Notes of Understanding the Ricardian Model

Notes of Understanding the Ricardian Model¹

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Problem Restatement

Considering a world consisting of country 1 and country 2, each with $M_i(i=1,2)$ consumer-producers. The individuals within a country are assumed to be identical. The utility function for individuals in country $i$ is:
$$U_i=(x_i+k{x}_i^d{)}^{\beta }(y_i+k{y}_i^d{)}^{1-\beta }$$

The production functions for a consumer-producer in country i are:
$$\begin{gathered} x_i+x_i^s=a_{ix}{l}_{ix} \\ {y}_i+y_i^s=a_{iy}{l}_{iy} \\ {l}_{ix}+l_{iy}=1 \end{gathered}$$
The decision problem for an individual in country $i$ Involves deciding on what and how much to produce for self-consumption, to sell and to buy from the market.

Hypothesis and Deductions

Let country 1 have a comparative advantage in producing good $X,i.e.,a_{1x}/a_{1y}>a_{2x}/a_{2y}.$

And there would be three types of configurations from which the individuals can choose:

• Self sufficiency. At $x_i,y_i>0,x_i^s=x_i^d=y_i^s=y_i^d=0,i=1,2.$
• Partial specialisation in the comparative advantage good.
  At $x_1,y_1,x_1^s,y_1^d>0,x_1^d=y_1^s=0$ Configuration $XY/Y$;
  Or, at $x_2,y_2,x_2^d,y_2^s>0,x_2^s=y_2^d=0$ Configuration $XY/X$;
• Complete specialization in the comparative advantage good.
  At $x_1,x_1^s,y_1^d>0,x_1^d=y_1=y_1^s=0$ Configuration $X/Y$;
  Or at $y_2,y_2^s,x_2^d>0,y_2^d=x_2=x_2^s=0$ Configuration $Y/X$;

Corner Equilibria

A Milestone for General Equilibrium. Corner equilibrium is defined as a relative price of the two goods and a resource allocation that satisfy:

• for a given structure (which is a combination of all individuals’ configurations), each individual maximizes utility at a given relative price,
• the relative price clears the market.

Two Steps from Corner Equilibria to General Equilibrium

The general equilibrium is solved in two steps.

First, we solve the corner equilibria for each structure, then we identify the parameter subspace within which each corner equilibrium is the general equilibrium where nobody has incentive to unilaterally deviate from his configuration in this structure.

For instance, in Structure Ba,

• Step1: Decide on the Corner Equilibria

the decision problem for individuals in country 1 is:
$$ma{x}_{x_1,x_1^s,y_1,y_1^d,l_{1x},l_{1y}}{U}_1=x_1^{\beta }(y_1+k{y}_1^d{)}^{1-\beta }$$

$$s.t.\{\begin{array}{rc}{x}_1+x_1^s& =a_{1x}{l}_{1x}\\ y_1& =a_{1y}{l}_{1y}\\ y_1^d& =p{x}_1^s\\ l_{1x}+l_{1y}& =1\end{array}$$

For the first order condition:
$$s.t.\{\begin{array}{r}p=a_{1y}/k{a}_{1x}\\ x_1=\beta a_{1x}\\ x_1^s=a_{1x}(l_{1x}-\beta )\\ y_1=a_{1y}(1-l_{1x})\\ y_1^d=a_{1y}(l_{1x}-\beta )/k\end{array}$$

the decision problem for individuals in country 2 is:
$$ma{x}_{x_2^d,y_2,y_2^s}{U}_2=(k{x}_2^d{)}^{\beta }{y}_2^{1-\beta }$$

$$s.t.\{\begin{array}{rc}{y}_2+y_2^s& =a^{2y}\\ y_2^s& =p{x}_2^d\end{array}$$

For the first order condition:
$$s.t.\{\begin{array}{rc}{x}_2^d& =\frac{k{a}_{2y}{a}_{1x}}{a_{1y}}\beta \\ y_2& =(1-\beta )a_{2y}\\ y_2^s& =\beta a_{2y}\end{array}$$
considering the market clearing condition²:
$$M_1{x}_1^s=M_2{x}_2^d$$

we get:
$$l_{1x}=(M_2\beta k{a}_{2y})/M_1{a}_{1y}+\beta$$
which is less than $1$ if and only if:
$$a_{2y}/a_{1y}<M_1(1-\beta )k{M}_2\beta$$
and that’s the condition when Structure Ba is chosen.

That’s how we get the corner equilibrium based on which we look into the general equilibrium and find out what conditions they need for that status.

• Step2: Conditions that Bring General Equilibrium

The general equilibrium holds on the condition that the corner equilibrium exists in some certain circumstances, that is:
$$\begin{gathered} U_2(Y/X)\ge U_2(A)\text{which holds iff }k\ge k_0\equiv [(a_{2x}/a_{2y})/(a_{1x}/a_{1y}){]}^{1/2}, \\ {U}_2(Y/X)\ge U_1(X/Y)\text{which holds iff }k\ge k_3\equiv [(a_{2x}/a_{2y})/(a_{1x}/a_{1y}){]}^{1/2\beta }. \end{gathered}$$
which implies that individuals in country 2 prefer specialisation in Y to the alternatives. While the corressponding requirement for individuals in country 1 is:
$$\begin{gathered} U_1(XY/Y)\ge U_1(X/Y)\text{which holds iff }{a}_{1y}/a_{1x}\ge kp=a_{1y}/a_{1x}, \\ {U}_1(XY/Y)\ge U_1(Y/X)\text{which holds iff }1\ge k. \end{gathered}$$
and we have to make sure no individual in country 1 is completely specialised in $X,i.e.,$ that is:
$$l_{1x}<1,\text{which holds iff }k<k_1\equiv a_{1y}{M}_1(1-\beta )/a_{2y}{M}_2\beta$$

In total, the general equilibrium holds if :
$$\begin{gathered} k\in (k_0,k_1),\text{where, }{k}_1\equiv a_{1y}{M}_1(1-\beta )/a_{2y}{M}_2\beta ; \\ {M}_1(1-\beta )/M_2\beta >[(a_{2x}{a}_{2y})/(a_{1x}{a}_{1y}){]}^{1/2} \end{gathered}$$

Conclusion

This analysis assumes the specific Structure Ba. To verify the conditions for general equilibrium under other structures, a similar workflow can be employed. Firstly, the solution to the corresponding corner equilibrium should be derived. Thereafter, the necessary prerequisites for this corner equilibrium must be investigated, which translate to the specific economic conditions that countries 1 and 2 must satisfy. It is crucial to note that these prerequisites represent the compatibility requirements between the chosen structure and the underlying economic environment.

References

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1. Cheng W, Sachs J, Yang X. An inframarginal analysis of the Ricardian model[J]. Review of International Economics, 2000, 8(2): 208-220. ↩︎

2. MARKET CLEARING CONDITION
   The market clearing condition refers to the point in a market where demand and supply are exactly equal. At this point, there are no unsold goods or services languishing, and all buyers willing and able to pay the prevailing price have found sellers. This price, aptly named the market clearing price, satisfies both buyer and seller preferences.
   Think of it as a perfectly balanced scale, where the weight of “things people want” (demand) on one side is precisely matched by the weight of “things available for purchase” (supply) on the other. No need for adjustments, everyone’s happy!
   Here’s a breakdown of the key points:

   • Equilibrium: Market clearing represents a state of equilibrium, where no forces are pushing for further price adjustments.
   • Price discovery: The market clearing price is determined through the forces of supply and demand interacting in the market.
   • Efficiency: In theory, a market clearing price leads to an efficient allocation of resources, where goods and services go to those who value them the most.
     It’s important to note that market clearing is a theoretical concept, and real-world markets may not always achieve perfect equilibrium. However, understanding the market clearing condition is crucial for analyzing various economic phenomena like price fluctuations, resource allocation, and market efficiency.
   ↩︎