Set Up A Ricardo-Type Comparative Advantage Numerical 116685

Set Up A Ricardo Type Comparative Advantage Numerical Example With T

Set up a Ricardo-type comparative advantage numerical example with two countries and two goods. Distinguish “absolute advantage” from “comparative advantage” in the context of your example. Then select an international terms-of-trade ratio and explain in some detail how trade between the two countries benefits each of them in comparison with autarky. When would either of your countries NOT benefit from engaging in trade? Explain.

Paper For Above instruction

Introduction

The concept of comparative advantage, introduced by David Ricardo, forms the foundation of international trade theory. It explains why countries benefit from trading goods even when one country is more efficient at producing all goods. This paper presents a numerical example based on Ricardo’s principles involving two countries and two goods to clarify the distinctions between absolute and comparative advantage, discuss the impact of choosing a terms-of-trade ratio, and analyze scenarios where trade may not be beneficial.

Numerical Example Setup

Consider two countries: Country A and Country B. They produce two goods: Good X and Good Y. The productivity of each country in terms of units of goods produced per worker is summarized in Table 1.

Based on the productivity data:

• Country A can produce 10 units of Good X or 5 units of Good Y per worker.
• Country B can produce 4 units of Good X or 8 units of Good Y per worker.

Absolute Advantage

Absolute advantage refers to the ability of a country to produce more of a good with the same amount of resources. In this example, Country A has an absolute advantage in Good X because it can produce 10 units per worker, versus 4 in Country B. Conversely, Country B has an absolute advantage in Good Y, producing 8 units per worker compared to 5 in Country A.

Comparative Advantage

Comparative advantage considers the opportunity cost of producing one good over another within each country. To determine this, we calculate the opportunity costs:

• Country A’s opportunity cost of producing 1 unit of Good X is 0.5 units of Good Y (since producing 10 units of X costs the same as sacrificing 5 units of Y).
• Country A’s opportunity cost of producing 1 unit of Good Y is 2 units of Good X.
• Country B’s opportunity cost of producing 1 unit of Good X is 2 units of Good Y.
• Country B’s opportunity cost of producing 1 unit of Good Y is 0.5 units of Good X.

From these, Country A has a comparative advantage in Good X because its opportunity cost (0.5 units of Y per X) is lower than that of Country B (2 units of Y per X). Conversely, Country B has a comparative advantage in Good Y because its opportunity cost (0.5 units of X per Y) is lower than that of Country A (2 units of X per Y).

Terms-of-Trade and Gains from Trade

Next, select a terms-of-trade ratio, which is the price of Good X in terms of Good Y. Suppose the ratio is 1 X for 1 Y, meaning trades are balanced and mutually beneficial if the ratio falls between the opportunity costs of both countries (i.e., between 0.5 and 2).

Under autarky (no trade), each country consumes only what it produces. Assume each country allocates all resources to produce and consume both goods in proportions reflecting their capacities. With trade at a terms-of-trade ratio within the opportunity cost bounds, both countries can specialize according to comparative advantage:

• Country A specializes in Good X, producing only Good X.
• Country B specializes in Good Y, producing only Good Y.

Trade allows each country to obtain more of the other good than they could produce on their own, resulting in a higher overall consumption possibility frontier. For instance, if Country A trades some of its Good X for Good Y at the ratio of 1:1, both countries can achieve better consumption bundles than in autarky, thus increasing welfare.

Conditions When Trade Is Not Beneficial

When would either country not benefit from trade? If the terms-of-trade ratio falls outside the opportunity cost bounds (i.e., less than 0.5 or greater than 2 in this example), then trade would make one or both countries worse off. For example, if the price of Good X in terms of Y is too low (2), Country B would prefer autarky because the terms are unfavorable to its situation, resulting in no real gains from trade and possibly a net welfare loss.

Conclusion

Through this numerical example inspired by Ricardo’s model, it is clear that comparative advantage leads to gains from trade, benefiting both countries when they specialize according to their comparative advantage and trade at appropriate terms-of-trade ratios. However, the benefits depend critically on the chosen terms-of-trade. When ratios fall outside the opportunity cost bounds, trade becomes detrimental, reaffirming the importance of appropriate trade policies and negotiation of fair terms to ensure mutual benefits.

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