1. International Trade and Comparative Advantage
Three reasons for trade :
(1) Cross country differences in supply (different technologies, different industrial organization, etc.)
(2) Cross country differences in demand (difference preferences)
(3) Exploiting Economies of Scale

2. Comparative Advantage: The Ricardian Model
Assumptions :
(1) One factor
(2) Differences in labor productivity across countries
(3) Two goods
(4) Two countries
(5) Constant returns to scale
Main idea :
Countries engage in trade because they are different from each other in relative labor productivity.

3. The Ricardian Model Two goods: W (wine), C (cheese)
Unit labor requirement (# of hours of labor per one unit of output) :

4. The Ricardian Model Two goods: W (wine), C (cheese).
Unit labor requirements (# of hours of labor per
one unit of output):
Production possibility frontiers:

5. = opportunity costs of producing one extra unit of C in
terms of output forgone in the W industry.
Wages, prices and output: If
An Equilibrium Price
Configuration

6. The Two Countries H F
Country H has a comparative advantage in the production of C.
Country F has a comparative advantage in the production of W.

7. Determining the Relative Price:3
Relative Supply
RD” 1 2 RD
= Relative Demand
RD’
Relative world
quantity of C
(in terms of W)
Point (1): H Completely specializes in C, Country F in W.
Point (2): F completely specializes in W, H produces both C & W.

8. Relative Wages At 1: Labor productivity ratio in the export industries
Factors terms
of trade
Goods
terms of
trade
At 2:

9. Gains From Trade
We show that the Specialization in Production and Trade
are beneficial to both countries.
Assume that the equilibrium is at point (1).
(a) H can produce W directly: one hour produces
Units of W.
(b) H can produce C , and then trade C for W: an “indirect”
method of production. One hour produces
units of
C to get through trade
units of W.

10. Thus, compare to
But at point (1)
Therefore,

11. Since
H benefits
F can produce C directly: one hour
Or “indirectly”