Chapter 3
Labor Productivity
and Comparative Advantage:
The Ricardian Model
Key Terms
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Absolute advantage （绝对优势）
Comparative advantage （比较优势）
Derived demand（派生需求）
Gains from Trade (贸易所得)
General equilibrium analysis (一般均衡分析)
Nontrade goods （非贸易品）
Opportunity Cost（机会成本）
Partial equilibrium analysis（局部均衡分析）
Pauper Labor Argument（贫民劳动论）
Production possibility frontier（生产可能性边界）
Relative Demand Curve
Relative Supply Curve
Relative wage
Ricardian model （李嘉图模型）
Unit labor requirement(单位产品劳动投入)
Preview
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Absolute Advantage ( added)
The Concept of Comparative Advantage
A One-Factor Economy
Trade in a One-Factor World
Misconceptions about comparative advantage
Comparative Advantage with Many Goods
Adding Transport costs and non-traded goods
Empirical evidence on Recardian Model
Absolute Advantage Theory
• Adam Smith (1723 – 1790)
• Background
 a classical economist, was leading advocate of free trade
(Laissez-Faire).
 “Inquiry into the Nature and causes of the Wealth of Nations”
1776 -The wealth of Nations
 Smith’s era is the time when governments granted
monopolies and protected their own merchants
against”unfair”competition , and the power of free trade was
scarcely understood.
• Main ideas
 Trade is based on absolute advantage and benefits both
nations.
 When each nation specializes in the production of the
commodity of its absolute advantage and exchanges part of
its output for the commodity of its absolute disadvantage,
both nations end up consuming more of both commodities.
Absolute Advantage Theory
• Basic Assumptions
One input:
Labor(L)
Two outputs: Wheat (Qw) and Cloth (Qc)
Two countries: US and China
Full Employment, Perfect Competition, and
Constant return to Scale
Different technologies different
productivity of labor
Wheat
Wheat
100
Import 20 units cloth
Export 20
units cloth
S’
50
Export 20 units wheat
30
20
0
40
C
S
C
20
12
15 20 25
50
S
Cloth 0
70 80
China
Production and consumption
before trade（S）
Production after trade（S’）
Consumption after trade (C)
US
Import 20
units wheat
S’
100
Cloth
China
20 wheat 15cloth
US
12 wheat 70cloth
50 wheat
30 wheat
0 wheat 100cloth
20 wheat 80cloth
0 cloth
20cloth
Preview
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Absolute Advantage (added)
The Concept of Comparative Advantage
A One-Factor Economy
Trade in a One-Factor World
Misconceptions about comparative advantage
Comparative Advantage with Many Goods
Adding Transport costs and non-traded goods
Empirical evidence on Recardian Model
The Concept of Comparative
Advantage
• The law of comparative advantage
 if a nation has an absolute cost disadvantage in
the production of both goods, a basis for mutually
beneficial trade may still exist.
 The less efficient nation should specialize in the
production and export of the commodity in which it
has a comparative advantage (where its absolute
disadvantage is less)
 The more efficient nation should specialize in and
export that commodity in which it is relatively more
efficient (where its absolute advantage is greater).
Wheat
Wheat
100
60
S’
50
30
20
0
C
S
C
20
16
15 20 25
50
S
Cloth 0
76 80
A
Cloth
B
A
Production and consumption 20 wheat
before trade（S）
Production after trade（S’） 50 wheat
Consumption after trade （C）30 wheat
S’
100
B
15cloth
16 wheat
76cloth
0 cloth 0 wheat 100cloth
20cloth 20 wheat 80cloth
The Concept of Comparative
Advantage
• The approach, in which international trade is solely
due to international differences in the productivity of
labor, is known as Ricardian model
• The Ricardian model is based on technological
differences across countries.
 These technological differences are reflected in differences in
the productivity of labor.
• The Ricardian model uses the concepts of opportunity
cost and comparative advantage.
• The opportunity cost of producing something
measures the cost of not being able to produce
something else because resources have already
been used.
The Concept of Comparative
Advantage
• For example:
• a limited number of workers could be employed to
produce either roses or computers.
 The opportunity cost of producing computers is the
amount of roses not produced.
 The opportunity cost of producing roses is the amount
of computers not produced.
• A country faces a trade off: how many computers
or roses should it produce with the limited
resources that it has?
The Concept of Comparative
Advantage
Millions of Roses
Thousands of
Computers
U.S.
-10
+100
South America
+10
-30
0
+70
Total
The Concept of Comparative
Advantage
• A country has a comparative advantage in
producing a good if the opportunity cost of
producing that good is lower in the country than it
is in other countries.
 The South America has a comparative advantage in rose
production: it uses its resources more efficiently in
producing roses compared to other uses.
 The U.S. has a comparative advantage in computer
production: it uses its resources more efficiently in
producing computers compared to other uses.
The Concept of Comparative
Advantage
• In this simple example, we see that when
countries specialize in production in which they
have a comparative advantage, more goods and
services can be produced and consumed.
 Initially both countries could only consume 10 million
roses and 30 thousand computers.
 If they produce goods in which they had a comparative
advantage, they could still consume 10 million roses, but
could consume 100,000 – 30,000 = 70,000 more
computers.
The Concept of Comparative
Advantage
• The simple example with roses and
computers explains the intuition behind
the Ricardian model.
• Trade between two countries can benefit
both countries if each country exports the
goods in which it has a comparative
advantage
Preview
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Absolute Advantage (added)
The Concept of Comparative Advantage
A One-Factor Economy
Trade in a One-Factor World
Misconceptions about comparative advantage
Comparative Advantage with Many Goods
Adding Transport costs and non-traded goods
Empirical evidence on Recardian Model
A One-Factor Economy
• The technology of Home’s economy can be summarized
by labor productivity in each industry, expressed in
terms of unit labor requirements:
• The unit labor requirement is the number of hours of
labor required to produce one unit of output.
 Denote with aLW the unit labor requirement for wine
• e.g. if aLW = 2, then one needs 2 hours of labor to produce one
gallon of wine
 Denote with aLC the unit labor requirement for cheese
• e.g. if aLC = 1, then one needs 1 hour of labor to produce a pound of
cheese
 A high unit labor requirement means low labor productivity
• The economy’s total resources are defined as L, the
total labor supply (e.g. if L = 120, then this economy is
endowed with 120 hours of labor or 120 workers).
Production Possibilities
•
The production possibility frontier (PPF) of an economy
shows the maximum amount of a goods that can be produced for
a fixed amount of resources.
•
If QC represents the quantity of cheese produced and QW
represents the quantity of wine produced, then the production
possibility frontier of the domestic economy has the equation:
aLCQC + aLWQW = L
Labor required for
each unit of
cheese production
Total units
of cheese
production
Labor required for
each unit of wine
production
Total amount of
labor resources
Total units
of wine
production
Production Possibilities
• the opportunity cost is defined as the number of
gallons of wine the economy would have to give
up in order to produce a extra pound of cheese.
• To produce an extra pound of cheese would
requires aLC hours of labor .
• each hours of labor could have been used to
produce a certain amount of wine instead, equal
to 1/aLW gallons of wine
• The trade-off (opportunity cost ) is the increased
amount of cheese relative to the decreased
amount of wine: aLC /aLW. (aLC *1/aLW)
Fig. 3-1: Home’s Production Possibility
Frontier
(L/aLW )/(L/aLC)= aLC /aLW
A One-Factor Economy
• Relative Prices and Supply
 The particular amounts of each goods produced
are determined by prices.
 The relative price of goods X (cheese) in terms of
goods Y (wine) is the amount of goods Y (wine)
that can be exchanged for one unit of goods X
(cheese).
 Examples of relative prices:
• If a price of a can of Coke is $0.5,
• then the relative price of Coke is?
• The relative price of a $ in terms of Coke is?
A One-Factor Economy
• Relative Prices and Supply
• Let PC be the price of cheese and PW be the price
of wine.
• Because of competition,
 hourly wages of cheese makers are equal to the market
value of the cheese produced in an hour: PC /aLC（ PC *
1/aLC ）
 hourly wages of wine makers are equal to the market value
of the wine produced in an hour: PW /aLW
• Because workers like high wages, they will work in
the industry that pays a higher hourly wage.
A One-Factor Economy
• Relative Prices and Supply
•
①If PC /aLC > PW/aLW workers will make only cheese. (PC /PW >
aLC /aLW )
 The economy will specialize in cheese production if the
price of cheese relative to the price of wine exceeds the
opportunity cost of producing cheese.
•
②If PC /aLC < PW /aLW workers will make only wine. ( PC /PW < aLC
/aLW )
 The economy will specialize in wine production if the price of wine
relative to the price of cheese exceeds the opportunity cost of
producing wine.
•
③If PC /aLC = PW /aLW . ( PC /PW = aLC /aLW )
 Production (and consumption) of both goods occurs when the
relative price of a good equals the opportunity cost of producing
that good.
 In the absence of international trade, the relative prices of goods
are equal to their relative unit labor requirement
Preview
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Absolute Advantage (added)
The Concept of Comparative Advantage
A One-Factor Economy
Trade in a One-Factor World
Misconceptions about comparative advantage
Comparative Advantage with Many Goods
Adding Transport costs and non-traded goods
Empirical evidence on Recardian Model
Trade in a One-Factor World
• Absolute Advantage
 A country has an absolute advantage in a production
of a goods if it has a lower unit labor requirement than
the foreign country in this goods.
 Assume that aLC < a*LC and aLW < a*LW
• This assumption implies that Home has an absolute
advantage in the production of both goods.
• Even if Home has an absolute advantage in both goods,
beneficial trade is possible.
• The pattern of trade will be determined by the
Trade in a One-Factor World
• Comparative Advantage
 Assume that aLC /aLW < a*LC /a*LW
(2-2)
• This assumption implies that the opportunity cost of cheese
in terms of wine is lower in Home than it is in Foreign.
• In other words, in the absence of trade, the relative price of
cheese at Home is lower than the relative price of cheese at
Foreign.
• Home has a comparative advantage in cheese
and will export it to Foreign in exchange for wine.
Determining the Relative Price After Trade
• Partial equilibrium analysis-focus on a single market
• General equilibrium analysis-linkage between the two
markets
• To see how all countries can benefit from trade, we
calculate relative prices when trade exists.
 Without trade, the relative price of a good equals the
opportunity cost of producing that good.
• To calculate relative prices with trade, we first calculate
relative quantities of world production: (QC + Q*C )/(QW +
Q*W)
World Relative Supply and Relative Demand
1.PC/PW <aLC /aLW <. a*LC /a*LW
no supply of cheese; only wine
Relative price
of cheese, PC/PW
5
a*LC/a*LW
2. PC /PW = aLC /aLW <. a*LC /a*LW
H both C and W; F only W
RS
4
3. aLC /aLW <PC /PW < a*LC /a*LW
H only C;
F only W
3
aLC/aLW
1
2
4. aLC /aLW < PC /PW = a*LC /a*LW
H only C; F both C and W
5. PC /PW > a*LC /a*LW > aLC /aLW
no supply of wine, only cheese
Fig. 3-3: World Relative Supply and
Demand
Point 1 :
Point 2:
the home need not
specialize in
Home produces
only cheese,
foreign only wine
Trade in a One-Factor World
• The Gains from Trade
If countries specialize according to their
comparative advantage, they all gain from
this specialization and trade.
We will demonstrate these gains from
trade in two ways.
First, we can think of trade as a indirect
method of producing goods and services.
Trade in a One-Factor World
 Another way to see the gains from trade is to consider
how trade affects the consumption in each of the two
countries.
 The consumption possibility frontier states the
maximum amount of consumption of a goods a
country can obtain for any given amount of the other
commodity.
 In the absence of trade, the consumption possibility
curve is the same as the production possibility curve.
 Trade enlarges the consumption possibility for each of
the two countries.
Fig. 3-4: Trade Expands Consumption
Possibilities
Relative Wages
• Relative wages are the wages of the domestic
country relative to the wages in the foreign country.
• Although the Ricardian model predicts that relative
prices equalize across countries after trade, it does
not predict that relative wages will do the same.
• Productivity (technological) differences determine
wage differences in the Ricardian model.
 A country with absolute advantage in producing a good will
enjoy a higher wage in that industry after trade.
• These relationships imply that both countries have a
cost advantage in production.
Do Wages Reflect Productivity?
• In the Ricardian model, relative wages reflect
relative productivities of the two countries.
• Is this an accurate assumption?
• Some argue that low wage countries pay low
wages despite growing productivity, putting
high wage countries at a cost disadvantage.
• But evidence shows that low wages are
Productivity and Wages
In 2000
Do Wages Reflect Productivity?
• Other evidence shows that wages rise as
productivity rises.
 After the Korean War, South Korea was one of the
poorest countries in the world, and its labor
productivity was very low. Even by 1975, average
wages in South Korea were still only 5% of U.S.
average wages.
 In 2000, South Korea’s labor productivity was 35%
of the U.S. level and its average wages were about
Preview
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Absolute Advantage (added)
The Concept of Comparative Advantage
A One-Factor Economy
Trade in a One-Factor World
Misconceptions about comparative advantage
Comparative Advantage with Many Goods
Adding Transport costs and non-traded goods
Empirical evidence on Recardian Model
Misconceptions About
Comparative Advantage
1. Productivity and competitiveness
Free trade is beneficial only if a country is strong
enough to stand up to foreign competition

But even an unproductive country benefits from free trade
by avoiding the high costs for goods that it would otherwise
have to produce domestically.

High costs derive from inefficient use of resources.

The benefits of free trade do not depend on absolute
advantage, rather they depend on comparative advantage:
specializing in industries that use resources most efficiently.
Misconceptions About
Comparative Advantage
2. The pauper labor argument
Foreign competition is unfair and hurts other
countries when it is based on low wages

While trade may reduce wages for some workers, thereby
affecting the distribution of income within a country, trade
benefits consumers and other workers.

Consumers benefit because they can purchase goods more
cheaply.

Producers/workers benefit by earning a higher income in
the industries that use resources more efficiently, allowing
Misconceptions About
Comparative Advantage
3. Exploitation(剥削)
Trade exploits a country and makes it worse off if its
workers receive much lower wages than workers in
other nations.

While labor standards in some countries are less than
exemplary compared to Western standards, they are so
with or without trade.

Are high wages and safe labor practices alternatives to
trade? Deeper poverty and exploitation may result without
export production.

Consumers benefit from free trade by having access to
Preview
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Absolute Advantage (added)
The Concept of Comparative Advantage
A One-Factor Economy
Trade in a One-Factor World
Misconceptions about comparative advantage
Comparative Advantage with Many Goods
Adding Transport costs and non-traded goods
Empirical evidence on Recardian Model
Comparative Advantage
With Many Goods
• Suppose now there are N goods produced,
indexed by i = 1,2,…N.
• The domestic country’s unit labor requirement
for good i is aLi, and that of the foreign country
is a*Li
• Goods will be produced wherever it is cheaper
to produce them.
Comparative Advantage
With Many Goods
• Let w represent the wage rate in the
domestic country and w* represent the
wage rate in the foreign country.
If waL1 < w*a*L1 then only the domestic
country will produce good 1, since total
wage payments are less there.
Or equivalently, if a*L1 /aL1 > w/w*
Comparative Advantage
With Many Goods
• Suppose there are 5 goods produced in the
world:
If w/w* = 3, if w/w* = 5
Comparative Advantage
With Many Goods
• If w/w* = 3, the domestic country will produce
apples, bananas, and caviar, while the foreign
country will produce dates and enchiladas.
 The relative productivities of the domestic country
in producing apples, bananas, and caviar are
higher than the relative wage.
Fig. 3-5: Determination of Relative Wages
P
D
L
w/w*
kinds
L
Comparative Advantage
With Many Goods (cont.)
• How is the relative wage determined?
• By the relative supply and relative (derived) demand
of labor services.
• The relative (derived) demand of domestic labor
services falls when w/w* rises. As domestic labor
services become more expensive relative to foreign
labor services,
 goods produced in the domestic country become more
expensive, and demand of these goods and the labor
services to produce them falls.
 fewer goods will be produced in the domestic country, further
Preview
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Absolute Advantage (added)
The Concept of Comparative Advantage
A One-Factor Economy
Trade in a One-Factor World
Misconceptions about comparative advantage
Comparative Advantage with Many Goods
Adding Transport costs and non-traded goods
Empirical evidence on Recardian Model
Adding Transportation Costs
and Non-traded Goods
•
The Ricardian model predicts that countries
should completely specialize in production.
•
But this rarely happens for primarily three
reasons:
1. More than one factor of production reduces the
tendency of specialization (chapter 4)
2. Protectionism (chapters 8–11)
3. Transportation costs reduce or prevent trade,
which may cause each country to produce the
Transportation Costs
and Non-traded Goods (cont.)
• Non-traded goods and services (ex.,
haircuts and auto repairs) exist due to
high transportation costs.
Countries tend to spend a large fraction of
national income on non-traded goods and
services.
Preview
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Absolute Advantage (added)
The Concept of Comparative Advantage
A One-Factor Economy
Trade in a One-Factor World
Misconceptions about comparative advantage
Comparative Advantage with Many Goods
Adding Transport costs and non-traded goods
Empirical evidence on Recardian Model
Empirical Evidence
Fig. 3-6: Productivity and Exports
Empirical Evidence
• Do countries export those goods in which their
productivity is relatively high?
• The ratio of U.S. to British exports in 1951
compared to the ratio of U.S. to British labor
productivity in 26 manufacturing industries
suggests yes.
• At this time the U.S. had an absolute
advantage in all 26 industries, yet the ratio of
exports was low in the least productive
Empirical Evidence
• Two principal do seem to be supported
by the evidence
Productivity differences play an important
role in international trade
It is comparative rather than absolute
advantage that matters
Summary
• the concepts of opportunity cost and
comparative advantage
• Relative Prices
• Trade in a One-Factor World(Figure3-3)
• Comparative Advantage with Many
Goods(Figure3-5)
• Adding Transportation costs and non-traded