03.+Comparative+Advantage


 * David Ricardo and Comparative Advantage**

The Theory of Comparative Advantage
David Ricardo, working in the early part of the 19th century, realised that absolute advantage was a limited case of a more general theory. Consider Table 1. It can be seen that Portugal can produce both wheat and wine more cheaply than England (ie it has an absolute advantage in both commodities). What David Ricardo saw was that it could still be mutually beneficial for both countries to specialise and trade.

//Table 1//
 * ~ Country ||~ Wheat ||~ Wine ||
 * ~  ||~ Cost Per Unit In Man Hours ||~ Cost Per Unit In Man Hours ||
 * England || 15 || 30 ||
 * Portugal || 10 || 15 ||

In Table 1, a unit of wine in England costs the same amount to produce as 2 units of wheat. Production of an extra unit of wine means foregoing production of 2 units of wheat (ie the opportunity cost of a unit of wine is 2 units of wheat). In Portugal, a unit of wine costs 1.5 units of wheat to produce (ie the opportunity cost of a unit of wine is 1.5 units of wheat in Portugal). Because relative or comparative costs differ, it will still be mutually advantageous for both countries to trade even though Portugal has an absolute advantage in both commodities. Portugal is relatively better at producing wine than wheat: so Portugal is said to have a **COMPARATIVE ADVANTAGE** in the production of wine. England is relatively better at producing wheat than wine: so England is said to have a comparative advantage in the production of wheat. Table 2 shows how trade might be advantageous. Costs of production are as set out in Table 1. England is assumed to have 270 man hours available for production. Before trade takes place it produces and consumes 8 units of wheat and 5 units of wine. Portugal has fewer labour resources with 180 man hours of labour available for production. Before trade takes place it produces and consumes 9 units of wheat and 6 units of wine. Total production between the two economies is 17 units of wheat and 11 units of wine.

//Table 2//
 * ~ C o u n t r y ||||||||~ Production ||
 * ^  ||||~ Before Trade ||||~ After Trade ||
 * ^  ||~ Wheat ||~ Wine ||~ Wheat ||~ Wine ||
 * E n g l a n d || 8 || 5 || 18 || 0 ||
 * P o r t u g a l || 9 || 6 || 0 || 12 ||
 * T o t a l || 17 || 11 || 18 || 12 ||

If both countries now specialise, Portugal producing only wine and England producing only wheat, total production is 18 units of wheat and 12 units of wine. Specialisation has enabled the world economy to increase production by 1 unit of wheat and 1 unit of wine. The simple theory of comparative advantage outlined above makes a number of important assumptions:
 * There are no transport costs.
 * Costs are constant and there are no economies of scale.
 * There are only two economies producing two goods.
 * The theory assumes that traded goods are homogeneous (ie identical).
 * Factors of production are assumed to be perfectly mobile.
 * There are no tariffs or other trade barriers.
 * There is perfect knowledge, so that all buyers and sellers know where the cheapest goods can be found internationally.

David Ricardo's Principles
David Ricardo first published his theory in On The Principles of Political Economy and Taxation, 1817.

//Table 3//
 * ~ L o c a t i o n ||||~ On the Principles of Political Economy and Taxation ||
 * ^  ||~ URL ||~ Notes ||
 * local copy || [|local copy] || this is **740k** long ||
 * [|The Library of Economics and Liberty] || [|Chapter 1] || conveniently formatted into Chapters, has searching! ||
 * [|McMaster University] || [|PDF] || 2Mb **enourmous** PDF ||

The 3rd and final edition, of 1821, is probably the more useful. All of the above are 3rd Edition. []