The Ricardian Model of International Trade

How differences in technology and labour productivity create comparative advantage, specialization, trade and gains from trade.

Source Technology and productivity
Pattern Comparative advantage
Gains Expanded consumption

1. How does the Ricardian model work?

The Ricardian model is the simplest formal model showing why countries trade and how both countries can gain from trade. The source of trade is a difference in technology: countries require different amounts of labour to produce the same goods.

These productivity differences create differences in opportunity cost. A country has a comparative advantage in the good it can produce at a lower opportunity cost, even when another country is absolutely more productive in every sector.

2. The central logic of the model

The Ricardian model begins with differences in unit labour requirements. These determine labour productivity, opportunity costs and the relative prices that would prevail in each country before trade.

Technology Different labour requirements
→
Opportunity Cost Different production trade-offs
→
Comparative Advantage Lower relative cost
→
Trade Relative-price incentive

The crux of the Ricardian model

Comparative advantage depends on relative productivity, not absolute productivity. A country can gain from trade even when it is less productive in producing both goods, provided that its relative disadvantage is smaller in one of them.

When trade opens, the world relative price settles between the two countries' autarky relative prices. Each country then specializes in the good in which it has a comparative advantage.

3. Practice questions: try before watching

Most multiple-choice questions can be answered by identifying the relevant productivity ratio, opportunity cost, autarky price, specialization pattern or wage relationship. Try each question before opening the explanation and watching the solution.

Q 1
Ricardian trade model practice question 1 on comparative advantage and specialization
Video: Learn How to Solve Question 1
Calculate the opportunity cost of each good in both countries. Which country has the lower opportunity cost?

This question shows how comparative advantage determines specialization. Calculate the opportunity cost of each good, compare the two countries, and assign each country to the good for which its opportunity cost is lower.

What to notice: Specialization is determined by comparative advantage, not absolute advantage. Compare opportunity costs rather than productivity levels alone.
Q 2
Ricardian trade model practice question 2 on autarky prices and terms of trade
Video: Learn How to Solve Question 2
Identify each country's autarky relative price. What world relative price would permit both countries to gain?

Calculate the two autarky relative prices first. The international terms of trade must lie between them for both countries to gain from trade.

What to notice: A country gains only when the terms of trade are more favourable than its own autarky price.
Q 3
Ricardian trade model practice question 3 on wage determination
Video: Learn How to Solve Question 3
Use the value of the marginal product of labour. How do price and productivity combine to determine the competitive wage?

Under perfect competition, the wage equals the value of labour's marginal product. Use the price of the good being produced together with labour productivity.

What to notice: Under perfect competition, the wage equals the value of labour's marginal product.
Q 4
Ricardian trade model practice question 4 comparing wage ratios across countries
Video: Learn How to Solve Question 4
Compare wages using productivity and goods prices. Do not infer wage ratios from absolute advantage alone.

Calculate the wage in each country using the price and productivity of the good that country produces, and then form the international wage ratio.

What to notice: International wage comparisons depend on productivity and on the relative prices of the goods countries produce.

4. How to answer a detailed Ricardian-model question

A full exam problem brings together labour requirements, opportunity costs, comparative advantage, specialization, world relative supply and demand, equilibrium relative prices, wages, production, consumption, exports and imports.

The final video works through a more demanding world-equilibrium problem. It is best approached after the basic model and the shorter applications are clear.

Suggested sequence

  • Calculate labour productivity and opportunity costs.
  • Identify comparative advantage and specialization.
  • Construct world relative supply and relative demand.
  • Find the equilibrium world relative price.
  • Calculate wages, production, consumption, exports and imports.

Solving for world equilibrium using relative supply and relative demand.

Prerequisites

Opportunity cost, comparative advantage, the PPF and perfect competition.

Assumption

Labour moves across industries within a country, but not across countries.

Important

The world relative price lies between the countries' autarky prices.

Takeaway

Specialization and trade expand each country's consumption possibilities.

“Differences in relative productivity are sufficient to create gains from trade, even when one country has an absolute advantage in producing both goods.”
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