The
theory of comparative advantage is an economic theory about the
work gains from trade for individuals, firms, or nations that arise
from differences in their factor endowments or technological progress. In an economic
model, agents have a comparative advantage over others in producing
a particular good if they can produce that good at a lower
relative opportunity cost or autarky price, i.e. at a lower relative marginal
cost prior to trade. One does not compare the monetary
costs of production or even the resource costs (labor needed per unit of
output) of production. Instead, one must compare the opportunity costs of
producing goods across countries. The closely related law or principle
of comparative advantage holds that under free
trade, an agent will produce more of and
consume less of a good for which they have a comparative advantage.
David Ricardo developed
the classical theory of comparative advantage in 1817 to explain why countries
engage in international trade even
when one country's workers are more efficient at producing every single
good than workers in other countries. He demonstrated that if two countries
capable of producing two commodities engage in the free market, then
each country will increase its overall consumption by exporting the good for
which it has a comparative advantage while importing the other good, provided
that there exist differences in labor productivity between
both countries. Widely regarded as one of the most powerful yet
counter-intuitive insights in economics, Ricardo's theory implies that
comparative advantage rather than absolute advantage is
responsible for much of international trade.
In 1817, David Ricardo published
what has since become known as the theory of comparative advantage in his
book On the Principles of
Political Economy and Taxation.
Ricardo's example
In a famous example,
Ricardo considers a world economy consisting
of two countries, Portugal and England,
which produce two goods of identical quality. In Portugal, the a priori more
efficient country, it is possible to produce wine and cloth with less labor than it would
take to produce the same quantities in England. However, the relative costs of
producing those two goods differ between the countries.
|
Hours of work necessary to produce
one unit
|
||
|
Country
|
Cloth
|
Wine
|
|
England
|
100
|
120
|
|
Portugal
|
90
|
80
|
In
this illustration, England could commit 100 hours of labor to produce one unit
of cloth, or produce units of wine. Meanwhile, in comparison, Portugal
could commit 90 hours of labor to produce one unit of cloth, or
produce units of wine. So, Portugal possesses an absolute
advantage in producing cloth due to fewer labor hours, and England has
a comparative advantage due to lower opportunity cost.
In the absence of trade,
England requires 220 hours of work to both produce and consume one unit each of
cloth and wine while Portugal requires 170 hours of work to produce and consume
the same quantities. England is more efficient at producing cloth than wine,
and Portugal is more efficient at producing wine than cloth. So, if each country
specializes in the good for which it has a comparative advantage, then the
global production of both goods increases, for England can spend 220 labor
hours to produce 2.2 units of cloth while Portugal can spend 170 hours to
produce 2.125 units of wine.
Moreover, if both countries
specialize in the above manner and England trades a unit of its cloth for to units
of Portugal's wine, then both countries can consume at least a unit each of
cloth and wine, with 0 to 0.2 units of cloth and 0 to 0.125 units of wine
remaining in each respective country to be consumed or exported. Consequently,
both England and Portugal can consume more wine and cloth under free trade than
in autarky.
