Chapter 3
Labor Productivity and Comparative
Advantage: The Ricardian Model
◼ Chapter Organization
The Concept of Comparative Advantage
A One-Factor Economy
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
Box: Do Wages Reflect Productivity?
The Pauper Labor Argument
Exploitation
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
Summary
8 Krugman/Obstfeld/Melitz • International Economics: Theory & Policy, Tenth Edition
◼ 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
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 because 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 that has different relative
unit labor requirements. Supply and demand curves relative to general equilibrium 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.”
Although 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.
Chapter 3 Labor Productivity and Comparative Advantage: The Ricardian Model 9
◼ Answers to Textbook Problems
1. a. The production possibility curve is a straight line that intercepts the apple axis at 400 (1,200/3)
and the banana axis at 600 (1,200/2).
2. a. The production possibility curve is linear, with the intercept on the apple axis equal to 160 (800/5)
and the intercept on the banana axis equal to 800 (800/1).
10 Krugman/Obstfeld/Melitz • International Economics: Theory & Policy, Tenth Edition
© 2015 Pearson Education, Inc.
800 bananas and no apples, giving a maximum relative supply at this price of 1/2. This relative
supply holds for any price between 3/2 and 5. At the price of 5, both countries would harvest apples.
The relative supply curve is again flat at 5. Thus, the relative supply curve is step shaped, flat at
the price 3/2 from the relative supply of 0 to 1/2, vertical at the relative quantity 1/2 rising from
3/2 to 5, and then flat again from 1/2 to infinity.
3. a. The relative demand curve includes the points (1/5, 5), (1/2, 2), (2/3, 3/2), (1, 1), (2, 1/2).
Chapter 3 Labor Productivity and Comparative Advantage: The Ricardian Model 11
could then gain 4 bananas by forgoing 2 apples, while Foreign could gain 1 apple by forgoing
only 2 bananas. Each country is better off with trade.
4. The increase in the number of workers at Home shifts out the relative supply schedule such that the
corner points are at (1, 3/2) and (1, 5) instead of (1/2, 3/2) and (1/2, 5). The intersection of the relative
7. The problem with this argument is that it does not use all the information needed for determining
comparative advantage in production: This calculation involves the four unit labor requirements
9. Gains from trade still exist in the presence of nontraded goods. The gains from trade decline as the