Chapter 2: Basics of Comparative Advantage

When the relative price of a good in one country is lower than in other countries, the first country is said to have a comparative advantage in this good over other countries. Differences in the relative prices are, among others, the most important driving force of international trade. A country will export its products to foreign markets where prices are higher than in its own markets and, conversely, import goods and services from foreign markets where prices are lower than in its own markets. In this way, there emerges a trade pattern — a description of which country imports or exports what kind of goods and services. Therefore, the first step to examine the structure of international trade is to show how the differences in relative prices across countries are determined. In this chapter, we first introduce a simple trade model called the Ricardian model, which highlights the roles of the differences in production technology as one of the determinants of comparative advantage. Then, we extend and generalize it into several different directions.