Question

From Krugman's 10th Edition International Economics CHAPTERS 1-4:

PLEASE SHOW WORK

2. Briefly describe the Ricardian Trade Model and show the following:

a. What causes trade,

b. What is the direction of trade,

c. What are the gains from trade

Answer 1

The simple version of the “Ricardian Model” is two country, two goods and one factor of production “general equilibrium” model, where we can analyze through “Ricardian Model” that two country having different opportunity cost can gain from trade.

a).

As we know that different country have different “marginal product” of an exact same input across countries, => the opportunity cost of producing will also differ across countries, => the “production cost” will also differ. Now, because of the difference in the price of the goods or the difference in the relative price of goods leads to trade between two countries. Since, if home country find it more profitable to import from the foreign country in exchange of some other good rather than to produce in the home country then the home country will choose to trade with the foreign country.

b).

According to the “Ricardian Model”, a country will totally specialize and export toward the good having “comparative advantage” in exchange of the other good. So, if there are two country “Home” and “Foreign” and there are two goods, “X” and “Y” and “labor” is the only factor of production. Let’s assume that “H” have a comparative advantage in the production of “X” and the “F” have the comparative advantage in the production of “Y”, => So, the direction of trade is given by, “H” will export “X” in exchange of “Y” and “F” will export “Y” in exchange of “X”.

c).

We can show through the following fig. let’s assume that “A1B” be the “PPF” of the home country and in the autarkic situation “E1” be the equilibrium where the “PPF” and the “U1” create the tangency condition.

So, at the autarkic “OC” be the consumption of “X” and “E1C” be the consumption of “Y”. Now, “home” country have comparative advantage in the production of “X”, => the home country will totally specialize towards “X”, => after the production point is given by “B” and the new consumption will be the tangency point between “A2b” and “U2”, where “A2B” be the post trade relative price. So, we can see that initially “home country” were getting “U1” level of utility and after trade the it getting “U2 > U1” level of utility, => the country is getting higher utility compare to autarkic, => “Home country” is gaining from trade.