Chapter No.

Comparative Advantage
and the Ricardian Model
Comparative Advantage
 A country has a comparative advantage in
producing a good if the opportunity cost
is lower than in other countries
 Samuelson: [comparative advantage] is
the best example of an economic
principle that is undeniably true yet not
obvious to intelligent people
 This is the fundamental source of mutual
gains from trade (another source is
economies of scale)
Assumptions of the Basic
Ricardian Model
1. Fixed resources and technology
2. Completely mobile factors of production
(labour in the simplest case) inside each
country
3. Completely immobile factors of production
between the countries
4. Full utilization of resources
5. Perfect competition
6. [Labour theory of value (not necessary for PPF analysis)]
7. Zero transportation costs
8. Constant unit costs
9. No government imposed obstacles
10. Full employment
11. Two countries, two commodities world
 Ricardian Production Conditions
Country A B Price ratios
Hr/ut. Hr/ut. in Autarky

Portugal 80 90 1A=8/9B
1A=0.89B
1B=1.13A
England 120 100 1A=6/5B
1A=1.2B
1B=0.83A
 Comparative Advantage
England has absolute advantage in both products if
e.g.
C W
Country
Hr/ut Hr/ut

England 1 3

Portugal 2 4
Relative Prices in Autarky
 Autarky (=no trade) price of wine in terms
of cloth
 England: 1 W = 3 C
 Portugal: 1 W = 2 C
 Autarky price of cloth in terms of wine
 England: 1 C = 0.33 W
 Portugal: 1 C = 0.5 W

→ C is relatively cheaper in England,

W in Portugal = the opportunity cost of
producing W is higher in England
Rationale for Trade
 If international trade is allowed
 England wants to buy W if it costs less
than 3 C (1W=3C
 Portugal wants to sell W if it gets more
than 2 C 1W=2C
→ Both are willing to trade (= both gain) for
any price between 2 - 3 C per W i.e.
international TOT should lie between autarky
prices of two trading partners 1w=2.5c
Gains from Trade for England
 Suppose that the international price turns
out to be 1W = 2.5 C
 In autarky England can produce 1W with
3 hours of labour
 In free trade England can produce 2.5 C
with 2.5 hour of work and exchange it for
1W
 1w=3c, 1w=2.5c
→England can get 1 W with 0.5 hour less
work than in autarky
Gains from Trade for Portugal
 International price: 2.5 C per W
 In autarky Portugal can produce 2.5 C with 5
hours of work
 In free trade Portugal can produce a 1 W
with 4 hours of work and exchanges it with
2.5 C
→Portugal gets 2.5 C with an hour less work
Exercise
What will happen if 1W=3C, 1W=2C
1W=1C, 1W=4C
 Resource Constraints
 Resource constraint:
Suppose that England has
9,000 hours of labour Country C W
available and Portugal has
16,000 hours of labour 3 hrs. /
England 1 hr. / ut.
ut.
 England can produce 9,000
uts. of C and no W or 3,000 4 hrs. /
uts of W and no C or some Portugal 2 hr. / ut. ut.
combination of these two
 Similarly for Portugal (8,000
C or 4,000 W. or
combination)
 Production Possibilities Frontier
(PPF) for England
C
Limits of production:
9,000 aC*QC+aW*QW≤L
C W where aj = unit labour requirement
of producing good j, Qj = quantity
9,000 0 of good j and L = total labour
4,500 1,500 supply
4,500
0 3,000
Slope of the PPF = the
amount of production of
one good that must be
given up to obtain one
1,500 3,000
additional unit of the other W
good
 Partial and complete Specialization
for England
C
CPPF (slope=1W=2.5C)
C W 9,000 6000x1+1000x3=9000LH
(6000-2500)+(1000+1000
9000 0 =3500+6000=9500LH
7500 500
6000
6000 1000 CPPF2
(slope=1W=2.5C)
4500 1500 Complete Specialization
CPPF1
3000 2000 (slope=1W=2.5C)
Partial
PPFSpecialization
(slope=1W=3C)
1500 2500 Autarky Equilibrium
0 3000 1000 3,000 3600
W
 Complete Specialization
Assume Country A produces only C
Country B produces only W

Exchange 2000ut of W with 5000ut of C

Country A
consumes 4000ut C (9000 produced – 5000 exports)
Labour value (4000hrs c + 2000*3) = 10000 hrs.

Country B
consumes 2000ut W (4000 produced – 2000 exports)
Labour value (10000hrs c + 2000*4) = 18000 hrs.
 Impact of International Price
Change from 2.5 yr./bbl. to 2.25

England Portugal
Cloth Cloth
10,000
9,000
9,000
8,000
2,
25
2,5

3,600 4,000 4,000 Wine

Wine