# Determining the Relative Price of Trade

I'm pretty sound with the concept behind comparative advantage, but still don't get how to calculate the exchange rate in terms of quantities of each products being exchanged, e.g. 1 apple for 2 cars etc.

Specifically: when two counties, each having two separate comparative advantages in producing two separate goods, wish to exchange these goods, how will the exchange quantity/rate be calculated?

• Can you please put more detail into the question? Is your question about international trade and comparative advantage i.e. Ricardian model? – london Dec 30 '15 at 18:58
• @london yes it is, so when two counties each have two separate comparative advantages in producing two separate goods and wish to exchange these goods, how will the exchange quantity/rate be calculated. – user98937 Dec 31 '15 at 6:10
• Comparative advantages determine supply but you also need demand functions to determine the equilibrium rate of exchange. – Giskard Dec 31 '15 at 8:31

If I understand correctly the question, the trick to calculate the equilibrium (relative) price of trade in the Ricardian model of comparative advantage is to specify demand once the opportunity costs have been determined. Prices of internationally traded goods, like other prices, are determined by supply and demand.

Consider two countries, two goods (computers and textiles), and given unit labor requirements such that in equilibrium the world price of computers will be between 0.5 and 2 textiles per computers. The opportunity costs define the bounds of equilibrium relative prices of trade (0.5 and 2), while the structure of demand determines the equilibrium relative price (p).

For instance, p=1 can be an equilibrium price such as one country will specialize in computers and the other in textiles. This price will be determined by the interaction of the relative supply and the relative demand of computers and textiles. This interaction is discussed in the Chapter 3 of International Economics: Theory and Policy of Krugman, Obstfeld and Melitz. An interesting video with a concrete example can be found here.

Ricardo did not explain how equilibrium prices are determined.

In autocracy

Labor is the only factor of production, the usage of this factor determine the cost of production.

Because their is only two goods the relative usage of the factor determine their exchange rate. And because we have constant return to scale and their is only one factor of production the PPF is a strait line -> exchange rate are constant and independent of the quantity demanded.

Also, because you have only two good, the idea of price doesn't make that much sens. You can only exchange good A for good B and vice-versa.

In other word, in Ricardian model, the price is the opportunity cost.

To know the quantity consumed, you need to know the utility function. But it will not change the price in autocracy.