Chapter 3. Labor Productivity and Comparative Advantage: The Ricardian Model. 1. 1 .The Concept of Comparative Advantage 2 .A One-Factor Economy 3 .Trade in a One-Factor World 4 .Misconceptions about Comparative Advantage Box: Do Wages Reflect Productivity?. 2.
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Labor Productivity and Comparative Advantage: The Ricardian Model
1.The Concept of Comparative Advantage
2.A One-Factor Economy
3.Trade in a One-Factor World
4.Misconceptions about Comparative Advantage
Box: Do Wages Reflect Productivity?
5.Comparative Advantage with Many Goods
6.Adding Transport Costs and Nontraded Goods
7.Empirical Evidence on the Ricardian Model
Winter Roses case : trade-off
The opportunity cost of a good in terms of other goods is the number of other goods that could have been produced with the resources used to produce a given number of a good.
Hypothetical Changes in Production
Million Roses Thousand Computers
United States -10 +100
South America +10 -30
Total 0 +70
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.
(2).Relative Prices and Supply
*produce two goods: Wine and Cheese
*one factor of production: labor
unit labor requirement: aLW, aLC
*total labor supply: L
aLCQC+ aLWQW < L (2-1)
QC + 2QW = 120
Home wine production, QW, in gallons
Absolute value of slope equals opportunity cost of cheese in terms of wine
Home cheese production, QC, in pounds
define: PC—the price of cheese
PW—the price of wine
then the hourly wage rate
in cheese sector will be PC/aLC
in wine sector will be PW/aLW
the economy will specialize in the production of cheese;
the economy will specialize in the production of wine.
In the absence of international trade, the relative prices of goods are equal to their relative unite labor requirement.
(1).Determining the Relative Price After Trade
(2).The Gains from Trade
(3).A Numerical Example
or equivivalently, that aLC / a*LC < aLW /a*LW (3-3)
1.When a country has a comparative advantage in a good, must it also have an absolute advantage in that good? Why or why not?
2.When a country has an absolute advantage in a good, must it also have a comparative advantage in that good? Why or why not?
Home: L, aLC, aLW
Foreign: L*, aLC*, aLW*
Assumption: aLC/aLW <aLC*/aLW* (2-2)
or aLC/aLC*<aLW/aLW* (2-3)
that is, Home has a comparative advantage in cheese.
Foreign wine production, QW*, in gallons
Foreign cheese production, QC*, in pounds
Figure 3-3 World Relative Supply and Demand
-Assume aLC/aLW<a*LC/a*LW, Home will specialize in the production of cheese.
-Home will specialize in the production of wine whenever PC/PW<aLC/aLW.(P=W)
-Similarly,Foreign will specialize in wine production whenever PC/PW<a*LC/a*LW.
Indirect method of production (as long as:
Or PC/PW>aLC/aLW )
Change the possibilities for consumption (figure 2-4)
Table 3-2 Unite Labor Requirements
aLC=1 hour per pound
aLW=2 hours per gallon
aLW*=3 hours per gallon
aLC*=6 hours per pound
Assumption: world equi. price=1
--A country with absolute advantage in producing a good will enjoy a higher wage in that industry after trade.
(1/aLC)PC = (1/1)$12 = $12
(1/a*LW)PW = (1/3)$12 = $4
$12/$4 = 3
(1).Productivity and Competitiveness
(2).The Pauper Labor Argument
Myth 1: Free trade is beneficial only if your country is strong enough to stand up to foreign competition
relative wage rate
Myth 2: Foreign competition is unfair and hurts other countries when it is based on low wages.
The Pauper Labor Argument
Myth 3: Trade exploits a country and makes it worse off if its workers receive much lower wages than workers in other nations.