Comparative advantage
In economics, the principle of comparative advantage (also known as comparative costs) explains how any country can benefit from free trade, whether it has absolute advantages or not. This principle was developed by Robert Torrens in 1815, and demonstrated in David Ricardo's Principles of political economy and taxation in 1817. Subsequent developments have not altered the basic intuition: if markets work perfectly, a country will always be better off under free trade, even though the gains from trade may be distributed unevenly.
Paul Samuelson once cited the principle of comparative advantage as the best example of an economic proposition that was both true and non-trivial. In modern economics, it is used to explain why countries export what they do. There are several model of comparative advantage, with differ in their assumptions and implications:
1. The Ricardian model, as developed by David Ricardo. In this model, each country produces the same goods, but with different technologies. Ricardo's example was Britain and Portugal, which both produce wine and textiles (or at least they did in 1817). It may be that Britain has an absolute cost advantage in both wine and textiles, but Portugal is better at producing wine in relative terms (that is, Portugal will have to give up fewer units of textiles to produce one more unit of wine). In this case, each country should specialize completely: so Portugal should produce only wine, export the surplus to Britain and buy textiles with the proceeds. Both countries will end up consuming more.
2. The Heckscher-Ohlin model, also known as the factor endowments model. This model assumes that technology is identical across countries, whereas the endowments of factors of production (like land, labour and capital) differ. Heckscher and Ohlin were two Swedish economists trying to explain why Europe imported beef from Argentina and Australia in the 19th century. Their explanation was that Argentina and Australia were abundant in land, so they should concentrate in producing goods like beef that use land intensively, while Europe should produce manufactured goods that use capital intensively. In general terms, countries should export whatever products are intensive in the factors of production in which they are relatively abundant.
Both of these theories assume perfect competition between firms and that perfect price information is available to all parties. Relaxing these assumptions does not alter the mathematical truth of the models, but may change their predictions.
Measuring comparative advantage is harder than measuring absolute advantage, because it is a relative concept and cannot be expressed in dollars. The most popular economic measure is 'revealed comparative advantage'. This assumes that if a country is a net exporter of a good, it must have comparative advantage in it. Economists disagree about the extent to which the theories above explain international trade, but most agree that a country should always chose free trade and specialize itself in the production for which it has a lower opportunity cost than its partners.
| Shoes | Clothes | |
|---|---|---|
| Aland | 300 | 500 |
| Bland | 1000 | 500 |
| World total | 1300 | 1000 |