The Importance of the Ricardian Model in International Trade
Explaining one of the oldest models of comparative advantage
In recent articles, I discussed both the benefits of trade and the concept of comparative advantage. As we know, a country has a comparative advantage in producing a good if the opportunity cost of producing that good is lower in that specific country than it is in other countries. We also know that trade between two countries can benefit both countries if each country exports the goods that they have a comparative advantage in.
Although it is easy to understand how the concept of comparative advantage might work, it is more difficult to understand just why comparative advantage shapes international trade. That’s where the Ricardian model comes in, introducing the idea of comparative advantage and illustrating why trade between two countries can be successful.
In the early nineteenth century, most economists believed in the idea of mercantilism — the concept that exporting goods would bring gold and silver into a country, while importing goods would drain a country of its gold and silver resources. Mercantilists favored high tariffs to achieve low imports and high exports.
The British economist David Ricardo first introduced the concept of comparative advantage in the early nineteenth century, directly refuting claims that mercantilists made. According to Ricardo’s model, countries can benefit from balanced international trade without implementing tariffs.
The Ricardian model was one of the original general equilibrium models, showing how the concept of comparative advantage shapes the way countries trade. Although there are technical formulas that prove the Ricardian model, there are a few important facts that can be understood without the use of formulas.
The Ricardian model helps us understand a few basic facts about trade:
- Trade is defined by comparative advantage.
- Trade between countries diminishes with distance.
- Large countries trade less relative to GDP, but trade relatively more in absolute terms. Thus, country size is quite important.
- Prices vary across locations, with greater price differences between countries that are further apart.
- Productivities within the same industry appear to differ across countries — suggesting that trade and specialization is based partly on technology differences.
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© Aaron Schnoor 2021
