Ventajas Comparativas

Chapter 2The Ricardian Theory of Comparative Advantage
by Steve Suranovic
2.7 Relationship between Prices and Wages
The Ricardian model assumes that the wine and cheese industries are both perfectly competitive. Among the assumptions of perfect competition is free entry and exit of firms in response to economic profit. If positive profits are being made in one industry, then because of perfectinformation, profit-seeking entrepreneurs will begin to open more firms in that industry. The entry of firms, however, raises industry supply, which forces down the product price and reduces profit for every other firm in the industry. Entry continues until economic profit is driven to zero. The same process occurs in reverse when profit is negative for firms in an industry. In this case, firmswill close down one by one as they seek more profitable opportunities elsewhere. The reduction in the number of firms reduces industry supply, which raises the product’s market price and raises profit for all remaining firms in the industry. Exit continues until economic profit is raised to zero. This implies that if production occurs in an industry, be it in autarky or free trade, then economicprofit must be zero.
Profit is defined as total revenue minus total cost. Let ΠC represent profit in the cheese industry. We can write this as
ΠC=PCQC−wCLC=0,
where PC is the price of cheese in dollars per pound, wC is the wage paid to workers in dollars per hour, PCQC is total industry revenue, and wCLC is total industry cost. By rearranging the zero-profit condition, we can write the wage as afunction of everything else to get
wC=PCQCLC.
Recall that the production function for cheese is QC=LCaLC. Plugging this in forQC above yields
wC=PC(LCaLC)LC=PCaLC
or just
wC=PCaLC.
If production occurs in the wine industry, then profit will be zero as well. By the same algebra we can get
wW=PWaLW.
2.8 Deriving the Autarky Terms of Trade
The Ricardian model assumes that all workers areidentical, or homogeneous, in their productive capacities and that labor is freely mobile across industries. In autarky, assuming at least one consumer demands some of each good, the country will produce on the interior of its PPF. That is, it will produce some wine and some cheese.
Question: Profit-maximizing firms would never set a wage rate above the level set in the other industry. Why?
Answer:Suppose the cheese industry set a higher wage such that wC > wW. In this case, all the wine workers would want to move to the cheese industry for any wage greater than wW. Since their productivity in cheese is the same as the current cheese workers and since it does not cost anything for them to move to the other industry, the cheese industry could lower their costs and raise profit by payinga lower wage. To maximize profit, they must lower their wage. Thus only equal wage rates can be sustained between two perfectly competitive producing industries in the Ricardian model.
In autarky, then, wC = wW. Plugging in the relationships derived in the previous section yields
PWaLW=PCaLC
or
(PCPW)Aut=aLCaLW.
This means that the autarky price ratio (cheese over wine) or terms of tradeequals the opportunity cost of producing cheese. Another way to say the same thing is that the price of cheese (in terms of wine) in autarky equals the opportunity cost of producing cheese (in terms of wine).
Question: Why is there an autarky terms of trade when there is no trade in autarky?
Answer: The Ricardian model represents a barter economy. Even though we define prices and wages in monetaryterms, all relevant solutions in the model are described in terms of ratios in which the money or dollars cancel out. Never will we solve explicitly for the dollar price of wine or cheese or the dollar wage rate.
Thus a good way to think about how the model works is to imagine that workers go to work in their respective industries and produce wine or cheese. At the end of the day, they are paid...