A ppt on David Ricardo's Comparative advantage with examples taking Portugal and England. The PPT aims to reveal Ricardo justification for doing trade even though Portugal has complete advantage in the production of cloth and wine

1. Chapter 3
David Ricardo and Comparative
Advantage

2. David Ricardo
• A stock broker, member of parliament and
brilliant economic thinker
• He read “The Wealth of Nations” while on
holiday in 1790 and studied political
economy from then on.

3. Some Terminology
• Autarky
– no trade
– example: autarky price ratio in country: relative
prices in the country when the country does
not trade.
• Terms of trade
– price of exports over price of imports
• Complete specialization
– each country only produces one good, buys
other good(s) through imports

4. Comparative Advantage
• This theory reinforces Adam Smith in
showing that countries can gain from trade.
• IDEA: Even if one country is absolutely
better at producing all goods and
services than its trading partners, it can
gain from trading with them.

5. Comparative Advantage
• A country has a comparative advantage in the
production of a good if it is better at producing that
good in comparison to its ability to produce
another good.
• “Better” means using comparatively less labour
in that good relative to its trading partners.
• To determine comparative advantage requires 4
numbers : we compare the value of 2 ratios
(fractions). More specifically, costs of opportunity
are compared.

6. Ricardo and Trade
• Trade can benefit all countries by making
goods cheaper for consumers and by
allowing more goods to be produced by all
countries.
• His example: cloth production and wine
production between England and Portugal.

7. • barrel (bbl) Unit of volume for crude oil
and petroleum products.
• One barrel equals 42 US gallons or 35 UK
(imperial) gallons, or approximately 159
liters

8. Labor requirement
• Portugal needs less hours to produce both
goods. (Wine 80 compared to 120)(Cloth 90
compared to 100)
• Portugal therefore has an absolute advantage in
the production of both goods. Does it still have
reasons (potential gains) to trade with England?
Wine Cloth Price Ratio
in Autarky
Portugal 80 hrs/bbl 90 hr/yd 1W:8/9C
England 120 hrs/bbl 100 hr/yd 1W:6/5C

9. Labor requirement
• For comparative advantage, we must look at all
four labor requirements at the same time!
The lowest relative requirement tells you who has
comparative advantage in which good.
Wine Cloth Price Ratio
in Autarky
Portugal 80 hrs/bbl 90 hr/yd 1W:8/9C
England 120 hrs/bbl 100 hr/yd 1W:6/5C

10. Labor requirement
• 80/90 < 120/100 Portugal has comparative advantage in
wine production than in cloth, in relation to England.
• Portugal has a comparative advantage in the
production of wine.
• 80 is the hrs/bbl for Portugal for wine.
Wine Cloth Price Ratio
in Autarky
Portugal 80 hrs/bbl 90 hr/yd 1W:8/9C
England 120 hrs/bbl 100 hr/yd 1W:6/5C

11. Comparative Advantage
• If 80/90 < 120/100 then we can be sure
that:
• 100/120 < 90/80 (this is the inverse of the
above).
• Therefore, England has a comparative
advantage in the production of cloth
when Portugal has a comparative
advantage in wine.

12. Labor requirement
• For comparative advantage, we must look at all four labor
requirements at the same time!
• It is useful to use the Opportunity Cost concept.
Wine Cloth Price Ratio
in Autarky
Portugal 80 hrs/bbl 90 hr/yd 1W:8/9C
England 120 hrs/bbl 100 hr/yd 1W:6/5C

13. Opportunity Cost
• Can be defined as how much you must
give up of one product in order to obtain
the other.

14. Labor requirement
Wine Cloth Price Ratio
in Autarky
Portugal 80 hrs/bbl 90 hr/yd 1W:8/9C
England 120 hrs/bbl 100 hr/yd 1W:6/5C
Wine Cloth
Portugal 8/9 C 9/8 W
England 12/10 C 10/12 W
• Opportunity Cost
Lower
opportunity cost
for wine in terms
of cloth
Lower
opportunity cost
for cloth in terms
of wine

15. Labor requirement
• According to classical trade theory, Portugal
should produce only Wine,
• England should produce only Cloth
• If they specialize in what they have lower
opportunity cost and trade for the good for which
they have higher opportunity cost, both countries
can gain from trade.

16. Gains from Trade
• Ricardo used a different method to discuss gains
from trade than we did in the last class (absolute
advantage).
• He argued that, as long as a country could SAVE
time or buy more of a good by trading, there
is a gain.
• He did not bother with the total production of the
country, but illustrated gains from the production
of One unit.

17. Gains from trade continued
• In the example.
• England needs 100 hours to produce one yd of
cloth.
• England needs 120 hours to produce one bbl of
wine.
• But Portugal can produce wine using less hours
(80) than it needs for cloth (90).
• Assume Pc/Pw = 1/1 with trade
– (NOTE: this is easy assumption, not always
price ratio!)

18. Gains from trade continued
• If international prices are 1C: 1W
• England can use 120 hours to produce one bbl of
wine itself (producing wine directly).
OR
• England can use 100 hours to produce a yard of
cloth which it can sell for one bbl of wine (he
called this indirectly producing wine).
• Therefore it seems to be better producing wine
indirectly, which is producing cloth and
exchanging for wine.

19. Gains from trade continued
• By producing cloth and trading, England
saves 20 hours for each unit of wine
consumed.
• These 20 hours can be used to produce
more cloth, either for consumption or
trade.

20. You do:
1. Which country has comparative advantage in cameras?
2. Which country has a comparative advantage in t-shirts?
3. What would be the price ratio in autarky?
4. What would be a possible price ratio with trade?
Cameras T-Shirts Price Ratio
in Autarky
Mexico 8 hrs/unit 4 hr/unit
US 3 hrs/unit 3 hr/unit

21. You do:
1. Which country has comparative advantage in cameras? US
2. Which country has a comparative advantage in t-shirts? MEX
3. What would be the price ratio in autarky?
4. What would be a possible price ratio with trade? 0.8C:1T
Cameras T-Shirts Price Ratio
in Autarky
Mexico 8 hrs/unit 4 hr/unit 1C:2T; 1/2C:1T
US 3 hrs/unit 3 hr/unit 1C:1T

22. You do:
1. Which country has comparative advantage in cameras?
2. Which country has a comparative advantage in t-shirts?
3. What would be the price ratio in autarky?
4. What would be a possible price ratio with trade?
Cameras T-Shirts Price Ratio
in Autarky
Japan 3 hrs/unit 6 hr/unit
US 3 hrs/unit 3 hr/unit

23. You do:
1. Which country has comparative advantage in cameras? JAP
2. Which country has a comparative advantage in t-shirts? US
3. What would be the price ratio in autarky?
4. What would be a possible price ratio with trade? 1C:0.8T
Cameras T-Shirts Price Ratio
in Autarky
Japan 3 hrs/unit 6 hr/unit 2C:1T;
1C:1/2T
US 3 hrs/unit 3 hr/unit 1C:1T

24. You do:
1. Which country has comparative advantage in cameras?
2. Which country has a comparative advantage in t-shirts?
3. What would be the price ratio in autarky?
4. What would be a possible price ratio with trade?
Cameras T-Shirts Price Ratio
in Autarky
Japan 3 hrs/unit 6 hr/unit
India 4 hrs/unit 8 hr/unit

25. You do:
1. Which country has comparative advantage in cameras?
2. Which country has a comparative advantage in t-shirts?
3. What would be the price ratio in autarky?
4. What would be a possible price ratio with trade?
Cameras T-Shirts Price Ratio
in Autarky
Japan 3 hrs/unit 6 hr/unit 2C:1T
India 4 hrs/unit 8 hr/unit 2C:1T

26. What do we learn from these
questions?

27. Gains from trade (if time permits)
• Look at examples 1, 2 and 3.
• I will put terms of trade on the board.
• Determine how much time each country can
save by producing the good in which it has a
comparative advantage and trading for the other
good. Determine this time saving if the country
does this for 1 million units of the good.