Exam 3: The Classical World of David Ricardo and Comparative Advantage

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To set up a Ricardo-type comparative advantage numerical example, let's consider two countries, Country A and Country B, and two goods, wheat and cloth.

Let's assume that in Country A, 1 unit of labor can produce either 4 bushels of wheat or 2 yards of cloth, while in Country B, 1 unit of labor can produce either 3 bushels of wheat or 1 yard of cloth.

In this example, Country A has an absolute advantage in producing both goods, as it can produce more of each good with the same amount of labor. However, when we consider comparative advantage, we see that Country A has a comparative advantage in producing cloth, as it has a lower opportunity cost of producing cloth compared to wheat. Conversely, Country B has a comparative advantage in producing wheat.

Now, let's consider an international terms-of-trade ratio where Country A can trade 1 yard of cloth for 3 bushels of wheat with Country B.

By engaging in trade, Country A can specialize in producing cloth and trade it for wheat with Country B. This allows Country A to consume more wheat than it could produce on its own, leading to a higher standard of living. Similarly, Country B can specialize in producing wheat and trade it for cloth with Country A, leading to a higher standard of living for Country B as well.

However, there are scenarios where either of the countries may not benefit from engaging in trade. For example, if the terms of trade are unfavorable and do not allow for mutually beneficial exchange, or if one country is able to produce both goods at a lower opportunity cost than the other, then trade may not be beneficial for both countries. Additionally, if there are significant transportation costs or trade barriers, the benefits of trade may be diminished.