Slides of International Economics lecture

1. CHAPTER 3
THE RICARDIAN MODEL
Labor Productivity and Comparative
Advantage

2. CHAPTER 3
THE RICARDIAN MODEL
Labor Productivity and Comparative
Advantage

3. Chapter Organization
▰ Concept of comparative advantage
▰ Production possibilities
▰ Relative prices and supply
▰ A one-factor economy
▰ Trade in a one-factor world
▰ Misconceptions about comparative advantage
Slide 2

4. Why is free trade beneficial?
▰ Free trade – a situation where a government does not
attempt to influence through quotas or duties what its
citizens can buy from another country or what they can
produce and sell to another country
▰ Trade theories show why it is beneficial for a country to
engage in international trade even for products it is able
to produce for itself
Slide 2

5. International trade theories
▰ Classical trade theories
▻ Mercantilism (Pre-16th century)
▻ Absolute advantage (A. Smith, 1776)
▻ Comparative advantage (D. Ricardo, 1817)
▰ Neo-classical trade theory
▻ Factor-Endowment (Heckscher-Ohlin, 1919)
▰ New trade theories
▻ Economies of scale & Int’l trade (P. Krugman, 1908s)
▻ International product life cycle (R. Vernon, 1966)
▻ National competitive advantage (M. Porter, 1990)
Slide 2
Chủ nghĩa trọng thương
Lợi thế tuyệt đối
Lợi thế so sánh

6. Historical development of trade theory
▰ The mercantilist philosophy makes a crude case for government
involvement in promoting exports and limiting import
▰ Smith, Ricardo, and Heckscher-Olin promote unrestricted free trade
▰ New trade theory and Porter’s theory of national competitive
advantage justify limited and selective government intervention to
support the development of certain export-oriented industries.
Slide 6

7. Historical development of trade theory
▰ Mercantilism:
▻ Regulation to ensure a positive trade balance
▻ Critics: possible only or short term; assumes static world economy
▰ Absolute advantage:
▻ Countries benefit from exporting what they produce more efficiently than anyone else
▻ But: Nations without absolute advantage do not gain from trade
▰ Comparative advantage:
▻ Nations can gain from specialization, even if they lack of absolute advantage
Slide 7

8. COMPARATIVE ADVANTAGE
CONCEPT
8
1

9. The Concept of Comparative Advantage
Slide 9

10. 10
ADAM SMITH’S QUOTE
• It is the maxim of every prudent master of a family
never to attempt to makee at home what it will cost
him more to make than to buy. The taylor does not
attempt to make his own shoe. All of them find it
for their interest to employ their whole industry in a
way in which they have some advantage over their
neighbours and to purchase with a part of its
produce whatever else they have occasion for
• What is prudence in the conduct of every private
family, can scarce be folly in that of a great
kingdom. Would it be a reasonable law to prohibit
the importation of all foreign wines, merely to
encourage the making of claret and burgundy in
Scotland?
- Smith, Adam
An inquiry into the Nature and Causes of the
Wealth of Nations

11. Review of Absolute advantage
▰ Adam Smith’s theory of Absolute advantage: Countries should
specialize in the production of goods for which they have an
absolute advantage and then trade these goods for goods
produced by other countries.
Slide 11

12. The Concept of Comparative Advantage
▰ David Ricardo asked what happens when one country has an
absolute advantage in the production of all goods.
▰ The theory of comparative advantage (1817) – countries
should specialize in the production of those goods they
produce most efficiently and buy goods that they produce less
efficiently from other countries
▻ Even if this means buying goods from other countries that
they could produce more efficiently at home
Slide 12

13. The Law of Comparative Advantage
▰ The less efficient nation should specialize in and export the
good in which it is relatively less inefficient (where its absolute
disadvantage is least). The more efficient nation should
specialize in and export that good in which it is relatively more
efficient (where absolute advantage is greatest)
Slide 13

14. A One-Factor Economy
▰ Assume that we are dealing with an economy (which we call Home).
In this economy:
▻ Labor is the only factor of production.
▻ Only two goods (say rice and steel) 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.
Slide 14

15. A One-Factor Economy
▰ Before specialization
▰ Specialization and international trade
▰ If each country specializes in the production of the good in which it has a
comparative advantage and trades for the other, both countries gain
→Trade is a positive sum game Slide 15
Output/Labor unit Vietnam Japan World
Rice 8 12 20
Steel 2 6
Output/Labor unit Vietnam Japan Gains
Rice +8 -8 (1/3) 0
Steel -2 +4 (2/3) +2
(16) (4 =1/3 đv lđ)
(6*2/3)

16. A One-Factor Economy
▰ Comparative advantage model
▰ Comparative advantage of the two countries?
▰ Determining comparative advantage:
𝐿𝑎𝑏𝑜𝑟 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑟𝑖𝑐𝑒 𝑉𝑁
𝐿𝑎𝑏𝑜𝑟 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑟𝑖𝑐𝑒 𝐽𝑃
<
𝐿𝑎𝑏𝑜𝑟 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑠𝑡𝑒𝑒𝑙 𝑉𝑁
𝐿𝑎𝑏𝑜𝑟 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑠𝑡𝑒𝑒𝑙 𝐽𝑃
Slide 16
Output Vietnam Japan
Rice 6 5
Steel 12 2
labor costs/output

17. Ricardo’s Theory of Comparative Advantage
▰ Comparative advantage theory provides a strong rationale for
encouraging free trade
▻ Total output is higher
▻ Both countries benefit
Trade is a positive sum game
Slide 17

18. A One-Factor Economy
▰ Suppose the Vietnam economy has only one factor of production: Labor
▰ It produces 2 products: rice and steel
▻ Denote with aLR the unit labor requirement for rice
▻ Denote with aLS the unit labor requirement for steel
▰ The economy’s total resources are defined as L, the total labor supply
Slide 2-18

19. A One-Factor Economy
▰ Production Possibilities
▻ The production possibility frontier (PPF) of an economy shows
the maximum amount of a good (say rice) that can be produced
for any given amount of another (say steel), and vice versa.
▻ The PPF of Vietnam economy is given by the following equation:
aLRQR + aLSQS = L
▻ For example, we have: aLR = 6; aLS = 12; L = 120
6QR + 12QS = 120
Slide 19

20. Slide 20
Figure 3-1: Vietnam’s Production Possibility Frontier
L/aLR
L/aLS
A One-Factor Economy
Absolute value of slope equals
opportunity cost of rice in
terms of steel
F
P
Vietnam rice
production, QR,
in tons
Vietnam steel
production, QS,
in tons
aLr/aLS = 6/12 = 0.5
aLS/aLR = 12/6 = 2

21. A One-Factor Economy
▰ Relative Prices and Supply
▻ The particular amounts of each good produced
are determined by prices.
▻ If price of rice is $4 and the price of steel is
$7, what will Vietnamese workers produce?
Slide 21

22. A One-Factor Economy
▰ The above relations imply that if the relative price of rice
(PR / PS ) exceeds its opportunity cost (aLR / aLS), then the
economy will specialize in the production of rice.
𝑃𝑅
𝑃𝑆
>
𝑎𝐿𝑅
𝑎𝐿𝑆
⟹ 𝑠𝑝𝑒𝑐𝑖𝑎𝑙𝑖𝑧𝑒 𝑖𝑛 𝑟𝑖𝑐𝑒
▰ In the absence of trade, both goods are produced, and
therefore PR / PS = aLR /aLS.
Slide 22

23. International Trade
▰ Absolute advantage concept can leave the impression that a country could lack an anything
▻ Therefore have nothing to export
▰ An absolute disadvantage in a product does not preclude having a comparative advantage
in that product
▻ Vietnam could have absolute advantage in rice, but still export rice because of its comparative
advantage
▰ Comparative advantage is a more powerful concept than absolute advantage
▻ Perhaps the most central concept in international economics
Slide 23
loại trừ

24. International Trade
▰ Gains from trade occur for the country as a whole
▻ Does not mean that every individual or group within the country benefits
▻ Good reasons to expect that there will be groups that lose from increased trade
▻ These groups will oppose increased trade despite the overall gains to their country
▰ Sometimes alleged international trade is almost always detrimental to the environment
▰ However, the situation is not straightforward
▻ Theoretical and empirical results demonstrate that increased trade can be either good or bad for the
environment
▻ Need to approach the trade and environment issue on a case-by-case basis
Slide 24

25. Comparative advantage and Opportunity cost
▰ Generalizes theory to include all factors, not just labor
▰ Shows combinations of products that can be made if all
factors are used effectively
▰ Slope, or marginal rate of transformation, shows the
opportunity cost of making more of one good (how
much of one good must be given up to make more of
another)
Slide 25

26. Comparative advantage and Opportunity cost
▰ A country has a comparative advantage in producing a
good if the opportunity cost of producing that good is
lower in the country than it is in other countries.
Slide 26

27. Summary of Ricardian model (Paul Krugman)
1. We examined the Ricardian model, the simplest model
that shows how differences between countries give
rise to trade and gains from trade. In this model, labor
is the only factor of production, and countries differ
only in the productivity of labor in different countries.
Slide 27

28. Summary of Ricardian model (Paul Krugman)
2. In the Ricardian mode, countries will export goods that
their labor produces relatively efficiently and will import
goods that their labor produces inefficiently. In other
words, a country’s production pattern is determined by
comparative advantage.
Slide 28

29. Summary of Ricardian model (Paul Krugman)
3. We can show that trade benefits a country in either of
two ways.
First, we can think of trade as an indirect method of
production. Instead of producing a good for itself, a country can
produce another good and trade it for the desired good. The simple
model shows that whenever a good is imported, it must be true that
this indirect “production” requires less labor than direct production.
Second, we can show that trade enlarges a country’s
consumption possibility, which implies gains from trade
Slide 29

30. Summary of Ricardian model (Paul Krugman)
4. The distribution of the gains from trade depends on the
relative prices of the goods countries produce. To
determine these relative prices, necessary to look at the
relative world supply and demand for goods. The relative
price implies a relative wage as well.
Slide 30

31. Summary of Ricardian model (Paul Krugman)
5. Extending the one-factor, two-good model to a world of
many commodities does not alter these conclusions. The
only difference is that it necessary to focus directly on the
relative demand for labor to determine relative wages
rather than to work via relative demand for goods. Also, a
many-commodity model can be used to illustrate the
important point that transportation costs can give rise to a
situation in which some goods are nontraded.
Slide 31

32. Revealed Comparative Advantage (RCA) –
Bela Balassa (1965)
▰ RCA is an index used in international economics to
measure the comparative advantage of a country in
an industry (product cluster)
𝑹𝑪𝑨𝒊𝒋 =
𝒙𝒊𝒋
𝑿𝒊
𝒙𝒂𝒋
𝑿𝒂
Slide 32
x: export of an industry
X: total exports
i: a country
j: an industry
a: the world

33. Revealed Comparative Advantage (RCA) –
Bela Balassa (1965)
▰ RCA < 1
▰ RCA > 1
▰ RCA > 2.5
Slide 33

34. Practice test (RCA)
▰ Calculate RCA of Vietnam’s top 20 biggest export
industries and Top-10 biggest import industries (4-digit
HS) in the period of 10 years.
▰ Analyse RCA in the context of Vietnam’s economy
(focusing on production factors and government
policies)
▰ Source: Trade Map (intracen.org)
Slide 34
code of products