Book Title
International Economics: Theory and Policy 9th Edition

978-0132146654 Chapter 3 Lecture Notes

December 18, 2019
8  Krugman/Obstfeld/Melitz •   International Economics: Theory & Policy, Ninth Edition
Chapter 3
Labor Productivity and Comparative
Advantage: The Ricardian Model
.1 Chapter Organization
The Concept of Comparative Advantage
A One-Factor Economy
  Production Possibilities
  Relative Prices and Supply
Trade in a One-Factor World
  Determining the Relative Price After Trade
Box: Comparative Advantage in Practice: The Case of Babe Ruth
  The Gains from Trade
A Note on Relative Wages
  Box: The Losses from Nontrade
Misconceptions About Comparative Advantage
  Productivity and Competitiveness
  The Pauper Labor Argument
Box: Do Wages Reflect Productivity?
Comparative Advantage with Many Goods
  Setting Up the Model
  Relative Wages and Specialization
  Determining the Relative Wage in the Multigood Model
Adding Transport Costs and Nontraded Goods
Empirical Evidence on the Ricardian Model
Chapter Overview
The Ricardian model provides an introduction to international trade theory. This most basic model of
trade involves two countries, two goods, and one factor of production, labor. Differences in relative labor
productivity across countries give rise to international trade. This Ricardian model, simple as it is, generates
important insights concerning comparative advantage and the gains from trade. These insights are necessary
© 2012 Pearson Education, Inc. Publishing as Addison-Wesley
9  Krugman/Obstfeld/Melitz •   International Economics: Theory & Policy, Ninth Edition
foundations for the more complex models presented in later chapters.
The text exposition begins with the examination of the production possibility frontier and the relative prices
of goods for one country. The production possibility frontier is linear because of the assumption of constant
returns to scale for labor, the sole factor of production. The opportunity cost of one good in terms of the other
equals the price ratio since prices equal costs, costs equal unit labor requirements times wages, and wages
are equal in each industry.
After defining these concepts for a single country, a second country is introduced which has different
relative unit labor requirements. General equilibrium relative supply and demand curves are developed.
This analysis demonstrates that at least one country will specialize in production. The gains from trade
are then demonstrated with a graph and a numerical example. The intuition of indirect production, that is
“producing” a good by producing the good for which a country enjoys a comparative advantage and then
trading for the other good, is an appealing concept to emphasize when presenting the gains from trade
argument. Students are able to apply the Ricardian theory of comparative advantage to analyze three
misconceptions about the advantages of free trade. Each of the three “myths” represents a common
argument against free trade and the flaws of each can be demonstrated in the context of examples already
developed in the chapter. The first myth is that trade is driven by absolute advantage. This chapter clearly
demonstrates that it is comparative advantage that matters. The second is the pauper labor argument, with
poor countries having an “unfair advantage” in trade given low-cost labor. The chapter highlights that the
gains from trade are irrelevant to the source of comparative advantage. Finally, the myth of workers in
poor countries being exploited by trade is exposed by asking whether these workers would be better off
without trade. As the numerical example in this chapter demonstrates, the answer is a resounding “no.”
While the initial intuitions are developed in the context of a two-good model, it is straightforward to extend
the model to describe trade patterns when there are N goods. Comparative advantage in this model is driven
by relative wages between countries rather than relative prices. However, the implication that countries will
export goods for which they have the lowest opportunity cost remains.
The N-good model is used to discuss the role that transport costs play in making some goods nontraded.
As transport costs rise, the gains from trade decrease, and in some cases they are completely eliminated.
The chapter ends with a discussion of empirical evidence of the Ricardian model. The authors are careful
to point out that while the rather simplified model cannot explain all trade patterns, the basic prediction that
countries tend to export goods for which they have a comparative advantage (high relative productivity)
has been confirmed by a number of studies.
© 2012 Pearson Education, Inc. Publishing as Addison-Wesley