As the rapid development of international trade, we are now studying special models to analyze economic situations. There are two models I want to compare and contrast in the world trade: the Ricardian trade model and the Specific factors model.
In the Ricardian trade model, there is only one factor of production that is labor. Labor productivities between countries were assumed to be different due to differences in technology and it is constant in each country. Labor was also assumed to be fully mobile across sectors but immobile between countries. Home and Foreign are two countries we considered in the model who produce only two goods. It is assumed that perfect competition happens in the world trade so that price equals to marginal cost.
we note that aj is the unit labor requirement which indicates the constant number of hours of labor required to produce one unit of good j. Then 1/aj is labor productivity. The production possibility frontier (PPF) is introduced to show the maximum amount of a good that can be produces for a fixed amount of resources. In autarky, the relative price of trade is determined by the technological references.
The frontier of the production possibilities (FPP) of home country: [pic]
From the diagram above, all possible combinations of productions are along this PPF and the slope of the curve is negative and corresponds to the opportunity cost.
In autarky, equilibrium in goods market is determined by where domestic supply equals domestic demand for each good. Consumers’ preferences determine the demand of good while supply is subject to the perfect competition. Wages equalize across sectors due to free labor mobility, that are determined by the productivity level and increase with productivity. (Relative prices determined by relative production costs.)
Countries specialize in producing...