Economic Analysis of International Trade: Comparative Advantage - Ricardo's Classical View RESOURCE GUIDE The Net-Text in PaperBack Learning Objectives

Ricardos' classical theory was first introduced as a conceptual improvement over Mercantilism at the end of the Age of Discovery and the beginning of the Industrial Revolution. Ricardos' concept defined the measure of relative price or relative value ("Opportunity Cost" price) and this theoretical advance allowed the application of Smith's theory of supply and demand to explain international trade flows. The resulting policy implications for free trade along with the role of free markets, proved to provide a profound and lasting effect on the course of economic history on the Continent and most importantly on the New World in the Americas.

Production Possibilities Frontier

The linear production possibilities frontier is shown to be a restraint/constraint and, it explains scarcity and quantitatively defines opportunity cost. The model assumes there are two goods, a fixed resource endowment and a known level of technological expertise in production. Operating on the PPF means resources are used efficiently; points below the PPF are attainable but inefficient; whilst, points beyond the restraint are unattainable.

Visualizing the problem of scarcity is accomplished when one recognizes that increasing the production of one good can only occur by reducing the output of the other. That is, resources are assumed to be fully employed, consequently increasing the production of one good is feasible only when resources are diverted from the other good.

The Meaning of Relative Value or, "Opportunity Cost(OC)" price

The slope of the PPF provides a convenient way to visualize the price of the product on the horizontal axis of the graph. Devising this visualization of the concept allows us to define OC price as the steepness of the PPF. It is a crucial analytical measure needed to amplify the graphical specification of comparative advantage.

Graphically Depicting Comparative Advantage

Comparative Advantage is graphically demonstrated as the lowest OC price , meaning a country is more competitive in the production of that product. In this section, we compare the OC prices, or relative values, of the two countries to find which one is producing more efficiently. The slope of the PPF has been shown to visually depict the OC price of the good appearing on the horizontal axis of the PPF.

Gains from the Introduction of Free Trade

The gains from trade allow a country to acquire levels of the products exceeding what can be accomplished in autarky. Trade advantages are intuitively depicted given the trading vector is beyond the PPF constraint. Profit margins arise from the difference of the OC price between the countries and, this margin attracts traders and gives rise to the gains from trade.

Was Ricardo Right?