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. 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. The benefits of buying its good or service outweigh the disadvantages. The law of comparative advantage describes how, under free trade, an agent will produce more. Country a has a comparative advantage at producing corn and country b has a comparative advantage at producing oil. 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. 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.
While absolute advantage refers to the superior production capabilities of one entity versus another in a single area, comparative advantage introduces the concept of. Competitive advantage represents any benefits and advantages that a company may have over its competitors. 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. The goal of this paper is to assess the empirical performance of ricardos ideas. This theory is developed by a classical economist david ricardo. Merits of ricardian theory of comparative advantage. It can produce it using less labor than other countries. Theory of comparative advantage of international trade. Difference between comparative and competitive advantage. Ruffin1 abstract this paper argues that ricardos discovery of the law of comparative advantage probably occurred in october 1816. This paper is based on an invited lecture, the author held at the university of applied sciences stralsund in may 2015. 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. Furthermore, senegal may have unexploited potential i.
It differs from absolute and competitive advantage. Comparative advantage is a term associated with 19th century english economist david ricardo. Comparative advantage theory hindi davis ricardo theory. 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. Some economists argue that a countrys comparative advantage is dynamic, instead of static. To do so, ricardo introduces to the economics literature a theory of comparative cost advantage which includes countries that do not have.
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. This is essentially a static analysis and hence unrealistic. 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. Instead, one must compare the opportunity costs of producing goods across countries. Its productivity is higher in producing the good than the productivity of other countries in producing it. Comparative cost ricardo theory of comparative cost. In the case of comparative advantage, the opportunity cost that is to say. He express the cost of these was the main production in labor time. This chapter presents the first formal model of international trade.
However, it must be noted that comparative advantage is a form of competitive advantage as having a comparative advantage. Definition of comparative advantage economics help. 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. The authorship of the principle of comparative advantage is generally credited to david ricardo.
One of the most important concepts in economic theory, comparative. According to theory of comparative advantage b should expand its production of c as the cheese production in b is relatively less costly. Absolute cost advantage theory of international trade to remove drawbacks and to increase trade between countries. Free trade is based on the theory of comparative advantage. There are two types of cost advantage absolute, and comparative. Comparative advantage is when a country produces a good or service for a lower opportunity cost than other countries. The other is that economists believe it to be valid under all circumstances. 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. The idea behind each of the two concepts is different.
The idea of comparative costs advantage is drawn in view of deficiencies observed by ricardo in adam. Comparative advantage international trade theory economics. Difference between absolute and comparative advantagewith. Comparative advantage theory says that market forces lead all factors of. Comparative advantage from now on ca implies an opportunity cost associated with. This is a foundational concept in economics that is used to model international trade and the competitiveness of nations. David ricardo believed that the international trade is governed by the comparative cost advantage rather than the absolute cost 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. 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. Note, this is different to absolute advantage which looks at the monetary cost of producing a good. Theory, empirical measures and case studies 61 that the autarky equilibriums are determined by ppf and cic. Comparative advantage is what a country produces for the lowest opportunity cost. 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. Study questions with answers university of michigan. Comparative advantage, economic structure and growth. In this report many aspects of the comparative advantage theory were discussed, what the comparative advantage theory is in regards to opportunity costs and internationalfree trade, as well as who benefits from the theory and what effects it has on canada. 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 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. Comparative cost theory of international trade grade 12.
A nation with a comparative advantage makes the tradeoff worth it. 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. Absolute and comparative advantage michigan state university. Pdf deconstructing the theory of comparative advantage. Adam smith had believed that absolute advantage was a necessity for beneficial trade. 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. So far, the dynamic theory of comparative advantage has put greater attention on the changes in supply production side. The history of david ricardo and his ideals for the future including the ricardian model. Since there are constant returns to scale, a competitive equilibrium with a large number of profitmaximizing firms would lead. As a matter of fact labour is used in varying proportions in the production of commodities. Even if one country is more efficient in the production of. Ricardo considered what goods and services countries should produce.
Absolute advantage means being more productive or costefficient than another country. The volume of trade is shown by the shaded triangles. Adam smith, the scottish economist observed some drawbacks of existing mercantilism theory of international trade and he proposed a new theory i. Theory of absolute advantage and comparative advantage. Truth, however, in samuelsons reply refers to the fact that ricardos theory of comparative advantage is mathematically correct, not that it is empirically valid. 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. Fall term 2019 comparative advantage study questions with answers page 3 of 7 9 4. The ricardo effect served as a red herring to cause scholars to possibly misread ricardos letters in a crucial period. David ricardo developed the classical theory of comparative advantage in 1817 to. 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. This is the substance of the principle of comparative advantage cost. 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. Brief explanation for the theory of comparative cost advantage. 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.
This could include things like having a low cost structure, low cost of labor, better access to raw materials, etc. If the uk produces a book, the opportunity cost is 14 0. Comparative advantage is when a nation can produce a particular good at a lower opportunity cost than other nations. A similar concept, competitive advantage is typically used to model the competitiveness of firms and. Again for clarity, the cost of production is usually measured only in terms of labour time and effort. 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. David ricardos discovery of comparative advantage roy j. Theory of comparative cost by david ricardo definition. 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. The classical theory of international trade is popularly known as the theory of comparative costs or advantage. Benefits and costs of following comparative advantage. A country will specialise in that line of production in which it has a greater relative or comparative advantage. Pdf the theory of comparative advantage how applicable. Pdf an evaluation of david ricardos theory of comparative.
The theory of comparative advantage tca is introduced based on a textbook. In a nutshell, this is the law of comparative advantage. In this article we will discuss about the david ricardos theory of comparative cost advantage. What are the merits and demerits of ricardian theory of. Read this article to learn about the theory of comparative costs. Smiths argument about absolute advantage was refined and developed by david ricardo in 1817. In order to accelerate gdp growth rate, senegal should focus on developing the. The classical and neoclassical formulations of comparative advantage theory differ in the tools they use but share the same basis and logic. David ricardos theory of comparative cost advantage. 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.
The theory of comparative advantages comparative 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. 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. According to the theory of comparative advantage, a country will export a good only if a. Chapter 2 the ricardian theory of comparative advantage. It is used as the justification for wto trade regulations.