Identical Preferences

Trading countries are located in different parts of the blue planet. Their climates and natural resource endowments are different. Thus, the production mix of various products that these countries produce in autarky are different. If the world prices of traded goods are exactly equal to the autarky prices that would prevail in the home country, then domestic consumers would be satisfied with the autarky consumption bundle and there is no need for them to trade with the rest of the world.

However, world prices are rarely equal to the domestic prices in autarky. Even if domestic and foreign prices differ considerably, consumers can insist on the autarky consumption bundle and choose not to trade with the rest of the world. This is what the Former Soviet Bloc countries used to do. They only traded with other members of the bloc and were reluctant to trade with the Western countries. Also, there are many symptoms suggesting that the European Union wants to increase the volume of internal trade and minimize its external trade with the rest of the world.

If two countries (or blocs) choose their autarky consumption bundles, despite the disparity between world and domestic prices, they must have different preferences. Consumers with different tastes need not trade. If consumers in the Banana Republic and the Chocolate Republic are content with their own outputs, they need not trade one another. However, world prices and domestic prices generally differ. Thus, it would be interesting to see if consumers will trade when domestic and foreign consumers have the same preferences or tastes.

Suppose that there is a representative consumer, a cosmopolitan consumer, so that the world consumption is simply the consumption bundle of the representative consumer times the world population. This amounts to assuming that all consumers have identical preferences. (Even identical twins with identical DNAs will eventually develop different tastes because consumer tastes are not completely determined by genetics but are modified by experiences and learning.) This cosmopolitan representative consumer is not nationalistic. He does not show loyalty to any government or show patriotic attitude toward any single country. Given this neutral and nonnationalistic attitude of the representative consumer, it would be interesting to see how the world would allocate the outputs between two or more countries. Of course, the representative consumer does not direct how the world outputs are to be produced. The output mix of each trading countries is determined by the business firms and their production decisions are guided by the world prices, rather than autarky prices. To go one step further, we need to know how the world production possibilities are derived from the production possibilities of trading countries..

Decline in Transportation Costs

Ricardo's model assumes zero transport costs between countries. If international transportation costs are high, they would become a trade barrier. In ancient times, high transport costs, together with lack of knowledge about the surrounding countries were a main reason for not trading with neighboring countries. Instead, countries with surplus labor trained men to become warriors to be used as conquerors.

Slavery and the Emerging Middle Class

Julius Caesar began his conquest of Gaul in 59 BC. Six million people had lived in Gaul. After six years of campaign, one million had been killed, and Caesar brought one million slaves to Rome when he left Gaul in 50BC (Jona Lendering). Rome's population was already about 1 million, and most of these slaves were sold to aristocrats to farm the land, effectively driving Roman farmers out of agriculture.

Rich aristocrats served as the role model for the emerging middle class and slaves. Pratically all land in Italy (south of Florence) were owned by 30 patrician families who used slave labor, and free men were not able to compete with them in farming, and were forced to engage in trade and other businesses, thus forming the emerging middle class in the first century AD. Their system demonstrated that hard work and shrewd business can produce wealth and the rich can acquire social status. Shrewed slaves were often able to buy freedom from the money they earned in business. After the collapse of the Roman Empire, travels once again became more hazardous for several centuries. A thousand years later, Venice became the shipbuilding center of the world.

The middle class began to take jobs in other occupations, thereby producing a variety of goods and trading with others. The number or variety of goods increased. Roman citizens mostly consumed porridge before. Meat was rarely consumed unless one is desperate. Now they began to consume a new variety of new foods, fruits and grains from other regions (grains from Egypt), and other luxuries (glass from Syria and oysters from England). (Trade increases varieties of goods.)

Augustus Caesar created a gigantic free trade area in the Roman Empire.	Because of huge price differences between regions, international trade has enabled traders to accumulate wealth. The Romans conquered the Mediterranean world and built the road, connecting various nations they controlled, and unwittingly ensured the safety of travelers and merchants.[This means a decline in travel risk and transportation costs, the most significant trade barrier in ancient times.] They accumulated wealth through trade and the Roman soldiers were well paid for their service. Free bread was distributed to spectators at gladiator games. Trade contributed to slavery and income inequality, especially in the early stages of world civilization.(Medical doctors and learned Greek teachers were mostly slaves.) However, income inequality also stimulates profit motives and economic growth. During the time of Augustus, for the first time it was relatively safe for people to travel and people enjoyed traveling, much as Americans began to travel after the middle class were able to acquire auomobiles. As a result, trade expanded throughout the Mediterranean world. Apostle Paul's missionary journeys are a good testimony indicating that the middle class traveled widely throughout the Roman Empire. There were many bandits [Mark did not follow Paul on his missionary journeys for this reason.] and pirates in the Mediterranean, but it was much safer than before. Without safe transportation it was difficult for countries to ship goods to other parts of the Empire. Octavian received the title of Augustus in 27 BC and became the first Emperor. He and Livia did not have their own children. Livia's son from her previous marriage, Tiberius, became the next emperor, but Augustus and Tiberius were joint rulers for 2 years (AD 12 - 14). Tiberius became the emperor on August 19, 14 AD when Augustus died.
	Corinthian Canal (1886) and Nero's bas relief. Emperor Nero initiated a project to build a canal in Corinth, connecting the Adriatic Sea on the left and the Aegian Sea on the right, but was not able to complete it. The Adriatic Sea around the Peloponnesian Peninsula was so trecherous that sailors often unloaded their cargoes and moved the ships via inland route to Corinth, and set sail again from there to reach other ports sin the Aegean Sea.
	Painted wall in a Roman villa. Abundance of murals and mosaics in Roman villas implies abundance of slaves or cheap labor. Riches of the world flowed into Rome, and the wealthy bought villas in coastal cities such as Pompeii and Hercolanum (which were covered by the dust of Mt. Vesuvius, then active volcano around AD 70). The Roman Empire became a common market (a subject to be studied shortly).
Etruscans were the ancestors of Romans who settled in northern Italy.	Etruscan Art
	Cretans in the Knossos Palace invented a plumbing system, carrying the sewage from the palace to outside. The Romans copied this technology from Cretans, and began to use indoor plumbing extensively. Indoor plumbing was not adopted in American until the 19th century. Without these modern facilities, people used outhouses, and people took bath infrequently, not even once a year, even in America. Indoor plubming is one of the most important indicators, if not the most important, of civilized people. Western countries also borrowed the Roman system of government.
	Cloaca Maxima = Great Sewage (system) in Rome.
	Roman mosaic, British Museum.
Theodora and her Christian retinue Theodora, Maximianus and Justinian	Mosaics of St. Vitale, Ravenna. Ravenna became the seat of the "Roman Empire" after the fall of the (Western) Roman Empire in 476 AD. Of these mosaics, it is said: "[N]o other work of art . . . conveys the spirit of Byzantium with so much eloquence as do these two mosaics." (von Simson)" Upon Empress Theodora's request, Emperor Justinian built this churc of St. Vitale. Reproduced in Archeological Diggings, vol 12, August/September 2005, p.29. The bottom mosaic shows portraits of Theodora and Justinian (527-65 AD) with Maximianus, the bishop of Ravenna in between.

A country's production possibilities are the area on or below the production possibility frontier (PPF). How do we add the production possibilities of two countries with different possibilities?

In the two-good world, a country's production possibilities are the triangular area in Figure 14. We are mostly concerned with the outermost possibilities or the PPF. It consists of two endpoints and all the points in between.Two endpoints indicate the absence of one good (meaning one good is not being produced) and the country specializes in one good.

Diversification vs Specialization

Diversification: A country produces all goods.

Specialization: A country produces only a few goods.

Figure 14. Specialization versus Diversification

Assume: The US has a comparative advantage in commodity 1, i.e., the PPF of UK is steeper than that of the US.

Figure 15. Production possibility curves of the two countries

World Production Possibility Frontier

Any production possibility (a combination of Y₁ and Y₂) is actually a vector from the origin (0,0) to (Y₁,Y₂).
Of course, two production vectors, say (1,2) in the UK and (3,7) in the US can be added, and the sum is (1+3,2+7) = (4,9). (More on vector addition later.)

Of course, it is also possible to add one UK prodution, say (1,2) to all US possibility points such as (4,1), (3,2), (2,3),... [Here, ... means "etc." or "so and so on," when the writer wants to list only a few examples rather and does not want to present a complete list.]

Then, the result is obvisouly:

(1,2)+(4,1), (1,2)+(3,2), (1,2)+(2,3), ... = (5,3), (4,4), (3,5), ...

Although it is considerably more complicated, it is possible to add all UK possibility points to all US possibility points. One has to repeat the above process for each and every US production possibility point. This physical process of adding all UK possibility points to all US possibility points can be tedious, to say the least. But there is no point in carrying out this laborious task, because a graphical method is much easier for completing this task. (Actually, it is the area below (1) R (2) and above Y₁ axis and to the right of Y₂ axis.)

Moreover, we are not concerned with all production possibilities, but the world production possibility frontier (WPPF).

To obtain WPPF, slide the production bloc of UK along the PPF of the US.

Figure 16 Wrong specialization

(1) US diversifies, and UK specializes in y₂.

(2) US specializes in y₁, and UK diversifies. (undesirable possibilities)

World production possibility frontier (WPPF)

(3) On the segment AR, US specializes in y₂ and UK diversifies (undesiable possibilities, because more can be produced by reassignment).

(4) On the segment RB, US diversifies, and UK specializes in y₁. At point R (Ricardo point), each country specializes in the good in which it has a comparative advantage.

The Ricardo Theorem (Specialization maximizes national incomes of trading countries)

1. a_L1/a_L2 < a*_L1/a*_L2 (HC has a CA in commodity 1),
2. a_L1/a_L2 < p*₁/p*₂ < a*_L1/a*_L2 (The relative price of 1 lies between those in autarky in the two countries)

then the Ricardo Point (where each country specializes in the commodity in which it has a comparative advantage) maximizes NDP, NDP* and NWP.

Significance of The Ricardo Theorem

When each country specializes in comparative advantage products, it not only maximizes national income but also forces the country to export them in order to maximize consumer welfare.

Ricardo Theorem holds even when a country has absolute advantages over another in all industries. One cannot tell which country has absolute advantages by comparing the slopes. The input output coefficients must be compared. In the special case where both countries have the same labor endowment, if a country's production possibility triangle is larger than the other, it has absolute advantages in all industries.

The Lighthouse on Honfluer, Georges Seurat.	Trade requires safe navigation of merchant ships. For the first time in history, Ptolemy, one of the four generals of Alexander the Great built in Alexandria a lighthouse, which was one of the Seven Wonders of ancient times. (Trade promotes new innovations.) The existence of lighthouses also is evidence of substantial gains from trade.
	Well developed ports reveal gains from trade. Infrastructure investment would not be made unless gains from trade are significant.
	A Fresnel lens, which magnifies the light at the center, was used in light houses in modern times. (Smithsonian Insitution).