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.
8 Krugman/Obstfeld/Melitz • International Economics: Theory & Policy, Eleventh Edition
Determining the Relative Wage in the Multigood Model.
Adding Transport Costs and Nontraded Goods.
Empirical Evidence on the Ricardian Model.
Summary
■ 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.”
Chapter 3 Labor Productivity and Comparative Advantage: The Ricardian Model 9
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.
■ Answers to Textbook Problems
1. a. The production possibility curve is a straight line that intercepts the apple axis at 400 (1,200/3)
b. The opportunity cost of apples in terms of bananas is 3/2. It takes 3 units of labor to harvest an
c. Labor mobility ensures a common wage in each sector, and competition ensures the price of
2. a. The production possibility curve is linear, with the intercept on the apple axis equal to 160
b. The world relative supply curve is constructed by determining the supply of apples relative to the
supply of bananas at each relative price. The lowest relative price at which apples are harvested is
3. a. The relative demand curve includes the points (1/5, 5), (1/2, 2), (2/3, 3/2), (1, 1), (2, 1/2).
b. The equilibrium relative price of apples is found at the intersection of the relative demand and
4. The increase in the number of workers at Home shifts out the relative supply schedule such that the
5. This answer is identical to that in Answer 3. The amount of “effective labor” has not changed because
6. This statement fails to connect wages and productivity. Though wages in China are undoubtedly
12 Krugman/Obstfeld/Melitz • International Economics: Theory & Policy, Eleventh Edition
7. Wages in China will be determined by productivity in both the manufacturing and the service sectors.
8. One explanation for a lower cost of living in China is that there is high labor productivity in the
service sector. This high productivity level will cause the price of services in China to be significantly
9. As more and more services become tradable, the gains from trade will increase, because the gains
10. The world relative supply curve in this case consists of a step function, with as many “steps”