Problem Set 2 - Answers Gains and Ricardian Page 1 of 11 Problem Set 2 - Answers Gains from Trade and the Ricardian Model 1. … a. In the gains from trade diagram in Figure 3-3, suppose that instead of having a rise in the relative price of manufactures, there is a fall in that relative price. Let us assume that there are two countries, A and B, that produce two goods, X and Y, which require labour for their production. Let there be three countries A, B and C that exchange goods X, Y and Z with each other. . Label this point on your diagram. Because of trade, production of both X and Y will increase in the following pattern: Thus, international trade is mutually ben­eficial. In the gains from trade diagram (Figure 3-3), suppose that instead of having a rise in the relative price of manufactures, there is a fall in that relative price.a. Which good is exported and which is imported? PLAY. Thus, the assumption of the labour theory of value seems to be unrealistic in ex­plaining the cause of trade. The gains from international trade arise because of the diversity in the conditions of production (natural or acquired) in different countries. (ii) Differences in Comparative Cost not Ex­plained: Secondly, Ricardo could not explain why comparative costs differ between coun­tries. Gains from Trade and the Ricardian Model 1. 2. Adam Smith, a famous economist from the 18th century, talked about this in his book, Wealth of Nations, and so did economist David Ricardo. Scientific Method. Diagram of trade creation Test. A gain from trade is a simple concept - two parties traded and both parties got something out of it. To Fisher, then, … DOI link for - The Welfare Gains from Trade - The Welfare Gains from Trade book - The Welfare Gains from Trade . Which good is exported and which is imported? Setting up the study: 1. 5.2 suggest that trade is a one-way traffic. The following example suggests that (de­veloped) country A has an absolute advantage in the production of both goods X and Y. Nev­ertheless, country A can gain from trade with the (less developed) country B because it has a cost advantage in the production of Y than in X. This assumption makes this extended Ricardian model into 2 x 2 model. Country B now trades with A at an exchange rate of 1: 3 by exchanging 1 unit of X for 4/3 = 1 1/3 units of Y. Let the international terms of trade be 1:3. Before trade, country A consumed 6 units of X and after trade it con­sumes additional (9-6 = 3) units of X. 1. b. Get … a. Thirdly, Ricardo could not determine the ex­act terms of trade or exchange rate at which trade takes place. Now, by exporting Y, it will bring more X. c. Explain why the overall gains from trade are still positive. Trade creation will occur when there is a reduction in tariff barriers, leading to lower prices. Which good is exported and which is imported? Write. In the gains from trade diagram in Figure 3-3, suppose that instead of having a rise in the relative price of manufactures, there is instead a fall in that relative price Starting at the no-trade point A in Figure 3-3, show what would happen to production and consumption. Ricardo argued that trade gains could arise if countries first specialize in their comparative advantage good and then trade with the other country. (iii) Multi-Countries, Multi-Commodities: Ricardo’s doctrine has also applicability in a multi-country, multi-commodity framework. Thus, inter­nal and domestic exchange ratio between the two goods of country A is 3 : 2 and for B is 4:1. Fur­ther, number of traded goods is not two but many. Privacy Policy3. In 1776, Adam Smith argued that absolute cost difference or absolute advantage is the basis of trade. Buyers and sellers participate in a market because they each benefit from doing so, and consumer and producer surplus provide a measure of their gains from trade. 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