International Trade

Ricardo Model - Comparative Advantage

Comparative Advantage

We constructed / < /.

This means:

  • X requires relatively less labour in H and
  • Y requires relatively less labour in F.


    • (We say H has a comparative advantage in X, and F has a comparative advantage in Y).

    As:

    = ., = .,
    = ., = .,

    the above inequality implies that X is relatively cheap in H and Y is relatively cheap in F (i.e. / < /).

    We can expect, then, that H will export X and F will export Y if they trade with each other. As a result, after trade, / will increase and / will decrease (until they are the same if there is no trade barrier and transport cost).

    Home Country

    As / increases by trade (export X and import Y), H's production moves from C to B: [1] complete specialisation. (Remember that H cannot produce beyond AB - the PPF). Producing at B, H can consume at any point on BD by trade (as / is the world price).

    H will choose to consume at E to maximise utility. [2] For this, H will export BXE of X and import YEO of Y. (This trade is possible because YEO/BXE = /.)

    Foreign Country

    As / decreases by trade, F's production moves from C' to A': complete specialisation. Producing at A', F can consume at any point on A'D' by trade.

    F will choose to consume at E' to maximise utility. F will export A'YE' of Y and import XE'O of X.

    Note:

  • H's export of X = F's import of X (BXE = XE'O)
  • H's import of Y = F's export of Y (YEO = A'YE')




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