FREC 410
International Ag. Trade & Marketing
Comparative Advantage
(Ricardian Model)
Dr. Titus Awokuse
207 Townsend Hall
Tel: 302-831-1323; Fax: 302-831-6243
kuse@udel.edu
http://www.udel.edu/FREC/Awokuse/FREC410_webpage.htm
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Principle of Comparative Advantage
Comparative Advantage
!
David Ricardo proposed the theory of C.A.
!
Gains from trade if:
Ricardian “Law” of Comp. Advantage:
!
A nation exports goods in which it has greatest C.A.
A country has C.A. in the production a good if
the Opportunity Cost (OC) or the Marginal
Cost (MC) of producing that good in terms of
other goods is lower in that country than in
other countries.
!
A nation imports goods in which it has the least C.A.
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Opportunity Cost
!
!
Computers or Roses
Trade-offs/Choices:
Choice:
Cost of what you choose to have in terms of
what you _______________
1 million Roses OR 10,000 Computers
Fresh Roses in February
" Grown
in greenhouses at high cost
" Cheaper
of 1 mil. Roses is 10,000 Computers
" O.C.
of 10,000 Computers is 1 mil. Roses
" O.C.
of producing Roses (in terms of computers)
in S.America will be less than in USA
thru int’l trade with S. America
" Opportunity
" O.C.
cost of imports: some US jobs
Differences in O.C offers basis for mutually
__________ trade among nations
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Comparative Advantage
What’s Basis for Trade?
!
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Main Assumptions of Ricardian Model:
! 2 countries – 2 commodities – 1 Factor of prodn
! Constant __________________
! Perfect mobility of resources w/in nations, but
immobility between nations
! Zero transportation cost
! Perfect competition prevails in all factor and
product ________
! Consumer tastes and preferences is ignored
" Focus only on production side, not
consumption
Differences in relative prices (i.e. O.C)
reflects each nation’s C.A. and forms the
basis for trade
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Implications of Assumptions
!
Comparative Advantage
Complete specialization of both nations in the
product in which they have a C.A.
Basis for Trade?
! Differences in relative prices (i.e. O.C)
reflects each nation’s C.A. and
______________________________
!
Only the potential range of ______________
can be determined – not specific terms of trade
(TOT)
!
Production levels can be determined, but not
the level of trade or consumption of either of the
two commodities
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Unit Labor Requirement
One Factor Economy
!
!
!
Labor is the ONLY factor of production
Labor productivity is expressed in terms of:
unit labor requirement
Differences in labor productivity is viewed as
basis for comparative advantage
!
!
!
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Assume
" 2 countries: US and France
" 2 commodities: Wine and Cheese
" One factor of production – Labor Only
! _______________________
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Definition:
Is the # of hours of labor required to produce a
gallon of wine (or pound of cheese)
Example:
Wine:
1 hour of labor per gallon (aLW)
Cheese: 2 hours of labor per pound (aLC)
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Production Possibilities
Frontier (PPF)
!
!
Production Possibilities Frontier
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Scarce resources implies trade-offs:
" can produce more W if less C is produced
_______ shows the various possible
combination of the 2 commodities that can be
produced
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PPF is a straight line if: only one Factor
" Wine and Chesse production: QW ; QC
PPF line equation: aLW QW + aLC QC = L
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Comparative Advantage: Review
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Opportunity Cost: Review
!
Since PPF is a straight line:
" O.C of a gallon of wine in terms of cheese
is constant
!
Recall: O.C of Cheese is the # of gallons of
Wine the economy give up to produce an
extra pound of cheese
" O.C. of C is: aLC/ aLW
! 1 lb. of C cost: aLC person-hours
! 1 gal. of W cost: aLW person-hours
What is the Ricardian “Law” of Comparative
Advantage?
What is the basis for trade?
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Opportunity Cost
!
!
!
!
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Who Trades in What?
EXAMPLE:
Let 1 lb. of C cost: aLC = 1
Let 1 gal. of W cost: aLW = 2
Then, O.C. of C is: aLC/ aLW =1/2
Then, O.C. of W is: aLW/ aLC = 2
!
The ratio of the unit labor req. determines
who has ________________________
" Country
with lower unit labor req. in producing
a commodity has comparative advantage in
that commodity
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Who Trades in What?
Numerical Example
Who Trades in What?
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Ratio of the unit labor req (Same as Opport.
Cost):
Cheese
US
aLC(us)/aLW(us) < aLC(France) /aLW(France)
!
France
Comparative Advantage:
" US
aLC = 6
more productive in W than US
" France
has C.A. in production and __________
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aLC/aLW = 1/2
aLW/ aLC = 2
aLW = 3
aLC/aLW = 6/3
aLW/ aLC = 3/6
!
Relative price of C (Pc/Pw):
" Range
" France
O.C.w
aLW = 2
US has lower unit labor req.
" Higher
has C.A. in production and export of C
O.C.C
!
more productive in C than France
! US
aLC = 1
Wine
labor productivity
b/w O.C. of C in both nations
!
US specialize in production and export of C
!
France specialize in production and export of W
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Conclusion…
!
One Factor Economy - Labor only
Differences in _____________________ is viewed
as basis for comparative advantage
!
This is only a partial explanation
!
" Other
basis for trade (ignored by Ricardo’s model) is
differences in countries resource endowments
" E.g. Canada X lumber to US not b/c of higher
productivity but b/c they have more forest land per capita
" Weakness:
"
Exclusion of role of resource endowment
We can improve Ricardian Model by allowing for other
factors such as (K, land, and mineral resources)
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