Ricardian Theory of International Trade: Gains from Specialization by

David Ricardo
According to David Ricardo (1817), countries engage in international trade because they stand to
gain if they specialize in the production of products with low opportunity cost. To Ricardo
countries should understand their factor endowments then direct production to the best
alternative in utilizing the available resources. A country undertaking such specialization would
then engage in international trade with others countries to get those products which are of
second best alternative in utilization of resources.

Ricardo emphasizes his point using the opportunity cost theory. Noting that resources are
scarce, a country has to give up production of one product in order to produce the other. To know
which one to give up, a country has to determine where it would have higher output if the same
resource available was utilized in the production of either product. A country would specialize in
production of that product whose utilization of the available resource produces the most output.
In opportunity cost terms, a country should specialize in production of that product whose cost for
failure to produce it is higher than that of the second alternative. To Ricardo countries are
endowed differently and so they have different opportunity costs. The difference in opportunity
cost is what would enable countries to enage in international trade with each other so as to get
the disdvantaged products.
Ricardo sums up the above with the use of what he called the absolute and comparative
advantages. To him even if a country would produce more of the two products than the other
country (the absolute advantage), it should specialize in producing that product in which it has an
advantage in utilization of the available resources (comparative advantage). Let us now examine
this theory using the following example.
The theory assumes;
1.
There are two countries to enage in international trade-We will use Rainlands and
United Parkland
2.

There are two products produced- i.e. Coffee and Computers

3.

One factor of production exists- i.e. Labour

4.

Factor productivity is constant

5.

Perfect competition exists in the market

6.
Homogeneous of factors-They have fixed and same abilities and productivity
levels
7.
Factors are perfectly mobile within country and between sectors Can be shifted
from production of one product to another and from one region to another
8.
Factors are immobile between countries Endowments in one country cannot
move to another country.
9.

Fixed level of technology

10.

Full employment

11.
Comparison is between no international trade and perfectly free why countries
engage in international trade trade (no tariff or non-tariff barriers)
12.

Transport costs are ignored

The table below indicates the quantities of coffee and computers that would be produced by
Rainlands and Parklands when a unit of labor is allocated in the production process. This table
also indicates the situation pertaining in each country before the countries enage in international
trade.
Coffee

Computers

50,000

50

Rainlands 100,000

400

Parklands

From the table Rainlands has an absolute advantage in the production of both coffee and
computers per unit of labour employed.Let us analyze opportunity costs so as to determine their
respective comparative advantages. We achieve this by looking at the cost (foregone benefit) of
not producing one product so as to produce the other. In the absence of international trade the
opportunity cost is calculated as the ratio of the produced product to the foregone alternative.
In a situation of autarky (i.e.no trade), the (relative) price of a good equals the opportunity cost of
producing that good in a country. Under free trade however, world (relative) prices are
determined by world supply and demand across countries (i.e. they fall between the opportunity
costs of the two countries)
If Parklands specializes in coffee, it will have to forego 50/50,000 = 0.001 units of computers for
each unit of coffee produced. If however Parklands decides to specialize in computers, it would
forego 50,000/50 = 1,000 units of coffee for every unit of computers produced. Likewise, if
Rainlands specializes in coffee, it will have to forego 400/100,000 = 0.004 units of computers for
each unit of coffee produced. If however Rainlands decides to specialize in computers, it would
forego 100,000/400 = 250 units of coffee for every unit of computers produced. The table below
summarizes the opportunity costs for both Rainlands and Parklands if they specialized in
production of one of the products
Summary the opportunity costs for specializing
Opportunity cost of Coffee Opportunity cost of Computers
Parklands

1,000

0.001

Rainlands

250

0.004

From the table we can conclude that Parkland has a comparative advantage in the production of
coffee and Rainlands has a comparative advantage in production of computers. For this reason,
Rainlands should specialize in production of computers and Parklands in coffee and the two
countries should engage in international trade and exchage the commodities in which they have
a comparative advantage with those in which they are disadvantaged.

If the opportunity cost (relative price) of coffee is higher in Rainlands than in Parklands, it is
profitable for the two countries if Parklands exports coffee to Rainlands and imports computers
from there.

Now let us examine the effect of transferring one unit of labor to specialize in production of a
product where each country has a comparative advantage. As one unit of labour is specialized in
production of coffee, Parklands foregoes (loses) 50 units of units of computers to gain 50,000
units of coffee. Likewise, as one unit of labor is transferred from the production of coffee to the
production of computers, Rainlands loses 100,000 units for a gain of 400 units. As the countries
specialize in their respective comparative advantages, the changes in their outputs will look as
follows;

Changes in outputs due to specialisation

Parklands

Coffee

Computers

+50,000

-50

Rainlands -100,000

+400

But each country will still need the products it has not produced. Rainlands will demand for the
100,000 units of coffee from Parklands. Parkland to be able to produce that amount will have to
allocate 2 units of labor. The effect of this labor transfer is that Parklands will forego production of
100 units of computers so as to meet the demand for coffee by Rainlands. Rainlands still using
its one unit of labor will have to exchange its 50 units of computers with the 100,000 units of
coffee from Parklands. The table shows the international trade related changes in output as
countries utilize their respective labor resource in the best alternative;
Changes in production with specialisation so as to engage in international trade

Coffee

Computers

Parklands

+100,000

-100

Rainlands

-100,000

+350

Total change in output

250

Due to specialization and trading based on comparative advantage, additional 250 units of
computers are produced and consumed without reducing the quantities of coffee produced and
traded in the international market.

In general, countries gain from free trade because the output and consumption possibilities of
both countries expand as opposed to no trade. Let us try to analyze the mechanism allowing
countries to gain from trade. If the world price of coffee is equal to $1and the price of a computer
equals $500, Parklands can buy 200 units of computers from the Rainlands by exporting 100,000
coffee units. As both countries engage in international trade, they end up consuming more
computers and the same amount of coffee than in the situation without trade.
Therefore enabling countries to specialize their resources in the economic activities in which they
have a comparative advantage and then engage in international trade to get products in which
they have a comparative disadvantage does not only expand the size of global production, it
allows for expanded global consumption possibilities.