Question

1. Graph and explain using the Ricardian model: Consumption gains from trade, Production gains from Trade. Assume that the country is producing only goods X and Y, and that the international relative price of X is lower than the domestic relative price of X.

Answer 1

Ricardian Model

The modern theory of the Ricardian Model presumes that there are two countries, producing two goods, using one component of production, usually labor. The model is a common equilibrium model in which all markets (i.e., goods and factors) are flawlessly competitive. The goods produced are supposed to be similar across countries and firms within an industry. There are no transportation costs for these goods Labor is equilvant within a country but may have different productivities foreign countries. This suggests that the production technology is supposed to differ across countries. Labor is costlessly move across industries within a country but is immoveable across countries. Full employment of labor is also considered.
If we assume that the country is producing only goods X and Y, and that the international relative price of X is lower than the domestic relative price of X, the consumption gains and production gains from trade:-

In the Ricardian model, the condition for consumption gains from trade is identical to saying a country gains whenever it becomes totally specialized in its comparative advantage good.

In the Ricardian model, the production gains from trade are available when workers have preference among the occupations.