Labor Productivity Model (Ricardian Model)

Introduction

• Also known as the Ricardian Model, developed by David Ricardo.
• Focuses on trade, specifically why two countries would trade.
• Key concepts: Comparative Advantage and Absolute Advantage.

Example Setup

• Two entities: a Farmer and a Rancher (can be thought of as two countries).
• Both can produce two goods: Meat and Potatoes.
• Trade scenario: initially no trade, then allow trade.

Production Details

Farmer

• Meat: 60 minutes/ounce.
• Potatoes: 15 minutes/ounce.
• In 8 hours (480 minutes):
  • Meat: 8 ounces.
  • Potatoes: 32 ounces.

Rancher

• Meat: 20 minutes/ounce.
• Potatoes: 10 minutes/ounce.
• In 8 hours:
  • Meat: 24 ounces.
  • Potatoes: 48 ounces.

Absolute Advantage

• Rancher is faster at producing both goods.
• Absolute Advantage: Rancher has it for both meat and potatoes.

No Trade Scenario (Autarchy)

• Production Possibilities Frontier (PPF): Shows all combinations of goods that can be produced.
• In autarchy, PPF = Consumption Possibilities Frontier (CPF).

Farmer's PPF

• Vertical axis = Meat; Horizontal axis = Potatoes.
• 8 ounces of meat or 32 ounces of potatoes.
• Example point: 4 ounces of meat, 16 ounces of potatoes (Point A).

Rancher's PPF

• 24 ounces of meat or 48 ounces of potatoes.
• Example point: 12 ounces of meat, 24 ounces of potatoes (Point A).

Trade Scenario

• Rancher proposes a trade: each specializes in one good.
• Farmer: Specializes in Potatoes (32 oz), produces no meat.
• Rancher: Specializes more in Meat (18 oz), some potatoes (12 oz).
• Trade: 15 oz of potatoes for 5 oz of meat.

Outcomes

• Farmer: 5 oz of meat, 17 oz of potatoes (better than in autarchy).
• Rancher: 13 oz of meat, 27 oz of potatoes (better as well).
• Both achieve consumption points outside their original PPF.

Gains from Trade

• Farmer: Gains 1 oz of meat, 1 oz of potatoes.
• Rancher: Gains 1 oz of meat, 3 oz of potatoes.
• Total world production increases.

Comparative Advantage

• Opportunity Cost: The cost of producing one good in terms of the other.

Farmer

• Potatoes: 1/4 oz of meat.
• Meat: 4 oz of potatoes.

Rancher

• Potatoes: 1/2 oz of meat.

• Meat: 2 oz of potatoes.

• Farmer: Has comparative advantage in potatoes.

• Rancher: Has comparative advantage in meat.

Implications

• Trade allows specialization in goods with comparative advantage.
• Neither can have a comparative advantage in both goods.
• Price of goods in trade falls between the opportunity costs.

Conclusion

• Ricardian model shows trade benefits through specialization and comparative advantage.
• Leads to greater overall production and better consumption possibilities.

Next Steps

• Explore the model more generally and symbolically in the next session.