Ricardian Model Illustration with Example, Theory of Comparative Advantage in International Trade, Autarky Price, Opportunity Cost, Production Possible Frontier(PPF)(Global Economics)

The Ricardian model was propounded after the theory of absolute advantage, a Ricardian model of international trade is considered to be the milestone in understanding the advantage of international trade practices, opening up of the borders and emphasizing in global integration of trade on the basis of comparative advantages. To further clarify the concepts a hypothetical scenario is created to analyze the impact of international trade on consumption and production.

The illustration of the Ricardian model has focused on the production of two products, i.e. cheese and cloth in Australia and France and is built on all the assumptions that model holds, i.e. labor theory of values, no government restriction, no transaction cost et cetera

Country	Cheese	Cloths
Australia	1hour/lbs	4hour/meter
France	3 hour/lbs	6hour/meter

Table: 1, Resource allocation for the production

The table above illustrates the labor hours required for the production of a unit of cheese and clothes in Australia and France. We can see that Australia has an absolute advantage in the production of both of the products, 2 units of labor hour are required less in the production of both of the goods in Australia, and as per the Adam Smith, Australia is efficient in the production of both the goods. Since Australia has an absolute advantage in production of both of the goods, the trade doesn’t take place and France has only an incentive to trade against Australia. But if we revised the data in the table as:-

Country	Cheese	Cloths
Australia	4hour/lbs	5hour/meter
France	2hour/lbs	6hour/meter

Table: 2,Resource allocation for production(to make trade happen under absolute advantage theory)

Then, France would have absolute advantage in the production of cheese, here as per Adam Smith; Australia trades the clothes and France exports Cheese. As Australia is efficient by 1labour hour in the production of 1 unit of cloth and France by 2 labor hour in the production of the cheese.

Leading higher on the scenario presented in table: 1, we move ahead to the international trade concept propounded by David Ricardo, where the modality shifts to relative advantage than in absolute advantage. Focusing on the opportunity cost, as depicted in table:3, we calculate the Autarky Price Ratio (APR), a price that is maintained by the country within its borders.

Country	Cheese	Cloths
Australia	1/4	4
France	3/6	2

Table: 3, APR calculation

From the table: 3, we can justify that Australia has APR less than of France, i.e. (1/4<3/6), so the opportunity cost of producing cheese is lower in Australia than in France, Similarly, the opportunity cost of producing clothes is less in France in-compare to Australia, i.e.(2<4), so as per the Ricardian  Model  Australia and France has a comparative advantage in the production of cheese and clothes respectively.  The model focuses on complete specialization with the product having relative advantage. In contrast to the absolute advantage model as in table:1, where there was no incentive to trade for Australia, the Ricardian model purports, the gain to be win-win situation for both the country’s leading to increase their production as well as consumption. Interesting here as per the Ricardian model, Australia will be better off with the specialization in cheese and France in cloths.

Now, let’s assume that the total number of labor hours for the production in Australia and France are 1500 labor hours and 2400 labor hours respectively as summarized in table:4.

Country	Cheese	Cloths	Labor hr
Australia	1	4	1500
France	3	6	2400

Table: 4, Total labor hour allocation

On the basis of production possible frontier (PPF), if Australia specializes in cheese and France in clothes than maximum units of cheese and clothes produced in Australia and France would be 1500 and 400 respectively from the available labor resources as shown in table: 5.

Country	Cheese	Cloths
Australia	1500	375
France	800	400

Table: 5, Maximum production on complete specialization

Now, assuming any point in PPF of Australia where it consumes 750 cheese and 187.5 units of clothes and similarly 400 cheese and 200 clothes as shown in table: 6.

Country	Cheese	Cloths
Australia	750	187.5
France	400	200

Table: 6, Consumption in Autarky Price (mid-point assumption)

If these countries are to trade, equally important, is the term of trade, or exchange rate at which the countries negotiate to trades. The amount/value for which these countries exchange cheese and cloths.

For the purpose, Australia and France agree to trade at an exchange rate of

1 clothes = 2.5 cheese (1 cheese =0.40 clothes)

Interestingly, under the above- mentioned term of trade, if Australia wants to continue to consume 750 cheeses, they now will have 750 cheeses to trade for the cloths. So, the revised amount of cloths consumed after the trade will be 300 units (i.e.750/2.5), similarly, if France wants to continue to consume 200 cloths, they will have 200 cloths to trade for cheese, here now the France can get the revised escalated cheese of 500 units (i.e.200/0.40). The findings could be summarized in the table: 7 as

Country	Cheese	Cloths
Australia	750	300
France	500	200

Table: 7, consumption after the trade

From the above table, after the occurrence of the trade between the countries we can see that Australia is able to consume 300 units of clothes which were 187.5 unit during non-trade (i.e., autarky price) and France is able to consume,500 units of cheese which was 400 unit during non-trade (autarky price).

So if the processes are graphically plotted than we will find that both the countries are consuming at the point out of the Production Possible Frontier (PPF) which was during the autarky price alone, i.e. the amount of goods produced and consumed has increased after the happening of the trade and both the countries have win-win situation.

Interestingly, the terms of trade; the negotiated amount that the countries voluntaries to trade is crucial parameter for the successful execution of the trade, it should always be between the autarky price to the two countries if the APR is beyond the limit the trade does not benefit. It is stated that higher the difference between the term of trade and APR, the country benefits more. So whenever the country has higher opportunity cost in the production of the product relative to another one, it is advisable to procure that from another country. But, if the terms of trade, which are generally set by the negotiation between the countries if are not favorable for anyone, or it is beyond the APR of countries, the trade could not happen.

To conclude, it could be inferred from the above illustrations that trade always benefit the involved countries as it helps to increase the production as well as consumption.