Ricardian Principle

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Chapter 3

Labor Productivity and Comparative Advantage: The Ricardian Model

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

• • • • • • • • Opportunity costs and comparative advantage Production possibilities Relative supply, relative demand & relative prices Trade possibilities and gains from trade Wages and trade Misconceptions about comparative advantage Transportation costs and non-traded goods Empirical evidence

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.


• Sources of differences across countries that lead to gains from trade:
– The Ricardian model (Chapter 3) examines differences in the productivity of labor (due to differences in technology) between countries. – The Heckscher-Ohlin model (Chapter 5) examines differences in labor, labor skills, physical capital, land, or other factors of production between countries.

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.


Ricardian Model Assumptions
1. Two countries: domestic and foreign. 2. Two goods: wine and cheese. 3. Labor is the only resource needed for production. 4. Labor productivity is constant. 5. Labor productivity varies across countries due to differences in technology. 6. The supply of labor in each country is constant. 7. Labor markets are competitive. 8. Workers are mobile across sectors.

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.


Comparative Advantage
• Suppose that the domestic country has a comparative advantage in cheese production: its opportunity cost of producing cheese is lower than in the foreign country.

aLC /aLW < a*LC /a*LW
When the domestic country increases cheese production, it reduces wine production less than the foreign country does because the domestic unit labor requirement of cheese production is low compared to that of wine production.

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