and wages as given opportunity cost - Answers : the opportunity cost of producing something measures the cost of not being able to produce something else The opportunity cost of producing a piece of cloth is the amount of wine that could be produced with the workers employed to produce that piece of cloth - Answers comparative advantage - Answers Definition: A country has a comparative advantage in producing a good if the opportunity cost of producing the good in that country is lower than it is in other countries Because labor productivity is constant, we can define a unit labor requirement as the constant number of units of labor required to produce one unit of output - Answers A high unit labor requirement means a low labor productivity level The Ricardian PPF - Answers Because the tradeoff is constant, the PPF is linear. Autarky equilibrium - Answers Production is competitive, hence: PC = waLC PW =waLW -Workers can move freely between sectors - Only when wages are equal will workers want to produce both goods -So production of both goods can only happen where PC/PW =aLC/aLW -Notice prices = opportunity cost: the price line will sit on top of the PPF Where price line / PPF are tangent to indifference curves, economy will be in equilibrium. Trade in the Ricardian Model - Answers Now Home and Foreign are allowed to trade The unit labor requirements in both countries satisfy aLC/aLW a∗LC/a∗LW under autarky - Answers Under autarky: 1. The opportunity cost of cloth in terms of wine is lower at Home than in Foreign 2. The relative price of cloth in terms of wine is lower at Home than in Foreign Home has comparative advantage in cloth What happens when a∗LC /a∗LW PC /PW aLC /aLW ? - Answers Home only wants to produce cloth: QC = L/aLC, QW = 0 Foreign only wants to produce wine: QC = 0, Q∗W = L∗/a∗LW This is called complete specialization Gains from trade here come from two sources: - Answers 1. As before, price changes make the previously scarce good less so, allow for substitution. 2. Now, also from specializing in production that uses resources more efficiently. Caveat: for both countries to gain from trade, we need an equilibrium with complete specialization If, instead, one country produces both goods: - Answers -relative prices must be identical to autarky ones for that country -with no prices changes, welfare unaffected by trade The Ricardian model is extremely simple in that: - Answers 1. All workers are identical (or units of skill are perfect subst.) 2. Workers costlessly transition between sectors 3. All markets are perfectly competitive and all markets clear (no unemployment) As a result, all workers gain from trade and there is no need for redistribution In fact, workers only gain when one of two national industries shuts down! The next model we will present will feature distributional effects Do countries export goods where their productivity is relatively high? - Answers Ratio of US to British exports in 1951 compared to the ratio of US to British labor productivity in 26 manufacturing industries, At this time the US had an absolute advantage in all 26 industries, yet the ratio of exports was low in the least productive sectors of the US The Ricardian model contradicts the following beliefs: - Answers 1. Trade is only good if a country can stand up to foreign competition -Gains from trade are related to comparative advantage. 2. Trade with countries that pay low wages hurts high-wage countries -Trade leads to worker dislocation, but workers can (in principle) transition to another sector with higher real income (due to lower relative price of imported good). 3. Free trade exploits less productive countries On welfare grounds they are better off Limitations of Ricardian Model - Answers The model ignores distributional issues, without which it is hard to make sense of protectionism It ignores the role of other factor endowments in determining trade flows across countries It ignores the role of scale economies in determining trade flows across countries In the Ricardian Model discussed in class, when Home has comparative advantage over Foreign in cloth, - Answers A. The Autarky relative price of cloth in terms of wine is lower at Home than in Foreign B. Foreign must have comparative advantage over Home in wine In the Ricardian model with cloth and wine discussed in class, if Home exports cloth and imports wine, then it must be the case that - Answers A fall in the relative price of cloth in terms of wine will reduce Home's welfare