Ricardo's Model

Review exercises on Ricardo’s model 1. Consider two countries, Argentina and Brazil, with Ricardian economies whose endowments and technologies are those described below. Each has a fixed endowment of labor – its only factor of production – and can produce two things, manufactured goods M and services S, using the indicated constant amounts of labor per unit of output: Per-unit labor requirement for producing Endowment of Labor Argentina Brazil 200 600 M 1 1.5 S 2 4

a) Draw the production possibility frontiers for each of these countries, showing clearly the intercepts and the slope of the frontier.

b)

Calculate the autarky relative prices of manufactured goods , pM/pS, in each country.

c) Which country has an absolute advantage in both sectors? d) Which country has a comparative advantage in manufactured goods, M? e) Which country has a comparative advantage in services, S? f) Suppose now that there is free trade between these countries. Say which country is exporting S and which is exporting M, and show graphically the gains from trade (in terms of expansion of consumption possibilities) for each country. g) With free trade there will be one international relative price for both countries. Say which can be this price. Will both countries also have the same wage for their workers?

2. Consider two countries (E, Europe and C, China) with economies whose endowments and technologies are those described in the table below. Each has a fixed endowment of L, labour – its only factor of production – and can produce two goods, X and Y, using the indicated constant amounts of L per unit of output. The table also gives the values of wages in local currencies, i.e. euro (€) for Europe, yuan (Y) for China, and the exchange rate expressed in units of € per unit of Y:

Per-unit labor requirement for producing

Wage per unit of labour (in local currency)

Exchange rate: €/ Y

Endowment of Labor Country E Country C 80 160

X 2 4

Y 4 6 10 2 1

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