Gains From Trade: Even the Toy Models Can Teach Us

Within a Ricardian framework there are several simplifications that we must take in mind as we discuss it. First is that labor is the only input, it is immobile within national borders, but it can move within industries and there is full employment. In terms of the markets, there are perfect competition and no trade frictions with the two economies only producing two outputs. Finally, the trading nations have the same technology and there are constant returns to scale.

If we take these assumptions as a given, we can look at the simple models and say that there are gains from trade as long as one of the countries has a lower opportunity cost in one of the goods than the other country (if they are the same there is no reason for trade). The toy models we work with show that a move down the production possibility frontier to specialize in the good that the nation has comparative advantage in makes everyone better off.

Even if you think within the constraints of the model, as unrealistic as they may be and think about how this operates in the real economy the logic still makes sense. There is an idea that there are only so many jobs and that for some reason the economy as it was in the US in say 1957 is the way that it should remain forever more. What it ignores is that US manufacturers have gotten better at some other things. If you think of the Trade between the US and China as comprising trade between airplanes and radios, “Making America Great Again” has the idea that we need to make more radios. What this ignores is that the tradeoff is much greater in the US because here we are much better at making airplanes, so the opportunity cost of making a radio is a much higher fraction of an airplane in the US than it is in China. This means that here we get to consume more radios than we would otherwise because we can specialize in the airplane market and trade those extra airplanes for radios.