Theory of Comparative Advantage

From the theory of A. Smith it followed that the factors of production have absolute mobility within the country and move to those regions where they receive the greatest advantage. However, after some time, the advantage of some regions over others may disappear, therefore, trade will also stop. David Ricardo developed the theory of absolute advantages and showed that trade is beneficial to every country, even if none of them has an absolute advantage in the production of specific goods.

D. Ricardo formulated the theory of comparative advantage, introducing the concept of an alternative price.

An opportunity price is the ratio of the working time required to produce a unit of one good to the working time required to produce a unit of another good.

Here is a classic example of the exchange of English cloth for Portuguese wine.

Example. Suppose that the production of 25 m of cloth in England requires the labor of 100 workers in a year. For this amount of cloth, England will spend 50 liters of Portuguese wine, the own production of which would require the labor of 120 workers during the year. To produce the same quantities of cloth and wine, Portugal spends the labor of 90 and 80 people, respectively, during the year.

Table 1 .

Labor costs for the production of goods (number of people)

The absolute costs in England are higher than in Portugal, both for cloth and for wine. However, Portugal’s comparative cost of cloth is greater than England’s. They are determined by the ratio of the absolute cost of producing a unit of cloth to the absolute cost of producing a unit of wine. In Portugal they are 90/25 +80/50 = 9/4 = 2.25.

In England, the comparative cost of cloth is relatively less and amounts to 100/25 + 120/50 = 1.666.

Consequently, it is profitable for England to export cloth to Portugal, buying wine there.

Thus, a necessary condition for the existence of international trade is the production in different countries of the same goods with different costs. It is advisable for each country, according to Ricardo’s views, to specialize in the production of such goods for which it has a comparatively lower cost of labor and capital.

The theory of comparative advantage clarifies that if countries specialize in producing those goods that they can produce at relatively lower costs compared to other countries, then trade will be mutually beneficial for both countries, regardless of whether the production of one of them is absolutely more efficient than the other.

Ricardo’s theory in an unchanged form cannot explain the modern processes occurring in the international division of labor. It ignores fluctuations in prices and wages, balances of payments, proceeds from the fact that workers, leaving one industry, move to another, and do not turn into unemployed, does not take into account the migration of labor and capital.

The disadvantages of the theory of comparative advantage also include the following:

this theory is based on the existence of only two countries and two commodities; assumes the absence of transportation costs; proceeds from fixed production costs; does not take into account the effect of STD, technical changes; proceeds from the availability of complete interchangeability of resources with their alternative use.

Nevertheless, the importance of this theory can hardly be overestimated: it was she who first described the balance of aggregate supply and demand, proved that a country benefits from trade without harming other countries, but by looking for opportunities to develop trade within the country and abandoning the introduction of trade barriers. In addition, it was the theory of comparative advantage that gave the scientific basis for the development of further theories.