International Economics: Theory and

Policy
Eleventh Edition

Chapter 3
Labor Productivity
and Comparative
Advantage: The
Ricardian Model

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Preview
• Opportunity costs and comparative advantage
• A one-factor economy, the Ricardian model
• Production possibilities
• How relative prices and opportunity costs are related to
trade

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Introduction
• Differences across countries are a key reason why trade
occurs:
– The Ricardian model (Chapter 3) examines differences
in the productivity of labor (due to differences in
technology) between countries.
– The Specific Factors model (Chapter 4) and the
Heckscher-Ohlin model (Chapter 5) examine
differences in labor, physical capital, land, or other
factors of production between countries.
• Trade may also arise due to economies of scale.

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The Concept of Comparative
Advantage (1 of 6)
• 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.

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The Concept of Comparative
Advantage (2 of 6)
Example
• Suppose a limited number of workers could produce
either roses or computers.
– What is the opportunity cost of producing
computers???
– What is the opportunity cost of producing roses???

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The Concept of Comparative
Advantage (3 of 6)
• 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.
• ??? has a lower opportunity cost of producing roses: has to
stop producing computers in order to free up resources to
make a rose.

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The Concept of Comparative
Advantage (4 of 6)

• 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.

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The Concept of Comparative
Advantage (5 of 6)

• Hypothetical Changes in Production

blank Million Roses Thousand Computers

United States −10 +100
Columbia +10 −30
Total 0 +70

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The Concept of Comparative
Advantage (6 of 6)

• When countries specialize in production in which they

have a comparative advantage, more goods and services
can be produced and consumed.

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David Ricardo
Following the example by Ricardo:
Portugal lower opportunity cost of producing wine
England lower opportunity cost of producing cloth

Methuen Treaty: a military and commercial treaty

between England and Portugal signed in 1703.
British economist
1772 - 1823
The treaty stipulated that no tax higher than the tax
charged for an equal amount of French wines could
be charged for Portuguese wines exported to
England, and that no English textiles exported to
Portugal would be charged any taxes.

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A One-Factor Economy (1 of 4)

• We formalize these ideas by constructing a one-factor

Ricardian model using some simple assumptions.

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A One-Factor Economy (2 of 4)
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: wine and cheese.
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 highest wage.
6. Two countries: home and foreign.

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A One-Factor Economy (3 of 4)
• A unit labor requirement indicates the constant number
of hours of labor required to produce one unit of output.
– aLC is the unit labor requirement for cheese in the home
country. aLC hours of labor produce one pound of
cheese in the home country.
– aLW hours of labor produce one gallon of wine in the
home country.
• High unit labor requirement means ??? labor productivity.
– Labor productivity is how much output one hour of
labor creates.

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A One-Factor Economy (4 of 4)
• Labor supply L indicates the total amount of labor
resources − the number of hours worked (a constant
parameter).
• aLC (a constant).
• Cheese production QC indicates how many total pounds of
cheese that the home country produces.
• aLW (a constant).
• Wine production QW indicates how many total gallons of
wine that the home country produces.

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Production Possibilities (1 of 4)
• 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.
• The production possibility frontier of the home economy is:
aLCQC + aLWQW ≤ L

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Production Possibilities (2 of 4)
L
• Maximum home cheese production is QC  when Qw  0.
a LC

L
• Maximum home wine production is Qw  when Qc  0.
a Lw

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Production Possibilities (3 of 4)
• For example, suppose that the home economy’s labor
supply is 1,000 hours.
– aLC = 1 hours/lb
– aLW = 2 hours/gallon
• The PPF equation aLCQC + aLWQW ≤ L becomes
QC + 2QW ≤ 1,000.
• Maximum cheese production is ???
• Maximum wine production is ???

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Home’s Production Possibility Frontier

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Production Possibilities (4 of 4)
• The opportunity cost of cheese is how many gallons of
wine Home must stop producing in order to make one
more pound of cheese: aLC
aLW
– The opportunity cost is constant because the unit labor
requirements are both constant.
– The opportunity cost of cheese appears as the
absolute value of the slope of the PPF.
L  a LC 
Qw    QC
a Lw  a Lw 

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Relative Prices and Supply (1 of 7)
• PC is the price of cheese; PW is the price of wine.
• wC is the wage paid to workers who make cheese
• wW is the wage paid to workers who make wine.
• Due to competition in the labor and goods markets:
– Hourly wages of cheese makers will equal the value of
the cheese produced in an hour: WC  PC
aLC
Pw
Ww 
aLw

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Relative Prices and Supply (2 of 7)
• Workers will choose to work in the industry that pays the
higher wage.
• If the price of cheese relative to the price of wine exceeds
the opportunity cost of producing cheese
PC a
 LC ,
PW aLW
– Then the wage paid when making cheese will exceed
the wage in wine
PC PW
WC    WW
aLC aLW
– So workers will make only cheese (the economy
specializes in cheese production).
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Relative Prices and Supply (3 of 7)
• If the price of cheese relative to the price of wine is less
than the opportunity cost of producing cheese
PC aLC
 ,
PW aLW
– Then the wage in cheese will be less than the wage in
wine
PC P
WC   W  WW
aLC aLW
– So workers will make only wine (the economy
specializes in wine production).

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Relative Prices and Supply (4 of 7)
• If the price of cheese relative to the price of wine equals
the opportunity cost of producing cheese
PC aLC
 ,
PW aLW
– Then the wage in cheese will equal the wage in wine

PC P
WC   W  WW
aLC aLW

– So workers will be willing to make both wine and

cheese.

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Relative Prices and Supply (5 of 7)
• For example, suppose cheese sells for $4/pound and wine
sells for $7/gallon.

– Would the workers be willing to produce cheese, wine,

or both???

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Relative Prices and Supply (6 of 7)
• What if the price of cheese drops to $3/pound? (assume
there is no change in the price of wine)

– Would the workers be willing to produce cheese, wine,

or both???

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Relative Prices and Supply (7 of 7)
• If the home country wants to consume both wine and cheese (in
the absence of international trade), relative prices must adjust
so that wages are equal in the wine and cheese industries.
P P
– If C  W workers will not care whether they work in the
aLC aLW
cheese industry or the wine industry, so that production of
both goods can occur.

– Production (and consumption) of both goods occurs when:

PC a
 LC
PW aLW

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