Absolute and comparative advantage michigan state university. Comparative advantage is when a nation can produce a particular good at a lower opportunity cost than other nations. Instead, one must compare the opportunity costs of producing goods across countries. Comparative advantage is when a country produces a good or service for a lower opportunity cost than other countries. If the uk produces a book, the opportunity cost is 14 0. Comparative advantage is a term associated with 19th century english economist david ricardo. Read this article to learn about the theory of comparative costs. The chapter examines the historical process of how the comparative advantage theory developed from james and john stuart mill to the modern theory, by way of viners real cost approach, haberler. Theory, empirical measures and case studies 61 that the autarky equilibriums are determined by ppf and cic. Ruffin1 abstract this paper argues that ricardos discovery of the law of comparative advantage probably occurred in october 1816. The ricardo effect served as a red herring to cause scholars to possibly misread ricardos letters in a crucial period. Difference between absolute and comparative advantagewith. The concept of comparative advantage belongs to the field of normative economics, and states that a country will benefit if it specializes in the pro. Country a has a comparative advantage at producing corn and country b has a comparative advantage at producing oil.
Comparative advantage theory hindi davis ricardo theory. It is one of the simplest models, and still, by introducing the principle of comparative advantage, it offers some of the most compelling reasons supporting international trade. It differs from absolute and competitive advantage. This is a foundational concept in economics that is used to model international trade and the competitiveness of nations. In a nutshell, this is the law of comparative advantage. According to this theory, the international trade between two countries is possible only if each of them has absolute or comparative cost advantage in the production of at least one commodity.
The theory of comparative advantage states that a country should specialise in the production of good or service in which it has lower opportunity cost and it should import commodities which have a higher opportunity cost of production. Absolute cost advantage theory of international trade to remove drawbacks and to increase trade between countries. However, it must be noted that comparative advantage is a form of competitive advantage as having a comparative advantage. Ricardian theory of comparative advantage has the merit of demonstrating that international trade is possible even when a country is able to produce all goods at cheaper cost, provided the cost advantage is comparatively more. Comparative advantage is an economic law referring to the ability of any given economic actor to produce goods and services at a lower opportunity cost than other economic actors. The theory of comparative advantage was developed by david ricardo, who built on adam smiths work to argue that, in fact, a country doesnt have to have an absolute advantage for beneficial trade to occur. The theory of comparative advantages comparative advantage. Comparative advantage international trade theory economics. There are two types of cost advantage absolute, and comparative. Its productivity is higher in producing the good than the productivity of other countries in producing it.
To do so, ricardo introduces to the economics literature a theory of comparative cost advantage which includes countries that do not have. The goal of this paper is to assess the empirical performance of ricardos ideas. One of the most important concepts in economic theory, comparative. The essence of the theory of comparative cost advantage is that if unrestricted free trade exists, then the potential world production would be greater, as compared. The volume of trade is shown by the shaded triangles. For clarity of exposition, the theory of comparative advantage is usually first outlined as though only two countries and only two commodities were involved, although the principles are by no means limited to such cases. Comparative advantage, economic theory, first developed by 19thcentury british economist david ricardo, that attributed the cause and benefits of international trade to the differences in the relative opportunity costs costs in terms of other goods given up of. This is essentially a static analysis and hence unrealistic. The principle of comparative cost states that a international trade takes place between two countries when the ratios of comparative cost of producing goods differ, and b each country would specialise in producing that commodity in which it has a comparative advantage. Ricardo, improving upon adam smiths exposition, developed the theory of international trade based on what is known as the principle of comparative advantage cost. The history of david ricardo and his ideals for the future including the ricardian model. The law of comparative advantage describes how, under free trade, an agent will produce more. An economics perspective and a synthesis by satya dev gupta there is a considerable amount of controversy about the models of comparative advantage and its applicability to international business, in particular as a guide to the success of nations andor firms in international markets. Definition of comparative advantage economics help.
The theory of absolute cost advantage rejected the theory of mercantilism, whereas the theory of comparative advantage is a development over the theory of absolute cost advantage. Merits of ricardian theory of comparative advantage. Ricardo considered what goods and services countries should produce. The theory of comparative advantage states that if countries specialise in producing goods where they have a lower opportunity cost then there will be an increase in economic welfare. According to theory of comparative advantage b should expand its production of c as the cheese production in b is relatively less costly. Comparative advantageit can be argued that world output would increase when the principle of comparative advantage is applied by countries to determine what goods and services they should specialise in producing. David ricardos theory of comparative cost advantage. This paper is based on an invited lecture, the author held at the university of applied sciences stralsund in may 2015. Difference between comparative and competitive advantage. A nation with a comparative advantage makes the tradeoff worth it. On the one hand, the theory of comparative advantage is much more broadly valid than you would guess from the simple numerical examples that may have. Comparative cost ricardo theory of comparative cost. It can produce it using less labor than other countries.
Note, this is different to absolute advantage which looks at the monetary cost of producing a good. In this article we will discuss about the david ricardos theory of comparative cost advantage. Pdf deconstructing the theory of comparative advantage. David ricardo believed that the international trade is governed by the comparative cost advantage rather than the absolute cost advantage. The classical theory of international trade is popularly known as the theory of comparative costs or advantage. The authorship of the principle of comparative advantage is generally credited to david ricardo. Recent papers published in scientific journals have cast doubt on this axiom and have debated roles of robert torrens, james mill and john stuart mill in its history. As a matter of fact labour is used in varying proportions in the production of commodities. Absolute advantage means being more productive or costefficient than another country. This chapter presents the first formal model of international trade. Comparative advantage, economic structure and growth. Adam smith, the scottish economist observed some drawbacks of existing mercantilism theory of international trade and he proposed a new theory i. He express the cost of these was the main production in labor time. This theory is developed by a classical economist david ricardo.
The classical theory of the international trade, also known as the theory of comparative costs, was first formulated by ricardo, and later improved by john stuart mill, cairnes, and bastable. Before this is done, a short introduction to the theory is given, which is closely linked to the name david ricardo,2 who formulates it in chapter 7 of his main work on the principles of political economy and. Comparative advantage is what a country produces for the lowest opportunity cost. Study questions with answers university of michigan. The theory of comparative advantage tca is introduced based on a textbook. To do so, ricardo uses torrens idea of comparative advantage and introduces to the economics literature a theory of comparative cost advantage, which includes countries that do not have absolute advantages in international trade. The benefits of buying its good or service outweigh the disadvantages. Comparative advantage theory says that market forces lead all factors of. Adam smith had believed that absolute advantage was a necessity for beneficial trade. Competitive advantage represents any benefits and advantages that a company may have over its competitors.
In the case of comparative advantage, the opportunity cost that is to say. While absolute advantage refers to the superior production capabilities of one entity versus another in a single area, comparative advantage introduces the concept of. The idea behind each of the two concepts is different. Fall term 2019 comparative advantage study questions with answers page 3 of 7 9 4. Free trade is based on the theory of comparative advantage. The idea of comparative costs advantage is drawn in view of deficiencies observed by ricardo in adam. Brief explanation for the theory of comparative cost advantage. The classical approach, in terms of comparative cost advantage, as presented by ricardo, basically seeks to explain how and why countries gain by trading. Truth, however, in samuelsons reply refers to the fact that ricardos theory of comparative advantage is mathematically correct, not that it is empirically valid. This could include things like having a low cost structure, low cost of labor, better access to raw materials, etc.
The other is that economists believe it to be valid under all circumstances. Smiths argument about absolute advantage was refined and developed by david ricardo in 1817. A similar concept, competitive advantage is typically used to model the competitiveness of firms and. The theory of comparative cost as applied to international trade is therefore, that each country tends to produce, not necessarily what it can produce more cheaply than an other country, but those articles which it can produce at the greatest relative advantage, i. Some economists argue that a countrys comparative advantage is dynamic, instead of static. Theory of absolute advantage and comparative advantage.
The theory of comparative advantage a country has a comparative advantage when it can produce a good at a lower opportunity cost than another country. So far, the dynamic theory of comparative advantage has put greater attention on the changes in supply production side. The theory of comparative costs is based on the assumption that labour is used in the same fixed proportions in the production of all commodities. Even if one country is more efficient in the production of. Portugal not only has an absolute advantage that is an advantage in terms of the absolute cost but also has a comparative relative advantage in the production of wine. A country will specialise in that line of production in which it has a greater relative or comparative advantage. Chapter 2 the ricardian theory of comparative advantage. Comparative advantage from now on ca implies an opportunity cost associated with. Furthermore, senegal may have unexploited potential i. Again for clarity, the cost of production is usually measured only in terms of labour time and effort. The classical and neoclassical formulations of comparative advantage theory differ in the tools they use but share the same basis and logic. David ricardos discovery of comparative advantage roy j.
In order to accelerate gdp growth rate, senegal should focus on developing the. This is the substance of the principle of comparative advantage cost. What are the merits and demerits of ricardian theory of. It is used as the justification for wto trade regulations. Since there are constant returns to scale, a competitive equilibrium with a large number of profitmaximizing firms would lead.
140 809 1467 310 385 592 881 911 353 881 1036 145 792 1507 1153 1097 76 561 421 184 1378 332 1425 479 1129 1039 1516 316 1248 1537 532 513 1103 1406 1340 705 265 1494 597 387 287 1264 378 776 638 1105 1140 993 644 315