Allocate labor between two goods in two countries. Find the terms of trade that leave both countries better off than working alone — the argument David Ricardo published in 1817 and the reason nations trade even when one is better at everything.
100 workers
| Good 1 | Good 2 | |
|---|---|---|
| Output per worker | 10 | 5 |
| Total output | 500 | 250 |
| Opportunity cost of 1 Good 1 | 0.5 Good 2 | |
100 workers
| Good 1 | Good 2 | |
|---|---|---|
| Output per worker | 4 | 6 |
| Total output | 200 | 300 |
| Opportunity cost of 1 Good 1 | 1.5 Good 2 | |
A trade only helps both countries if the price sits between their two opportunity costs. Slide until you find that window.
| Country A | Country B | World | |
|---|---|---|---|
| Without trade · each country splits labor 50/50 | |||
| Good 1 | 500 | 200 | 700 |
| Good 2 | 250 | 300 | 550 |
| With trade at these terms | |||
| Good 1 | — | — | — |
| Good 2 | — | — | — |
| Gains from trade (bundles better than autarky?) | |||
| Verdict | — | — | — |
Even if one country is better at making everything, both countries can gain by specializing in the good they give up the least to produce. That "give up the least" quantity is opportunity cost. A country has a comparative advantage in the good with the lower opportunity cost — regardless of whether it also has an absolute advantage. Trade at any price between the two opportunity costs makes both sides better off.
Based on David Ricardo, On the Principles of Political Economy and Taxation, Chapter 7 (1817). Historical scenarios use round numbers, not literal 1817 productivity figures.
Let's play through Ricardo's argument together.