chapter 3: labor productivity and comparative advantage - the ricardian model

the ricardian model

examines differences in the productivity of labor between countries

the specific factors model and the heckscher-ohlin model examines

the differences in

• labor

• labor skills

• physical capital

• land

• other factors of production

between countries

trade may also arise due to

economies of scale (larger scale of production is more efficient)

the opportunity cost of producing something measures

the cost of not being able to produce something else with the resources used

comparative advantage will be determined by

comparing opportunity costs across countries

absolute advantage

when a producer can provide a good or service. in greater quantity for the same cost, or the same quantity at a lower cost, than its competitors

comparative advantage

is an economy’s ability to produce a particular good or service at a lower opportunity cost than its trading partners

what is the opportunity cost of producing computers vs roses

the opportunity cost of producing computers is the amount of roses not produced

what is the opportunity cost of producing roses vs. computers

the opportunity costs of producing roses is the amount of computers not producedsu

suppose that in the United States, 10 million roses could be produced with the same resources as 100,000 computers

suppose that in Colombia, 10 million roses could be produced with the same resources as 30,000 computers

Colombia has a lower opportunity cost of producing roses: has to stop producing fewer computers in order to free up resources to make a rose

a country has a comparative advantage in producing a good if the opportunity cost of producing that good is lower in the country than in other countries

• the United States has a comparative advantage in computer production

• Colombia has a comparative advantage in rose production

when countries specialize in production in which they have a comparative advantage

more goods and services can be produced and consumed

we formalize these ideas by constructing a one-factor Ricardian model using the following assumptions

1. labor is the only factor of production

2. labor productivity varies across countries due to differences in technology, but labor productivity in each country is constant

3. the supply of labor in each country is constant

4. two goods

5. competition allows workers to be paid a wage equal to the value of what they produce, and allows them to work in the industry that pays the higher wage

6. two countries: home and foreign

a unit labor requirement

indicates the constant number of hours labor required to produce one unit of output

a high unit labor requirement means

low labor productivity

labor productivity is how much

output one hour of labor creates

labor supply L

indicates the total amount of labor resources - the number of hours worked (a constant parameter)

production possibility frontier PPF of an economy shows

the maximum amount of a good that can be produced for a fixed amount of resources

production possibility frontier PPF

is a curve on a graph that illustrates the possible quantities that can be produced of two products if both depend upon the same finite resource for their manufactureth

the PPF is also referred to as

production possibility curve

the line PF shows the maximum amount of cheese home can produce given any production of wine, and vice versa

use * to indicate

foreign country variables

when one country can produce a unit of a good with less labor than another country, we saw that the first country has an ___________ in producing that good

absolute advantage

comparative advantage determines

the pattern of trade

because foreign relative unit labor requirement in cheese is higher than home’s (it needs to give up many more units of wine to produce one more unit of cheese), its production possibility frontier is steeper

the RD and RD’ curves show that the demand for cheese relative to wine is a decreasing function of the price of cheese relative to that of wine, while the RS curve shows that the supply of cheese relative to wine is an increasing function of the same relative price

gains from trade comes from specializing

in the type of production that uses resources most efficiently and using the income generated from that production to buy the goods and services that countries desire

“using resources most efficiently” means

producing a good in which a country has a comparative advantage

domestic workers earn a higher income from cheese production because

the relative price of cheese increases with trade

foreign workers earn a higher income from wine production because

the relative price of cheese decreases with trade (making cheese cheaper), and the relative price of wine increases with trade

without trade

a country has to allocate resources to produce all of the goods that it wants to consumewi

with trade

a country can specialize its production and exchange for the mix of goods that it wants to consume

consumption possibilities expand beyond the production possibility frontier when

trade is allowed

with trade, consumption in each country is expanded because

world production is expanded when each country specializes in producing the good in which it has a comparative advantage

international trade allows home and foreign to consume anywhere within the outer lines, which lie outside the countries’ production frontiers

free trade is beneficial only if a country is

more productive than foreign countries

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 uses of resources

the benefits of free trade do not depend on absolute advantage, rather

they depend on absolute advantage: specializing in industries that use resources most efficiently

free trade with countries that pay low wages hurts

high wage countries

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 from trade because

they can purchase goods more cheaply

producers/workers benefit from trade by

earning a higher income in the industries that use resources more efficiently, allowing them to earn higher prices and wages

free trade exploits less productive countries

whose workers make low-wages

the Ricardian model predicts

that countries completely specialize in production

the Ricardian model predicting countries completely specialize in production is a rare occurrence, because of what 3 reasons

1. more than one factor of production reduces the tendency of specialization

2. protectionism

3. transportation costs reduce or prevent trade, which may cause each country to produce the same good or service

non-traded goods and services (like haircuts and auto repairs) exist

due to high transport costs

countries tend to spend a large fraction of national income on

non-traded goods and services

a comparative study showed that U.S. exports were high relative to British exports in industries in which the United States had high relative labor productivity.

each dot represents a different industry

a very poor country like Bangladesh can have a comparative advantage in clothing despite being less productive in clothing than other countries such as China because

it is even less productive compared to China in other sectors

the main implications of the Ricardian model are well supported by empirical evidence:

• productivity differences play an important role in international trade

• comparative advantage (not absolute advantage) matters for trade