ECON 3601 Study Guide - Summer 2018, Comprehensive Midterm Notes - Labour Economics, International, Free Trade
12 Oct 2018
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Department
Course
Professor
ECON 3601
MIDTERM EXAM
STUDY GUIDE
Fall 2018
Lecture 3
Comparative Advantage and Opportunity Cost
• The Ricardian model uses the concepts of opportunity cost and comparative advantage.
• The opportunity cost of producing something measures the cost of not being able to
produce something else with the resources used.
• For example, a limited number of workers could produce either roses or computers.
• The opportunity cost of producing computers is the amount of roses not
produced.
• The opportunity cost of producing roses is the amount of computers not
produced.
• Suppose that in the United States 10 million roses could be produced with the same
resources as 100,000 computers.
• Suppose that in Colombia 10 million roses could be produced with the same resources
as 30,000 computers.
• Colombia has a lower opportunity cost of producing roses: has to stop producing fewer
computers.
• A country has a comparative advantage in producing a good if the opportunity cost of
producing that good is lower in the country than in other countries.
• The United States has a comparative advantage in computer production.
• Colombia has a comparative advantage in rose production.
• Suppose initially that Colombia produces computers and the United States produces
roses, and that both countries want to consume computers and roses.
• Can both countries be made better off?
Comparative Advantage and Trade
• When countries specialize in production in which they have a comparative advantage,
more goods and services can be produced and consumed.
– Have the United States stop growing roses and use those resources to make
100,000 computers instead. Have Colombia stop making 30,000 computers and
grow roses instead.
– If produce goods in which have a comparative advantage (the United States
produces computers and Colombia roses), they could still consume the same 10
million roses, but could consume 100,000 – 30,000 = 70,000 more computers.
A One-Factor Ricardian Model
• The simple example with roses and computers explains the intuition behind the
Ricardian model.
• We formalize these ideas by constructing a one-factor Ricardian model using the
following assumptions:
• Labor is the only factor of production.
• Labor productivity varies across countries due to differences in technology, but labor
productivity in each country is constant.
• The supply of labor in each country is constant.
• Two goods: wine and cheese.
find more resources at oneclass.com
find more resources at oneclass.com
• Competition allows workers to be paid a wage equal to the value of what they produce,
and allows them to work in the industry that pays the highest wage.
• Two countries: home and foreign.
• A unit labor requirement indicates the constant number of hours of labor required to
produce one unit of output.
• aLC is the unit labor requirement for cheese in the home country. For example,
aLC = 1 means that 1 hour of labor produces one pound of cheese in the home
country.
• aLW is the unit labor requirement for wine in the home country. For example, aLW
= 2 means that 2 hours of labor produces one gallon of wine in the home
country.
• A high unit labor requirement means low labor productivity.
• Labor supply L indicates the total number of hours worked in the home country (a
constant number).
• Cheese production QC indicates how many pounds of cheese are produced.
• Wine production QW indicates how many gallons of wine are produced.
Production Possibilities
• The production possibility frontier (PPF) of an economy shows the maximum amount of
a goods that can be produced for a fixed amount of resources.
• The production possibility frontier of the home economy is:
aLCQC + aLWQW ≤ L
• Maximum home cheese production is
QC = L/aLC when QW = 0.
• Maximum home wine production is
QW = L/aLW when QC = 0.
• Fo eaple, suppose that the eoo’s lao suppl is , hous.
• The PPF equation aLCQC + aLWQW ≤ L becomes QC + 2QW ≤ 1,000.
• Maximum cheese production is 1,000 pounds.
• Maximum wine production is 500 gallons.
• The opportunity cost of cheese is how many gallons of wine Home must stop producing
in order to make one more pound of cheese:
aLC /aLW
• This cost is constant because the unit labor requirements are both constant.
• The opportunity cost of cheese appears as the absolute value of the slope of the PPF.
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
Comparative advantage and trade: when countries specialize in production in which they have a comparative advantage, more goods and services can be produced and consumed. Have the united states stop growing roses and use those resources to make. Have colombia stop making 30,000 computers and grow roses instead. If produce goods in which have a comparative advantage (the united states produces computers and colombia roses), they could still consume the same 10 million roses, but could consume 100,000 30,000 = 70,000 more computers. A one-factor ricardian model: the simple example with roses and computers explains the intuition behind the. Ricardian model: we formalize these ideas by constructing a one-factor ricardian model using the following assumptions: For example, alc = 1 means that 1 hour of labor produces one pound of cheese in the home country: alw is the unit labor requirement for wine in the home country.
