Academic Wiki

1776 – adam smith, the wealth of nations.

 

Assumptions of the Ricardian model:

 

1. Only two countries are compared at a time.

 

2. Both countries produce just two goods – Beer and Chips.

 

3. Labor is homogenous (one unit of labor in the U.S. is the same as another unit of labor in the US.  The same goes for trade inbetween two countries.

 

4. Labor is the only factor of production.

 

5. Both countries have a fixed amount of labor.

 

6. Labor within both countries are fully employed.

 

7. Labor can move freely within a country (labor can change at will from producing one product to another).

 

8. Labor is immobile between countries.

 

9. Goods can move freely between countries.

 

10. The level of technology used to produce the goods is constant.

 

11. Transportation costs are zero.

 

12. Countries engage in barder trade.

 

13. Production costs are constant.

 

 

Absolute advantage:

(all items below refer to production amounts)

U.S:  5 beer or 10 chips

Mexico: 2 beer or 20 chips

 

U.S. should export beer and import chips.

 

 

Comparative advantage:

U.S: 4 beer, 8 chips.

Mexico: 1 beer, 4 chips.

 

 

U.S wages are $60 a day.  Wages in Mexico are 200 pesos a day.

 

US:  Price of beer is $15 (60/4).  Price of chips is $7.50 (60/8)

Mexico: Price of beer is 200 pesos.  Price of chips is 50 pesos

 

Exchange rate is 10 to 1.

 

 

Chips: 300

Beer: 0150