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
The Pauper Labor Argument
Exploitation
Comparative Advantage with Many Goods
Setting Up the Model
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.
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
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.
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).
b. The opportunity cost of apples in terms of bananas is 3/2. It takes 3 units of labor to harvest an
apple but only 2 units of labor to harvest a banana. If one forgoes harvesting an apple, this frees
up 3 units of labor. These 3 units of labor could then be used to harvest 1.5 bananas.
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).
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 apples per 2 bananas. The relative supply curve is flat at this price. The maximum number of
apples supplied at the price of 3/2 is 400 supplied by Home while, at this price, Foreign harvests
10 Krugman/Obstfeld/Melitz • International Economics: Theory & Policy, Tenth Edition
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
relative supply curves. This is the point (1/2, 2), where the relative demand curve intersects the
vertical section of the relative supply curve. Thus, the equilibrium relative price is 2.
Chapter 3 Labor Productivity and Comparative Advantage: The Ricardian Model 11
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
5. This answer is identical to that in Answer 3. The amount of “effective labor” has not changed because
the doubling of the labor force is accompanied by a halving of the productivity of labor.
6. This statement is just an example of the pauper labor argument discussed in the chapter. The point is
that relative wage rates do not come out of thin air; they are determined by comparative productivity
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
(for both the industry and service sectors, not just the two for the service sector). It is not enough
8. Although Japanese workers may earn the equivalent wages of U.S. workers, the purchasing power of
their income is one-third less. This implies that although w = w* (more or less), p p* (because 3p =
p*). Because the United States is considerably more productive in services, service prices are
9. Gains from trade still exist in the presence of nontraded goods. The gains from trade decline as the
share of nontraded goods increases. In other words, the higher the portion of goods that do not enter
the international marketplace, the lower the potential gains from trade. If transport costs were high
enough so that no goods were traded, then, obviously, there would be no gains from trade.
10. The world relative supply curve in this case consists of a step function, with as many “steps”
(horizontal portions) as there are countries with different unit labor requirement ratios. Any