1. Trade and Technology: The Ricardian Model Readings: Chapter 2 sections 1-3 2

2. Chapter 2 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Introduction. U.S. Imports of Snowboards Why do countries trade?

3. Chapter 3 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Introduction This chapter explains comparative advantage by looking at how technology differences across countries affects trade This is referred to as the Ricardian model because it was proposed by the 19 th century economist David Ricardo

4. Chapter 4 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor The Home Country We will use two goods to develop a Ricardian model of trade: Wheat and Cloth There are two countries, Home and Foreign.

5. Chapter 5 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Road Map Part 1. Home country, before trade Part 2. Home and Foreign countries, who exports wheat and who exports cloth?  Comparative advantage Part 3. Is trade “good” or “bad”?

6. Chapter 6 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor The Home Country  We will assume that labor is the only resource used to produce both goods  One worker can produce 4 bushels of wheat or 2 yards of cloth  The Marginal Product of Labor is the extra output obtained by using one more unit of labor  MPL W = 4 and MPL C = 2  Key Assumption: Marginal Products of Labor are fixed  Suppose Home has 25 workers; i.e. = 25. Labor endowment.

7. Chapter 7 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor The Home Country: Summary Cloth MPL wheat MPL Labor Home2425

8. Chapter 8 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Drawing the PPF

9. Chapter 9 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Notes: Drawing of PPF Home Production Possibilities Frontier  We can use the marginal products of labor to construct Home’s PPF.  Assume there are 25 workers in Home.  If all the workers were employed in wheat, the country could produce 100 bushels  If they were all employed in cloth they could produce 50 yards.  The PPF connects these two points

10. Chapter 10 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Slope of PPF

11. Chapter 11 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Notes: PPF Slope: formular Showing these calculations we can see:  Labor = 25, MPL W = 4, MPL C = 2  If Home produces wheat only, Q W = MPL W * = 25*4 = 100  If Home produces cloth only, Q C = MPL C * = 25*2 = 50 This gives us a straight line PPF which is a unique feature of the Ricardian model  Assumes marginal production of labor is constant

12. Chapter 12 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Notes: Slope of PPF and Opportunity Cost The slope of the PPF can be calculated as the ratio of marginal products of the two goods The slope also equals the opportunity cost of wheat – the amount of cloth that must be given up to obtain one more unit of wheat – if we put wheat quantity on the horizontal axis.

13. Chapter 13 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Slope of PPF and Opportunity Cost The slope of the PPF reflects the opportunity cost of producing one more bushel of wheat in terms of cloth Labor used in 1 wheat = labor used in ½ cloth; i.e. cost of 1 wheat = cost of ½ cloth

14. Chapter 14 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Indifference Curves A B U1U1 Wheat, Q W (bushels) Cloth, Q C (yards) The country is indifferent between A and B U 0 < U 1 < U 2 U2U2 U0U0

15. Chapter 15 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Notes: Indifference Curves Home Indifference Curve  Given Home’s PPF, we still don’t know how much Home will choose to produce  We need information about the country’s preferences – we need indifference curves  A single indifference curve shows the combinations of wheat and cloth that the country can consume and be equally satisfied.

16. Chapter 16 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Notes: Indifference Curves Indifference curves increase in utility as the curves move northeast. All points on a single indifferent curve have the same level of utility. A country cannot produce outside their PPF so, without trade, they are constrained in their utility by the PPF. We use these indifference curves to show the preferences of an entire country

17. Chapter 17 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor closed-economy equilibrium (Home) A B D U1U1 U0U0 Wheat, Q W (bushels) 50 U2U2 Cloth, Q C (yards) C Home PPF The country could produce at point D but would be at a higher level of utility at point A. The country is better off on U2 but cannot produce that much At point A, on U1, is the best the country can do 50 25 100 Home closed-economy equilibrium Figure 2.2

18. Chapter 18 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Notes: Figure 2.2 Home Equilibrium  Without trade, the PPF acts like a budget constraint for the country  The country will produce at its highest level of utility within the limits of the PPF  In the graph, the highest level of utility that can be reached and still stay within the PPF is U1 with production at point A

19. Chapter 19 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Wage Equation Wages  In competitive markets, suppose for cloth P = $2 and MPL = 4. How much are firms willing to pay?  Cost of a marginal worker to the firm = wage  Value of a marginal worker to the firm = the value of one more hour of production = 4 cloth x $2/cloth = $8  So firms are happy if w = $8

20. Chapter 20 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Wage Equation w = P*MPL  Meaning in English: The value of one more worker equals the amount of goods produced by this worker (MPL) times the price of the good.  Predictions: (1) you earn more if your products are worth more; (2) you earn more if you are more productive

21. Chapter 21 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Ave. Wage Purdue Graduates 2011 Source: The Exponent, 2011.

22. Chapter 22 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Oil Boom in North Dakota and Wages Oil prices http://www.macrotrends.net/1369/crude-oil- price-history-chart http://www.macrotrends.net/1369/crude-oil- price-history-chart The average wage in the energy industry in ND = ? Source: “U.S. News: North Dakota Enjoys Oil Boom – But Girds for Slowdown”, by Russel Gold, 24 December 2012, The Wall Street Journal.

23. Chapter 23 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Example: A Snow-covered Paradise in Alberta Wood Buffalo, Alberta

24. Chapter 24 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Wood Buffalo: A Luxury Resort Town? Medium Single Family House: $625,000 In and out: private airports Life style of residents:  20-inch flat-screen TV, double bed  high-speed Internet access and daily maid service.  Prime rib is on the Thursday dinner menu.  The bar opens at 6 p.m., there's a yoga class at 7 Earnings of residents:  $100,000 for inexperienced truck drivers  $200,000 for experienced welders Source: “This Is the Life: Luxurious Digs On Frigid Oil Sands --- Firms in Canada Pay Well, And Steak Is on the Menu; 'Smell of Money' Beckons”, by Douglas Belkin, 5 December 2007, The Wall Street Journal, A1

25. Chapter 25 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Relative Prices at closed-economy equilibrium  W=P*MPL holds for both wheat and cloth  Since labor can move freely between industries, wages must be equalized:  The right had size is the slope of the PPF and the opportunity cost of obtaining one more bushel of wheat.  The left hand side is the relative price of wheat.  Value of 1 wheat = ½ value of 1 cloth

26. Chapter 26 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Relative Prices and OC The price ratio, P W /P C, always denotes the relative price of the good in the numerator, measured in terms of how much of the good in the denominator must be given up. For the good on the horizontal axis of the PPF picture, |PPF slope| = OC = relative price before trade

27. Chapter 27 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Real Wages Before Trade Real Wage = wage/price  Real wage for wheat = wage/price_of_wheat; i.e. quantity of wheat the wage can buy Calculate the real wage for wheat Calculate the real wage for cloth

28. Chapter 28 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Notes: the calculation of Real Wages Before Trade Real Wages  Real wage for wheat = wage/price_of_wheat; i.e. quantity of wheat the wage can buy  Since Home produces both wheat and cloth, Home wage is: w = P W *MPL W = P C *MPL C  The real wage for wheat = w/P W = (P W *MPL W )/P W = MPL W = 4 wheat  The real wage for cloth = w/P C = (P C *MPL C )/P C MPL C = 2 cloth Before trade, real wage = marginal product of labor

29. Chapter 29 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Real Wages Before Trade Before trade, real wage = marginal product of labor

30. Chapter 30 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Part 1 Summary MPL PPF PPF Slope and OC Wage Equation Relative price before trade

31. Chapter 31 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor The Foreign Country: Summary Cloth MPL wheat MPL Labor Foreign11100

32. Chapter 32 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Notes: The Foreign Country in Detail The Foreign Country  Foreign Production Possibilities Frontier  MPL* W = 1, MPL* C = 1  Key Assumption: Marginal Products of Labor are fixed  Assume there are 100 workers available in Foreign  If all workers were employed in wheat they could produce 100 bushels.  If all workers were employed in cloth they could produce 100 yards.  The Foreign country’s PPF connects these two points.

33. Chapter 33 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Foreign PPF

34. Chapter 34 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor closed-economy equilibrium (Foreign) A*A* 50 100 Wheat, (bushels) Cloth, (yards) 100 Foreign before-trade equilibrium Foreign PPF 50 Figure 2.4

35. Chapter 35 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Notes: Figure 2.4 Equilibrium in Foreign  Foreign’s preferences can also be represented by indifference curves  Economy produces at the point of highest utility for the country within the PPF constraint  |The slope of the PPF| = the opportunity cost of wheat = the before-trade relative price of wheat, P* W /P* C = 1

36. Chapter 36 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Pattern of Trade Which country exports wheat and which country exports cloth? Assume: no trade cost

37. Chapter 37 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Absolute Advantage = Higher MPL Summary of Home and Foreign MPL, Cloth (Yard/worker) MPL, wheat (Bushel/worker) Labor Home2425 Foreign11100

38. Chapter 38 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Notes: Absolute Advantage Absolute advantage = higher MPL  Foreign’s technology is inferior to Home’s  Home has an absolute advantage in both wheat and cloth as compared to Foreign  Clearly, Home can’t export both wheat and cloth when trade opens up.

39. Chapter 39 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Comparative Advantage = Lower OC Summary of Home and Foreign MPL, Cloth (Yard/worker) MPL, wheat (Bushel/worker) Labor Home2425 Foreign11100 OC of wheat in Home = ?? OC of wheat in Foreign = ??

40. Chapter 40 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Table of Opportunity Cost Cloth (Yard)Wheat (Bushel) Home2 wheat½ cloth Foreign1 wheat1 cloth Opportunity Costs for Goods in Home and Foreign

41. Chapter 41 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Notes: OC Table Comparative Advantage = Lower Opportunity Cost  Remember a country has a comparative advantage in a good when it has a lower opportunity cost of producing that good  By looking at the chart we can see that Foreign has a comparative advantage in producing cloth  Foreign’s Opportunity cost of cloth is lower  Home has a comparative advantage in producing wheat  Home’s opportunity cost of wheat is lower

42. Chapter 42 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Why does comparative advantage drive trade patterns? Because OC = relative prices before trade Wheat (Bushel) Home½ cloth Foreign1 cloth

43. Chapter 43 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Notes: Relative Price Table Why does Home export wheat?  Relative price of wheat in Home is P W /P C = 1/2  Relative price of wheat in Foreign is P W * /P C * = 1  Therefore Home would want to export their wheat to Foreign – they can make it for 0.50 cloth and export it for 1 cloth! The opposite is true for cloth  Home will export wheat and Foreign will export cloth  Both countries export the good for which they have the comparative advantage

44. Chapter APPLICATION 44 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Comparative Advantage in Apparel, Textiles, and Wheat US Textile and apparel industries face intense import competition Burlington Industries announced in January 1999 it would reduce production capacity by 25% due to increased imports from Asia After layoffs they employed 17,400 persons in the US with a 1999 sales of $1.6 billion Sales per employee were therefore $92,000 This is the average for all US apparel producers Textiles are even more productive with annual sales per employee of $140,000 in the US

45. Chapter APPLICATION 45 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Comparative Advantage in Apparel, Textile and Wheat Table 2.2

46. Chapter 46 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Equilibrium with trade The relative price of wheat in the trade equilibrium will be between the before-trade prices in the two countries For now lets assume the free-trade price, P W T /P C T = 2/3. This is between the price of ½ in Home and 1 in Foreign. We can now take this price and see how trade changes production and consumption in each country

47. Chapter 47 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Notes: Equilibrium with trade How prices change after trade  As Home exports wheat, quantity of wheat sold at Home falls  The price of wheat at Home goes up  More wheat goes into Foreign’s market  The price of wheat in Foreign falls  For the same reason, as Foreign exports cloth, the quantity sold in Foreign falls. Therefore, the price in Foreign for cloth rises, and the price of cloth in Home falls.

48. Chapter 48 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Notes: Equilibrium with trade Trade Equilibrium  Two countries are in a trade equilibrium when the relative price of wheat is the same in the two countries – this means the relative price of cloth is also the same in both countries.  This is because we assume there is no trade cost

49. Chapter 49 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Pattern of Production P W T /P C T = 2/3. Home exports wheat. How many wheat does Home make? Cloth (Yard)Wheat (Bushel) Home2 wheat½ cloth Foreign1 wheat1 cloth Opportunity Costs in Home and Foreign

50. Chapter 50 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Complete specialization Home’s workers will want to work in wheat and no cloth will be produced With trade, Home will be fully specialized in wheat production

51. Chapter 51 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Summary Part 2 Absolute advantage Comparative advantage  OC = relative price before trade Trade equilibrium Free-trade price Complete specialization

52. Chapter 52 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Is trade good or bad: Home A U1U1 Wheat, Q W (bushels) 50 Cloth, Q C (yards) Home PPF P W T /P C T = 2/3. Home exports wheat 50 25 100 Home closed-economy equilibrium

53. Chapter 53 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Consumption possibility frontier With free trade, what choices does Home country have for consumption? i.e. what is Home country’s “budget line”?

54. Chapter 54 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Consumption Possibility Frontier (CPF), Home U2U2 CPF, Slope = –2/3 U1U1 A 50 100 Wheat, Q W (bushels) Cloth, Q C (yards) B Home production 50 25 The new world price, P W T /P C T = 2/3, shows us the new range of consumption possibilities The country can now achieve a higher utility with the new consumption possibilities

55. Chapter 55 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Is trade good or bad: Foreign Foreign PPF 100 Wheat, (bushels) Cloth, (yards) 100 U0U0 Foreign closed-economy equilibrium A*A* P W T /P C T = 2/3. Foreign exports cloth

56. Chapter 56 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor CPF, Foreign Foreign production C*C* Foreign consumption 60 100 Wheat, (bushels) Cloth, (yards) 100 60 B*B* World price line, Slope = –2/3 U0U0 U1U1 The new world price, P W T /P C T = 2/3, shows us the new range of consumption possibilities The country can now achieve a higher utility with the new consumption possibilities

57. Chapter 57 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Notes: Gains from Trade Gains from trade for BOTH countries!  Under the new production, each country specializes fully in the good for which they have the comparative advantage  They then export some of their production and import some of the other good from the other country  Home specializes in wheat and Foreign specializes in cloth  The new indifference curves show the new consumption points.  The difference between production and consumption give us trade patterns

58. Chapter 58 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Gains from Trade: intuition International Trade  Trade allows both countries to engage in consumption possibilities they did not have before trade  This is a demonstration of gains from trade  Intuition: trade increases the choices a country can make (the PPF remains available after trade); both countries gain because they help each other out.

59. Chapter 59 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Trade is Balanced: Foreign Foreign production C*C* Foreign consumption Foreign exports 40 yards of cloth Foreign imports 60 bushels of wheat 60 100 Wheat, (bushels) Cloth, (yards) 100 60 B*B* World price line, Slope = –2/3 U0U0 U1U1 Foreign produces 0 wheat but consumes 60 so imports equal 60. Foreign produces 100 cloth but consumes only 60 so exports equal 40

60. Chapter 60 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Trade is Balanced: Home Home consumptionHome production Home imports 40 yards of cloth Home exports 60 bushels of wheat U1U1 40 100 Wheat, Q W (bushels) Cloth, Q C (yards) C B U2U2 World price line, Slope = –2/3 50 40 Home produces 100 wheat but consumes only 40 so exports equal 60 Home produces 0 cloth but consumes 40 so imports equal 40.

61. Chapter 61 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Notes: Trade is Balanced Trade is the difference between domestic production and consumption  Quantity of exports = quantity of production – quantity of consumption  Quantity of imports = quantity of consumption – quantity of production

62. Chapter 62 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Trade and Wages How do wages change after trade for Home and Foreign? Under free trade, which country has a higher wage?  Wages actually differ – they are determined by absolute advantage – not comparative advantage Real wages: = wage/price.

63. Chapter 63 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Real Wages Before Trade: Home Before trade, real wage = marginal product of labor since Home makes both wheat and cloth  The real wage for wheat = MPL W = 4 wheat  The real wage for cloth = MPL C = 2 cloth

64. Chapter 64 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Real Wages After Trade: Home Solving for Real Wages Across Countries  Since Home produces and exports wheat, Home wage is: w = P W T *MPL W  The real wage for wheat = w/P W T = (P W T *MPL W )/P W T = MPL W = 4 wheat. Same as before trade  The real wage for cloth = w/P C T = (P W T *MPL W )/P C T =(P W T /P C T )*MPL W = (2/3)*4 = 8/3 cloth. Higher than before trade. Trade increases real wage for cloth! Same intuition as gains from trade.

65. Chapter 65 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Terms of Trade The real wage for cloth =(P W T /P C T )*MPL W The Terms of Trade for Home = P W T /P C T  An increase in P W T or a fall in P C T will raise Home’s terms of trade  An increase in the terms of trade is good for a country  They earn more for its exports  They pay less for their imports  Home real wage for cloth is higher  In general, the price of a country’s exports divided by the price of its imports.  Foreign’s Terms of Trade = P C T /P W T

66. Chapter 66 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Real Wages Before Trade: Foreign Before trade, real wage = marginal product of labor since Foreign makes both wheat and cloth  The real wage for wheat = MPL W * = 1 wheat  The real wage for cloth = MPL C * = 1 cloth

67. Chapter 67 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Real Wages After Trade: Foreign Solving for Wages Across Countries  Since Foreign produces and exports cloth, Foreign wage is: w * = P C T *MPL C *  The real wage for cloth = w * /P C T = (P C T *MPL C * )/P C T = MPL C * = 1 cloth, same as before trade  The real wage for wheat = w * /P W T = (P C T *MPL C * )/P W T = (P C T /P W T )*MPL C * = (3/2)*1 = 3/2 wheat, higher than before trade Again, free trade increases real wages!

68. Chapter 68 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Comparing Wages Across Countries Summarizing  Home real wage is  4 bushels of wheat  8/3 yards of cloth  Foreign real wage is  3/2 bushels of wheat  1 yard of cloth  The ratio Home_wage/Foreign_wage = 8/3, so Foreign workers earn less  What is the intuition for this?

69. Chapter 69 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Comparing Wage Across Countries What determines w/w * ?  Since Home produces and exports wheat, Home wage is: w = P W T *MPL W  Since Foreign produces and exports cloth, Foreign wage is: w * = P C T *MPL C *

70. Chapter 70 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Summary: Comparing Wages Across Countries Home_wage/Foreign_wage depends on Home country’s TOT and absolute advantage So comparative advantage gives you trade patterns, and absolute advantage gives you high wages The intuition: the only way a country with poor technology can export at a price others are willing to pay is by having low wages.

71. Chapter 71 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Predictions Prediction:  In a given year, the countries that have better technology should have higher wages (i.e. comparing across countries)  Over time, as a given country develops better technology, its wages will rise (i.e. looking at changes for a given country)

72. Chapter APPLICATION 72 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Labor Productivity and Wages for 2001 Figure 2.7

73. Chapter APPLICATION 73 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Notes: Figure 2.7. Labor productivity can be measured by the value- added per hour in manufacturing  Value-added is the difference between sales revenue in an industry and the costs of intermediate inputs  Equals the payments to labor and capital in an industry.  The Ricardian model ignores capital so we can measure labor productivity as value-added divided by the number of hours worked, or value-added per hour Figure 2.7 shows value added per hour in manufacturing for several countries  Countries with higher labor productivity pay higher wages, just as the Ricardian model predicts

74. Chapter APPLICATION 74 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Figure 2.8. Labor Productivity and Wage Over Time

75. Chapter APPLICATION 75 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Notes: Figure 2.8. We can also see the connection between productivity and wages over time Figure 2.8 shows the general upward movement in labor productivity is matched by upward movement in wages  This is also predicted by the Ricardian Model

76. Chapter 76 of 84 2 © 2007 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Summary Part 3 CPF Trade is balanced Real wages