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London Metropolitan University Bachelor of Business Administration Top-up Cover Sheet STUDENT LMU ID NUMBER17032692/1MODULE CODEEC6054DEADLINE10.06.2018MODULE TITLEINTERNATIONAL FINANCE AND TRADEASSIGNMENT NUMBER01TUTORS NAMEHANSANI PABASARA NIRIELLATEACHING BUILDINGCOLOMBO BRANCHSTUDENT NAMEELIZABETH MARTINSTUDENT DECLARATION I declare that the work submitted is my own Signature of the student Date Submitted 09.06.2018 PLAGIARISM is covered by the universitys regulations on Academic Misconduct sources of academic misconduct in coursework can include fellow students, published sources including internet, essay banks and other commissioned and non-commissioned sources.

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Ricardian Model of international trade Introduction International trade is the exchange of goods and services between countries. Total trade equals HYPERLINK https// exports plus HYPERLINK https// imports. In 2017, HYPERLINK https//www. world trade was 34 trillion. Thats 17 trillion in exports plus 17 trillion in imports (Amadeo, 2018). There are many reasons for international trade.

Some of them are diversity of conditions which means nations are different in resources, cost advantage and different preferences and to achieve economies of scale from specialization. International trade advantages, increase world output, variety of goods, services, higher economic growth, sharing of resources basically technology and information, trade increase competition and lower prices and increase employment. Absolute advantage and comparative advantage are two important concepts of international trade. These concepts describe basic economic benefits that nations get from trading with each other.

Absolute advantage is production of a good when it is more efficient than the other country. Which means it can produce more of goods than the other country using the same amount of resources. Comparative advantage Ability of a country to produce a particular good or service at a lower marginal and opportunity cost than the other country. Basically there are 7 international trade theories. Those are theory of mercantilism, theory of absolute advantage, theory of comparative advantage (Ricardian model), Heckscher-ohlin model, new trade theory based on economies of scale, product life cycle theory and porters competitive advantage theory (Dibiky,2017).

This report will explain the key features and implications and shortcomings of Ricardian model of international trade. Word Count-1925 1 Ricardian Model David Ricardo introduced the theory of comparative advantage and based on that explained why nations need to trade and why trade is mutually beneficial to countries. If a country is relatively more efficient in the production of a good than the other country it is considered that country has comparative advantage over that particular product. Since countries have limited resources and level of technology they tend to produce goods or services in which they have a comparative advantage (Kilic, 2002). A country has comparative advantage in producing a certain good if the opportunity cost of producing that good is lower than in the other country.

That is why countries are specializing in producing certain products. Opportunity cost is the loss of potential gain from other alternatives when one alternative is chosen. Following example demonstrate the comparative advantage and the opportunity cost. Product XProduct YCountry A105Country B44 According to this example Country A has absolute advantage for product X and product Y as it produces more products compared to country B. The table below shows opportunity cost of each good for both countries. Product XProduct YCountry A2 Y products X productsCountry B1Y product1 X product Therefore, country B (foreign) has a comparative advantage in producing product X as foreign country opportunity cost of X product is lower and country A (home) has a comparative advantage in producing product Y as home country opportunity cost of Y product is lower. 2 For an example limited number of workers could produce either X or Y.

The opportunity cost of producing X is the amount of Y not produced. The opportunity cost of Y is the amount of X not produced. a unit labor requirement indicates the constant number of hours of labor required to produce one unit of output. aLX is the unit labor requirement for X in the home country. For an example aLX 1 means that one hour of labor produce produces one unit of X in the home country.

aLY is the unit labor requirement for Y in the home country. For an example aLY 1 means that one hour of labor produce produces one unit of Y in the home country. Labor supply L indicates the total number of hours worked in the home country. X production QX indicates how many units of X products are produced. Y production QY indicates how many units of Y products are produced. The Production Possibility Frontier (PPF) describes the maximum amount of goods that can be produce for a fixed amount of resources (Pearson Education, 2015).

Therefore production possibility frontier of the home country can be showed as follows, aLX QX aLY QY L 3 Ricardian model has developed on the following assumptions (Suranovic, 2007), There are two countries as home and foreign. The two countries are assumed to differ only with respect to the production technology. Bothe countries gain from free trade and it is a win-win situation. Two goods are produced by both countries. Trade between the two countries takes place based on the barter system which means that there is no money used to make transactions. Goods must be traded for other goods. Labor is the only factor of production and that is homogeneous.

This assumes that the supply of labor in each country is constant. Labor is the ultimate source of value. Theory assumes that labor is used in the same fixed proportions in the production of all commodities (Sethy, 2018). Theory developed based on the assumption of full employment.

This believes that free trade benefit to everyone and nobody will be leaved unemployed. The technological difference is basically considered as supply side difference between the two countries involved in international trade. Model assumes all other factors to be similar across the countries. Ricardian model is a general equilibrium model. It describes a complete circular flow of money in exchange for goods and services.

Therefore, the sale of goods and services generates revenue to the firms which in turn is used to pay for the factor services (wages to workers in this case) used in production. Perfect Competition-Following conditions are assumed in perfect competition. In perfect competition when choosing output to maximize profit each firm takes the price as given. The rule used by perfectly competitive firms is to choose that output levels which equalize the price with the marginal cost. Output is similar across all firms. Goods that are produced in different firms are perfect substitutes for all consumers.

Free entry and exit of firms based on profits. Which means positive profits will bring new firms to the industry and negative profits will lead 4 to exit the business. This has Perfect information too. All firms have the necessary info to maximize profit, to identify the positive profit and negative profit industries, etc. The goods produced are assumed to be homogeneous across countries and firms within an industry as this believes consumers across countries have equal and homogeneous tastes. No transport costs are involved in carrying trade between the two countries. This means goods can be shipped costlessly between countries.

As this model based on free trade this believes that transport cost prevents trade which may results each country to produce the same goods or the services. Model assumes that labor is supposed to be freely and costlessly mobile between industries within a country but is immobile across countries. This means that workers working in the one industry can be moved to the other industry without any cost incurred by the firms or the workers. Moreover, this implies that labor, the only factor, remains stuck in its original industry as the country moves from autarky to free trade. 5 Shortcomings of the theory Comparative advantage theory was the foundation to many theories developed later. Basic structure of the theory still can be used with modifications to match with the real-world context.

Shortcomings of the theory can be listed as follows, (Akrani, 2011) Restrictive model This theory discussed about only two countries and two products. But when it comes to international trade many countries engage in trade with many products. One factor of production Ricardian model is explained based only on the labor theory of value. It takes only the labor cost without considering non-labor costs involved in production process. This implies that the prices of goods are fixed based on labor costs. Theory assumes that other costs are constant. This is somewhat possible only when producing large scale of commodities cost reduced and increase comparative advantage.

Constant cost The theory assumes that the law of constant cost in all the industries. Therefore, additional units of the same product can be produced at a constant labor cost per unit. This assumption is also unrealistic.

In real world, the law of constant cost operates only temporarily (Knowledgiate,2016). Homogeneous labor Theory considered that labor is homogeneous. This is highly unrealistic since labor cannot be similar as it is varied due to many reasons.

The goods produced are assumed to be homogeneous This also another unrealistic fact as there would not be similar tastes. This may vary due to economic changes. Commodities never can be homogeneous but it can be differentiated. 6 Full employment Theory explains using one factor of production. That is labor.

But cost of production, even in terms of labor may change as the countries at different levels of employment move towards full employment. Utilization of labor also depend on the type of the good being produced. Therefore, every economy has unemployment. Ignorance of transport cost In international trade transport cost is an important fact that need to be considered in determining comparative cost differences. Demand not considered. Comparative advantage theory is a one-sided theory.

This theory explains the trade based only on supply of goods. It does not consider about the demand that has enormous impact on supply. Mobility of factor of production. Theory assumes that labor is mobile only within industries of the same country but immobile across countries which cannot be possible to the real world. Even within a country factor do not move freely between industries. Free trade This theory assumed that there are no barriers to the movements of goods between two countries.

But in real world there are many tariffs, restrictions applies when doing international trade. Complete specialization Ricardian model explained that a country is specialized fully on one commodity. That is not practical in real world and if that product has less importance the demand for the product will decline and no point of specializing on that product further. 7 Conclusion International trade has rising drastically over the past decades. This uplift living standards, increase employment opportunities and enable people to enjoy variety of goods and services. Further international trade enables countries to utilize abundant resources fully.

If not as a country they would not be able to benefit from the resources. Ricardian model theory was the first formal model of international trade. His theoretical framework was developed based on comparative advantage. Further the Ricardian model is one of the most supported economic ideas to aid the benefits of international trade. Basically in his theory he argues that countries gain from trade if there is a comparative advantage.

Simply the comparative advantage means that country should specialize in those goods where they have a relatively low opportunity cost (Pettinger, 2017). But it is doubtful how practical this model is when applying in a real world context. Further Ricardian theory explains how two countries gains from international trade. But it fails to show how the gains from trade are distributed between the two countries. Ricardian theory descried how two countries engaged in trade with two products which would not happen in the real international context.

International trade has been evolved to a new paradigm with everyday changing demand and supply. This model does not explain about demand it talks only about the supply. This report examined Key characteristics, application, assumptions and shortcomings of the Ricardian model of the international trade. 8 References Akrani, G. (2011) Criticicsm limitations of Ricardian comparative cost theory. online Available from HYPERLINK http//kalyan-city. http// Accessed 06 June 2018.

Amadeo, K. (2018) International trade, its pros, cons and effect on the economy. online Available from HYPERLINK https//www. https// https// 3305579 Accessed 04 June 2018. Dibiku, G.

M. (2017) International trade theories and its trends. online Available from HYPERLINK https// https//www.researchgate.

net/publication/312212506_International_trade_theories_and_its_trend HYPERLINK https// s Accessed 02 June 2018. Kilic, R. (2002) Absolute and comparative advantage Ricardian model.

online Available from HYPERLINK https// https// Accessed 02 June 2018.

Knowldgeiate (2016) Assumptions and criticism of comparative cost theory. online Available from HYPERLINK http//www.knowledgiate.

com/assumptions-and-criticisms-of-comparative-cost-theory/ http// Accessed 06 June 2018. Pearson Education (2015) International Economics theory policy Labor productivity and comparative advantage The Ricardian model. online Available from HYPERLINK https//www. https// https// advantage-the-ricardian-model Accessed 04 June 2018.

Pettinger,T.(2017) The importance of international trade. online Available from HYPERLINK https// https//www. Accessed 07 June 2018. 9 Sethy, P. (2018) 15 important criticism of comparative advantage theory in relation to international Available from HYPERLINK http//www. http//www.shareyouressays.

com/knowledge/15-HYPERLINK http// important-criticism-of-comparative-advantage-theory-in-relation-to-international-trade/95856 HYPERLINK http// Accessed 06 June 2018. Suranovic, M.S. (2007) International Trade Theory And Policy Ricardian model assumptions. online Available from HYPERLINK http// http// Accessed 06 June 2018. 10 ZuO JiqK) WorN5 G)5v5m9.orQVVXf-KKpw,zJSN_SESB1q,qBj, Q(xlLr4Ek6NZa@Zg,HPvBF AmrIwR5n.qkq(b)tr(-ifyr, qM6ZAXd PxQRa5yXxKkoj-WFXstgnogEeHcAxU,E rsR_ETw114Qc 1859o uUGk_K6,JN(pzEI6@1Ve5Ih4)8JL9a/mYS3OY9K194QMj)(2umqp6y3BesYQK-_d- tySu_((OP(ywJ ql4QCv_SkFlS dXk i5Zo88zgz g)KzxP0r8yr@O,5 xv PP mkS0i Otrid@-7GE K CEdeiQGLOWh/CtX3EN9GTgAHhH cFMUBE cQxsH4cKTHch6(, mcEDQYCiiZ.. lglQ@q)4xv1gIQ@o ZNCKzny(wS@u1pGum,)26B0LkWyO8iXaUXyk9AEL(b p834fFhL x Y, dXiJ(x(I_TS1EZBmU/xYy5g/GMGeD3Vqq8K)fw9xrxwrTZaGy8IjbRcXIu3KGnD1NIBsRuKV.ELM2fiVvlu8zH(W uV4(Tn7_m-UBww_8(/0hFL)7iAs),Qg20ppf DU4pMDBJlC52FhsFYn3E6945Z5k8Fmw-dznZxJZp/P,)KQk5qpN8KGbe Sd17 paSR 6Q

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