ECO230Y1 Lecture Notes - Lecture 4: Economic Equilibrium, Production Function, World Food Programme

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Published on 30 Apr 2016
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Limitations of Ricardian Model
Model results in full specialization
Model does not explain sources of labour productivity differences
Not clear why productivities are different
Model considers only one production factor
This could have worked in the 19th century when labour force was not that important
Income distribution: Model predicts that all factors gain
This is not the case because resistant still exists
There are winners and losers
It cannot explain intra-industry trade
New theme in trade happens in very similar sectors
What is factors are not perfectly substitutable in different sectors, as the model assumes
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Specific Factors and Income Distribution
Specific Factors Model of Trade
-Ricardian Model suggest all individuals are better off by trade
-But is this is the case, why is there so much opposition against trade?
-Because, trade has substantial effects on the income distribution within each
trading nation
-There are two main reasons why international trade has strong effects on the
distribution of income:
oResources cannot move immediately or costlessly from one industry
to another
oIndustries differ in the factors of production they demand
-The Specific Factors Model allows trade to affect income distribution
-Assumptions:
oTwo goods, say, food (F) and manufacturing goods (M) are produced
by an economy
oThere are three production factors, labour (L), capital (K), and land
(T) in this economy
oTo produce food , labour and land are needed
oTo produce manufacturing goods, labour and capital (but not land)
are needed
oLabour is a mobile factor, so can be used in either sector, but land and
capital are specific factors that can be used only in one sector,
oPerfect competition prevails in all markets
Sectors Technologies
The production function for manufacturers: M=M(K, LM)
oM: Output of manufacturing sector
oK: Capital stock
oLM: Labour force in manufacturing
The production function for food industry: F=F(T, LF)
oF: Output of food sector
oT: Land used in food sector
oLF: Labour force in food sector
Marginal Product of a Factor: Extra output due to use of extra unit of the factor
(input)
Law of Diminishing Returns: As the use of an input rises (given fixed other input),
output rises but in a decreasing way.
oRicardian models assume that the rate of return of labour is fixed
Production Possibility Frontier
Production possibility frontier: All combinations of mix output that the economy
can produce as labour is shifted from one sector to the other
*Note: LM + LF + L
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Document Summary

Model does not explain sources of labour productivity differences. This could have worked in the 19th century when labour force was not that important. Income distribution: model predicts that all factors gain. This is not the case because resistant still exists. New theme in trade happens in very similar sectors. What is factors are not perfectly substitutable in different sectors, as the model assumes. Ricardian model suggest all individuals are better off by trade. Because, trade has substantial effects on the income distribution within each trading nation. There are two main reasons why international trade has strong effects on the distribution of income: resources cannot move immediately or costlessly from one industry to another, industries differ in the factors of production they demand. The specific factors model allows trade to affect income distribution. The production function for manufacturers: m=m(k, lm: m: output of manufacturing sector, k: capital stock, lm: labour force in manufacturing.

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