Comparative Advantage

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Chapter 2 Labor Productivity and Comparative Advantage: The Ricardian Model

Chapter Organization
§ § § § § § § § §
Introduction 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 Nontraded Goods Empirical Evidence on the Ricardian Model Summary Slide 2- 2

Prepared by Iordanis Petsas To Accompany International Economics: Theory and Policy Sixth Edition Policy, by Paul R. Krugman and Maurice Obstfeld

Copyright © 2003 Pearson Education, Inc.

Introduction
§
Countries engage in international trade for two basic reasons:

The Concept of Comparative Advantage
§ §
On Valentine’s Day the U.S. demand for roses is about 10 million roses. Growing roses in the U.S. in the winter is difficult.

• They are different from each other in terms of
climate, land, capital, labor, and technology.

• They try to achieve scale economies in production.

§

The Ricardian model is based on technological differences across countries.

• Heated greenhouses should be used. • The costs for energy, capital, and labor are substantial.

• These technological differences are reflected in
differences in the productivity of labor.

§
Slide 2- 3

Resources for the production of roses could be used to produce other goods, say computers. Slide 2- 4

Copyright © 2003 Pearson Education, Inc.

Copyright © 2003 Pearson Education, Inc.

The Concept of Comparative Advantage
§
Opportunity Cost

The Concept of Comparative Advantage
§
The principle of comparative advantage: • If each country exports the goods in which it has comparative advantage (lower opportunity costs), then all countries can in principle gain from trade.

• The opportunity cost of roses in terms of computers is
the number of computers that could be produced with the same resources as a given number of roses.

§

Comparative Advantage

• A country has a comparative advantage in producing a
good if the opportunity cost of producing that good in terms of other goods is lower in that country than it is in other countries.

§

What determines comparative advantage?

• Answering this question would help us understand how
country differences determine the pattern of trade (which goods a country exports).

Copyright © 2003 Pearson Education, Inc.

Slide 2- 5

Copyright © 2003 Pearson Education, Inc.

Slide 2- 6

1

A One-Factor Economy
§
Assume that we are dealing with an economy (which we call Home). In this economy:

A One-Factor Economy
§
The constant labor productivity is modeled with the specification of unit labor requirements:

• The unit labor requirement is the number of hours of
labor required to produce one unit of output.
– Denote with a L W the unit labor requirement for wine (e.g. if a LW = 2, then one needs 2 hours of labor to produce one gallon of wine). – Denote with a L C the unit labor requirement for cheese (e.g. if a LC = 1, then one needs 1 hour of labor to produce a pound of cheese).

• • • • •

Labor is the only factor of production. Only two goods (say wine and cheese) are produced. The supply of labor is fixed in each country. The productivity of labor in each good is fixed. Perfect competition prevails in all markets.

§
Copyright © 2003 Pearson Education, Inc. Slide 2- 7

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). Slide 2- 8

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A One-Factor Economy
§
Production Possibilities

A One-Factor Economy
Figure 2-1: Home’s Production Possibility Frontier
Home wine production, QW , in gallons

• The production possibility frontier (PPF) of an
economy shows the maximum amount of a good (say wine) that can be produced for any given amount of another (say cheese), and vice versa. • The PPF...
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