THE CLASSICAL

WORLD OF DAVID
RICARDO AND
COMPARATIVE
ADVANTAGE
PREPARED BY: SANDRA MAE R. PEREZ

SOME COMMON MYTHS

Trade makes us poorer.

Exports are good because they support domestic
industry, but imports are bad because they steal
business from domestic producers.

ASSUMPTIONS OF THE BASIC RICARDIAN

MODEL
1. fixed endowment of resources

7. full employment

2. factors of production are mobile

within

8. perfect competition

3. factors of production are

immobile externally
4. labor theory of value
5. different but fixed level of
technology
6. constant costs of production

9. no government barriers to
economic activity
10.transportation costs are
zero
11.two-country, twocommodity world

RICARDIAN COMPARATIVE ADVANTAGE

absolute advantage is effective only if factors are perfectly
mobile
from absolute advantage to comparative advantage

relative cost difference (there is an incentive to trade)

RICARDIAN COMPARATIVE ADVANTAGE

Consider their autarky prices:
England

1W : 6/5C (1C : 5/6W)

Portugal

1W : 8/9C (1C : 9/8W)

England (Autarky): 1W:1.2C (gains if it can buy 1W for less than 1.2C)
Portugal (Autarky): 1W:0.89C (gains if it can sell its wine for more than 0.89C)
After trade, there will be a common price of wine in terms of cloth in the two
countries
With trade, prices are no longer determined by the labor theory of value

RICARDIAN COMPARATIVE ADVANTAGE

ENGLAND
use 100 hrs. in producing
cloth
1W at home needs 120
hrs.
saves 20 hrs. labor time if
it can exchange 1C for 1W

PORTUGAL
use 80 hrs. in producing
wine
1C at home needs 90
hours of labor
saves 10 hrs. of labor
time if it can exchange
1W for 1C

RICARDIAN COMPARATIVE ADVANTAGE

PORTUGAL (gains more)

ENGLAND (smaller gains)

will receive more clothes with the

same amount of wine

will give more clothes with the

same amount of wine

1W (80hrs.) will exchange for 1.1C

1.1C (110hrs.) will exchange

for 1W

1.1C at home needs 99 hrs. (90

hrs. x 1.1C)
Portugal gains 19 hrs. per each
1.1C

1W at home needs 120 hours

England saves 10 hours

instead of 20 hours

COMPARATIVE ADVANTAGE AND THE TOTAL

GAINS FROM TRADE

COMPARATIVE ADVANTAGE AND THE TOTAL

GAINS FROM TRADE
Country A (9000 hours)
Countr
y
A
B

Country B (16,000 hours)

Cloth

Wine

9,000
yards
8,000
yards

3,000
barrels
4,000
barrels

Any combination that absorbs 9,000

hours of labor
Any combination that absorbs
16,000 hours of labor

COMPARATIVE ADVANTAGE AND THE TOTAL

GAINS FROM TRADE
COUNT
RY
A
B
COUNTR
Y
A

CLOTH (in
yards)
3,500 (6,0002,500)

5,500
(3,000+2,500)

CLOTH

WINE

6,000
1,000
Before trade
yards
barrels
3,000
2,500
Before trade
Terms
yards of Trade:
barrels 1W:2.5C
WINE (in barrels)
GAIN(in labor hours)
2,000
(1,000+1,000)
1,500 (2,5001,000)

9,500 hours = (3,500x1hr)

+(2000x3hrs)
Gain = 9,500 9,000 = 500
17,000 = (5,500x2hrs.)
+(1,500x4hours)
Gain = 17,000 16,000 = 1,000

COMPARATIVE ADVANTAGE AND THE TOTAL

GAINS FROM TRADE
Country A produces only cloth, Country B produces only wine (Terms of
Trade 2000W:5000C)
COUNT
CLOTH (in
WINE (in barrels)
GAIN (labor hours)
RY
yards)
A
4,000 (9,0002,000 (all
10,000
5,000)
imported)
Gain = 10,000 9,000 = 1,000
B
5,000 (all
2,000 (4,000
18,000
imported)
2,000)
Gain = 18,000 16,000 = 2,000
COUNT
Autarky
With trade
Trade with complete
RY
specialization
A
B

9,000 hours
16,000 hours

9,500 hours
17,000 hours

10,000 hours
18,000 hours

REPRESENTING THE RICARDIAN MODEL

WITH PRODUCTION-POSSIBILITIES
FRONTIER
Production-possibilities Frontier
reflects all combinations of two products that a country can produce
at a given point in time given its resource base, level of technology,
full utilization of resources, and economically efficient production.
constant cost assumption: opportunity cost is the same at all levels
of production
escape limitations of labor theory of value while retaining
comparative advantage as basis for trade
slope of PPF: reflects opportunity costs

PRODUCTION-POSSIBILITIES (EXAMPLE)

PRODUCTION-POSSIBILITIES (EXAMPLE)

MAXIMUM GAINS FROM TRADE

Economic incentives lead to maximum gains
from trade
EXAMPLE:

1W:2.5C from 1W:2C

Country B has an incentive to expand production

MAXIMUM GAINS FROM TRADE (AN

EXEMPTION)
Demand for cloth of both countries are greater than
Country As capacity (9,000 yards)
Country B will continue to produce both cloth and wine at
1W:2C

COMPARATIVE ADVANTAGE AND THE

DEVELOPING COUNTRIES
Even if rich nations have an absolute advantage, developing countries
can benefit from trade because of comparative advantage.
Participation in foreign trade could be a string positive force for
development.
David Ricardo: benefits from trade resulted not from the employment
of underused resources but from the more efficient use of domestic
resources which came about through the specialization in
production according to comparative advantage.
John Stuart Mill: dynamic effects of trade that are critical a countrys
economic development
ability to acquire foreign goods and capital
impact of trade and resource allocation on the accumulation of savings

COMPARATIVE ADVANTAGE AND THE

DEVELOPING COUNTRIES
Break binding chains of tradition, alter wants and stimulate
entrepreneurship, inventions and innovations.
Governments of developing countries often build trade
barriers to offset the absolute advantage of developed
countries in manufactured consumer goods.
Trade is a positive vehicle for economic growth and
development.