The theory or principle of comparative advantage holds that under free trade, an agent will produce more of and consume less of a good for which they have a comparative advantage. David Ricardo developed the classical theory of comparative advantage in 1817 to explain why countries engage in international trade even when one country’s workers are more efficient at producing every single good than workers in other countries. If a foreign country can supply us with a commodity cheaper than we ourselves can make macroeconomics paul krugman 3rd edition pdf, better buy it of them with some part of the produce of our own industry employed in a way in which we have some advantage.

I wish to know the extent of the advantage, which arises to England, from her giving France a hundred pounds of broad cloth, in exchange for a hundred pounds of lace, I take the quantity of lace which she has acquired by this transaction, and compare it with the quantity which she might, at the same expense of labour and capital, have acquired by manufacturing it at home. In 1817, David Ricardo published what has since become known as the theory of comparative advantage in his book On the Principles of Political Economy and Taxation. In a famous example, Ricardo considers a world economy consisting of two countries, Portugal and England, which produce two goods of identical quality. So, Portugal possesses an absolute advantage in producing cloth due to fewer labor hours, and England has a comparative advantage due to lower opportunity cost. In the absence of trade, England requires 220 hours of work to both produce and consume one unit each of cloth and wine while Portugal requires 170 hours of work to produce and consume the same quantities. England is more efficient at producing cloth than wine, and Portugal is more efficient at producing wine than cloth. Portugal’s wine, then both countries can consume at least a unit each of cloth and wine, with 0 to 0.

2 units of cloth and 0 to 0. 125 units of wine remaining in each respective country to be consumed or exported. Consequently, both England and Portugal can consume more wine and cloth under free trade than in autarky. The Ricardian model is a general equilibrium mathematical model of international trade. The following is a typical modern interpretation of the classical Ricardian model. In the interest of simplicity, it uses notation and definitions, such as opportunity cost, unavailable to Ricardo. The world economy consists of two countries, Home and Foreign, which produce wine and cloth.

We denote the same variables for Foreign by appending a prime. We don’t know if Home is more productive than Foreign in making cloth. Similarly, we don’t know if Home has an absolute advantage in wine. In the absence of trade, the relative price of cloth and wine in each country is determined solely by the relative labor cost of the goods. We assume that the relative demand curve reflects substitution effects and is decreasing with respect to relative price.

The behavior of the relative supply curve, however, warrants closer study. Recalling our original assumption that Home has a comparative advantage in cloth, we consider five possibilities for the relative quantity supplied at a given price. However, Home workers are indifferent between working in either sector. As a result, the quantity supplied can take any value. Home and Foreign specialize in wine, for similar reasons as above, and so the quantity supplied is zero.

Home specializes in cloth whereas Foreign specializes in wine. Home and Foreign specialize in cloth. The quantity supplied tends to infinity as the quantity of wine supplied approaches zero. Home specializes in cloth while Foreign workers are indifferent between sectors. Again, the relative quantity supplied can take any value. By trading, Home can also consume bundles in the pink triangle despite facing the same productions possibility frontier.

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