Comparative advantage meaning and concept evolution

Comparative advantage is when a particular country produces a good or service for a lower opportunity cost than other countries. In other words, it is the ability to produce a good at a lower opportunity cost of the resources used (Guell, 2012).

Nowadays comparative advantage is very important for stabilizing overseas market demand and assuring exports. Chinese manufactured exports are of greater comparative advantage in the world market than in the US market (Hao & Zhao, 2012).

Nineteenth-century English economist David Ricardo propounded the theory of comparative advantage. He argued that in order to boost the economic growth of a country, the particular country should have to focus on the industry in which it has the most substantial comparative advantage.

Ricardo developed this theory to combat trade restrictions on imported wheat in England. He argued that when a high-quality and lost-cost wheat is imported from a country which has the right climate and soil conditions then there is no sense to restrict it. England can acquire more wheat from other countries in a trade that could grow on its own soil. Thus, instead of restriction of import, it should rather export that kind of product which requires more skilled labor and machinery.

This theory explains why trade protectionism doesn’t work in the long run. Local constitutes always give pressure to political leaders to protect jobs from international competition by raising tariffs. However, this doesn’t work in long run, it is only for a temporary fix instead. It says that a country shouldn’t waste its resources on unnecessary industries which hurts only the nation’s competitiveness. Instead, a country should focus on those industries which give a competitive cost advantage.

It is said that a country can increase its output when the theory of comparative advantage is applied

Ricardo considered that countries should specialize on producing that goods and services for which they have a comparative cost advantage. There are two types of cost advantage i.e. absolute and comparative. A country should apply a theory of comparative advantage in order to determine what goods and services it should specialize in producing for increasing its revenue and output.

We can understand the concept and the theory of comparative advantage with the help of the table and figure.

As seen in the table, suppose there are two countries (A and B) that produce only two goods i.e. cars and trucks. Country A can produce 30 motor cars and 6m commercial trucks whereas country B produce 35m motor cars and 21m commercial trucks (see figure 1).

Figure1: Comparative advantage matrix

Figure 2: Comparative and absolute advantage

In this situation, country B has an absolute advantage in producing both cars and trucks. Having said that, it has a comparative advantage in trucks as it is comparatively better at producing them than country A. Country B is 3.5 times better at trucks, and only 1.17 times better at cars than country A. Hence, country B should specialize in manufacturing trucks, leaving county A to produce cars because country B is more productive and find the greatest advantage in truck production (see figure2).

References

Guell, R. C. (2012). The Benefits of International Trade. In R. C. Guell, Issues in Economics Today (sixth ed., pp. 92-93). New York, United States: McGraw-Hill.

Hao, W., & Zhao, C. (2012). The comparative advantage of Chinese manufactured exports. Journal of Chinese Economic and Foreign Trade Studies, 5 (2), 107-126.

Guell (2015), in their book Issues in Economics Today, comparative advantage is the ability to produce a good at a lower opportunity cost of the resources used. It gives an ability to sell goods and services at a cheaper price than its competitors and earn a great profit margin. It also explains how trade can create value for both parties even when one can produce all goods with fewer resources than the other.

For instance, moreover a country has a comparative advantage if it can produce a good at a lower opportunity cost than another country. Let’s assume two nation which produce coffee and tea using one of labor. In the table1we assume Nepal can produce 1kg of tea and 4kg of coffee using one labor. Likewise India can produce 2 kg tea and 3 kg coffee using one labor.

Table 1: Comparative advantage

In case of absolute advantage for Nepal is Tea whereas for India also absolute advantage is tea. Whereas in case of opportunity cost, Nepal can produce 1kg of Tea and 4 kg of Coffee and India can produce 2kg of Tea and 3kg of coffee. So Nepal has a comparative advantage in producing of tea as we can see low opportunity cost in tea.

The opportunity cost for India to produce tea 1 kg of tea is 2/3 which is 0.66kg whereas for Nepal it is 0.25kg. It shows Nepal has comparative advantage in producing coffee. If the nation which has higher opportunity cost then they must not produce that products rather country should focus on production of that product in which they have the lower opportunity cost.

David Ricardo (1772-1823) probably got word the legal philosophy of comparative advantage around the first two weeks of October 1816. In his example, Ricardo imagined two countries, England and Portugal, producing two goods, cloth and wine, using labor as the sole input in output. He accepted that the productivity of project (i.e., the quantity of output produced per worker) varied between industries and across countries (Ruffin, 2002). Thus, through free trade Portugal and England can both reduce their labor hours and redirect those resources to their best relative use.

The key implication of the law of comparative advantage is that if free trade is taken into account, then all nations can and will be integrated through the international division of labor. No nation is so poor or ineffective that it cannot earn from free trade.

References

Guell, Robert C. (2015). Issues in Economics Today , 7th edition- 2015 ISBN: 978-0078021817

Ruffin, R. (2002). David Ricardo’s discovery of comparative advantage. History of political economy, 34 (4), 727-748.