1. Extend the Ricardo’s Model
Loose the assumptions of Ricardo’s Model
Review the Assumptions of Ricardo’s Model, Loose those assumptions and see what will happen to Ricardo’s model
Summary
2. Other extensions

2. Review the Main Assumptions
2*2*1 model: One input(L), Two outputs, Two countries
Costs are constant and there are no economies of scale.
Factors of production are perfectly mobile.
Perfect Competition (Goods are identical)
No transaction costs (No transport costs, No tariffs or other trade barriers, Perfect knowledge, etc)

3. Loose the Assumptions 1 (1)
One input
Two or more inputs
H-O Model
Specific Factor Model
Talk about it later

4. Loose the Assumptions 1 (2)
Two outputs &Two countries
Ricardo Model with Many Goods or Many Countries
Ricardo’s model no essential change
Many Goods and Two Countries
Many Countries and Two Goods

5. Many Goods and Two Countries
Setting up the model: list relative productivity by order (note: * is US)
Deriving the relative demand for labor
Determining the relative wage
Determining the comparative advantages
αL1*/ αL1> αL2*/ αL2>…… > αLi*/ αLi
If or than china has
advantage in product i

6. Example
If = 5，then China has advantage in apple and Banana, US has advantage in other three goods;
If =4,then China and US both can produce caviar; If =1，then China can export apple, banana, caviar and Dates.

7. Many Countries and Two Goods
Setting up the model: list relative costs by order
Deriving the relative supply
Determining the relative price
Determining the comparative advantages
< <…<

8. Principle
In the case of two products and many countries, one country’s comparative advantage is determined by the relative costs of the products it produces and the relative price in the world market
If < , this country has comparative advantage in product 1.

9. Example
USA
France
China
Thailand
Nation
L per Unit
Relative cost
Rice
Wheat
Suppose the relative price of Rice in equilibrium is 2, then Thailand and China produce and export Rice, while USA and France produce and export Wheat.

10. Determining the relative price
Relative productions of Rice
Relative Demand
Relative price of Rice 4
2.5 2
1.5 1
Relative Supply

11. Determining the relative price
Relative price of Rice is determined by the produce capability of Thailand in Rice, that of USA in Wheat and the relative demand of 4 countries.
If the produce capability of Thailand in Rice is strong, while that of USA in Wheat is weak, the relative supply of Rice is large; or else it is small.

12. Determining the relative price
When the relative demand of Rice is given, the larger the relative supply of Rice is, the lower the relative price of Rice in equilibrium, and the less countries Rice productions will need, even just Thailand is enough.
But if the produce capability of USA in Wheat is strong, while that of Thailand in Rice is weak, the relative price of Rice will be higher.

13. Loose the Assumptions 2 (1)
Increasing opportunity costs or decreasing returns to scale
Costs are constant QC QW
PPF

14. International Trade under Increasing Opportunity Cost
Autarky
The Patten of Production and Trade
Comparison
Conclusion

15. Autarky
Foreign
Home

16. The Patten of Production and Trade
Foreign C’
TOT=
Export
Import P’ C
Import P
Export
Home
TOT=

17. Increasing Opportunity Cost
Comparison
Home C
TOT=
Import
Export
Increasing Opportunity Cost
Constant Cost

18. Conclusion
The principle of comparative advantage is still effective under the increasing opportunity cost.
However, pure specialization is impossible.

19. Loose the Assumptions 2 (2)
Decreasing opportunity costs or decreasing returns to scale
Costs are constant QC QW
PPF

20. Trade gains under decreasing costsQC QW
PPF A B A’ B’ C’ C
Trade gain
TOT

21. Loose the Assumptions 2 (3)
Economics-of-scale and imperfect competition model
No economies of scale
Talk about it later

22. Loose the Assumptions 3 Factors of production are perfectly mobile
Transfer Costs
Factors of production are perfectly mobile
Factors of production can’t move freely among sectors
Industry Obstruct
Reduce the volume of international trade
Increasing the production costs of export

23. Goods are idiosyncratic
Loose the Assumptions 4
Goods are identical
Goods are idiosyncratic
Intra-sector Trade
Talk about it later

24. Loose the Assumptions 5 (1)
Perfect knowledge
Imperfect knowledge
Reduce the volume of international trade
More difficult to find the right goods and reach contractions

25. Loose the Assumptions 5 (2)
No transport costs
transport costs
Reduce the volume of international trade
Non-traded Goods

26. Loose the Assumptions 5 (3)
No tariffs or other trade barriers
Trade Barriers
Reduce the volume of international trade
Increasing the Transaction Costs
Talk about it later

27. Summary
Loosing some assumptions of Ricardian Model will not affect the Law of Comparative Advantage substantially, but increase the transaction costs in international trade, and lead to imperfect specialization, reduce the volume of international trade.
But loosing the assumptions that goods are identical and there are no economies of scale is the base of intra-sector trade and economics-of-scale model.

28. Increasing Transaction Costs
What is transaction costs?
—— expenses of searching for a trading partner, specifying the product(s) to be traded, negotiating the price and contract,and the ex post costs.
Who find the “transaction costs”?
Reasons of transaction costs especially in IT
Imperfect Information(Knowledge)
Transport Cost
Trade Barrier
Political Risk

29. Ronald H. Coase Great Britain University of Chicago, USA Major Work
“The Firm，the Market，and the Law”
“The Nature of the Firm”

30. Trade gains with transaction costs
Before trade (autarky)
A country: 1 Wheat=a Cloth
B country: 1 Wheat=b Cloth1 Cloth=1/b Wheat
After trade
TOT: 1 Wheat=P Cloth1 Cloth=1/P Wheat
Transaction costs: F per unit Wheat or Cloth
A country: exchange 1 Wheat not less than a Cloth, ie P-F>a
B country: exchange 1 Cloth not less than 1/b Wheat, ie (1/P)-F>1/b

31. Trade with transaction costs and increasing opportunity costs
TOT
A: no trade
P & C: Productions & Consumptions under trade without transaction costs
P’ & C’: Productions & Consumptions under trade with transaction costs
TOT-F O A P P’ C C’

32. Imperfect Specialization
Increasing Opportunity Cost
Transaction Costs
The Size of Trader (talk about it later)
The existence of more than one factor of production reduce the tendency toward specialization

33. Other Extensions for Ricardian’s Model
Trade Between Big Country and Small Country
Trade with Currency (not barter)

34. Trade Between Big Country and Small Country
There is an implicit assumption in Ricardian two-country model that the size of the two countries are similar, so they can give up the productions without comparative advantage, and input all the resources to the production with comparative advantage.
But in reality, the size of the trading countries may be very different. For example, China’s population as well as land is hundreds of times of Sri Lanka’s, so even China has comparative advantage in Cloth, while Sri Lanka in Wheat, China can’t produce Cloth only under free trade. Because even all Wheat produced by Sri Lanka are exported to China, they still can’t meet the consumption need in China.

35. Trade Between Big Country and Small Country
So，If trade happens between big country and small country, small country can only produce the product with comparative advantage, but big country still need to produce both products.
Case Study:Who will feed China?

36. Imperfect Specialization for Big and Small CountriesQC P Qw O C
China
Sri Lanka
TOT O QC

37. Trade with Currency Bicycle Toy USA (Dollar) 100 25 China (RMB) 400 50
Suppose RMB/Dollar=X
For Bicycle, if 100X>400(ie X>4), no trade in Bicycle and Toy(25×4＝100>50);
For Toy, if 25X<50(ie X<2), no trade in Toy and Bicycle(100×2＝200<400).
So X must be between 2 and 4, if there is trade