Lecture on the Labor Productivity Model (Ricardian Model)

Introduction

• The lecture covers the Labor Productivity Model, also known as the Ricardian Model.
• Developed by David Ricardo, this model explains trade between two countries or individuals based on comparative advantage.
• Key concepts include comparative advantage and absolute advantage.

Example Setup

• Two individuals (or countries): Farmer and Rancher.
• Both can produce two goods: meat and potatoes.

Production Times

• Farmer:
  • 60 minutes for an ounce of meat.
  • 15 minutes for an ounce of potatoes.
• Rancher:
  • 20 minutes for an ounce of meat.
  • 10 minutes for an ounce of potatoes.
• Rancher has an absolute advantage in producing both goods.

Production in Eight Hours

• Farmer:
  • 8 ounces of meat.
  • 32 ounces of potatoes.
• Rancher:
  • 24 ounces of meat.
  • 48 ounces of potatoes.
• Absolute advantage illustrated by higher outputs for Rancher.

Autarky: No Trade Situation

• Each person's Production Possibilities Frontier (PPF) represents their capability in producing meat and potatoes.
• Farmer's PPF: (8, 0) to (0, 32)
• Rancher's PPF: (24, 0) to (0, 48)
• Consumption limited to what each can produce.

Trade Scenario

New Production Points

• Farmer: Specializes in potatoes, moves to 32 ounces of potatoes.
• Rancher: Moves towards meat production, produces 18 ounces of meat and 12 ounces of potatoes.

Trade Agreement

• Farmer trades 15 ounces of potatoes for 5 ounces of meat.

Post-Trade Consumption

• Farmer:
  • 5 ounces of meat (gained 1)
  • 17 ounces of potatoes (gained 1)
• Rancher:
  • 13 ounces of meat (gained 1)
  • 27 ounces of potatoes (gained 3)
• Both achieve a consumption point outside their PPF, illustrating gains from trade.

Comparative vs Absolute Advantage

• Absolute advantage: Ability to produce more with the same input.
• Comparative advantage: Lower opportunity cost of production between goods.

Opportunity Costs

• Farmer:

  • 1 ounce of meat = 4 ounces of potatoes
  • 1 ounce of potatoes = 0.25 ounces of meat

• Rancher:

  • 1 ounce of meat = 2 ounces of potatoes
  • 1 ounce of potatoes = 0.5 ounces of meat

• Farmer has a comparative advantage in potatoes, Rancher in meat.

Gains from Trade

• Allows specialization based on comparative advantage.
• Trade leads to a larger economic "pie".

Conclusion

• Trade based on comparative advantage results in mutual gains.
• Each party ends up better than in autarky.

Next Steps

• Exploration of the general Ricardian model.
• Symbolic representation and numerical example to be covered in the next video.