Comparative advantage
Comparative Advantage refers to the ability of an entity (individual, company, or country) to produce a good or service at a lower opportunity cost than another one. It is the ability to produce a product with a higher relative efficiency than one's trading partner, given all the other products that could be produced. It can be contrasted with Absolute Advantage which refers to the ability of one to produce a particular good or service at a lower absolute cost than another.
Comparative Advantage is also know as comparative cost, the law of association or the Ricardian Law of Association.[1]
Origins and Original Example
In Principles of Political Economy and Taxation, David Ricardo uses the example of wine production in Portugal and cloth production in England to illustrate comparative advantage. England can produce a certain quantity of cloth with 100 men for one year or a certain quantity of wine with 120 men in the same time. Portugal, on the other hand, may only require 90 men for one year to produce the same quantity of cloth and 80 men for one year to produce the wine. Portugal, in Richardo's example, has an absolute advantage: it makes both wine and cloth more efficiently than England. Yet, Ricardo concludes:
Though [Portugal] could make cloth with the labor of 90 men, she would import it from a country where it requires the labor of 100 men to produce it, because it would be advantageous to her rather to employ her capital in production of wine, for which she would obtain more cloth from England, than she could produce by diverting a portion of her capital from cultivation of vines to the manufacture of cloth.[2]
If Portugal did not trade, she would need to produce the cloth locally, therefore devoting part of her capital to the manufacture of cloth, "which she would thus obtain probably inferior in quality as well as quantity."[2] The conclusion to be drawn is that the benefits of division of labor and specialization apply to international trade as well as to domestic trade.
Examples
In addressing the "paradox" where it is worthwhile for a country with absolute advantage to trade with a country who has absolute disadvantage (i.e., is more efficient in nothing), Paul Samuelson writes:
A traditional example used to illustrate this paradox of comparative advantage is the case of the best lawyer in town who is also the best typist in town. Will she not specialize in law and leave typing to a secretary? How can she afford to give up precious time from the legal field, where her comparative advantage is very great, to perform typing activities in which she is efficient but in which she lacks comparative advantage? Or look at it from the secretary's point of view. She is less efficient than the lawyer in both activities; but her relative disadvantage compared with the lawyer's is least in typing. Relatively speaking, the secretary has a comparative advantage in typing.[3]
The Meaning of Comparative Advantage
Ricardo's explication is a particular instance of the more universal law of association: all division of labor brings advantages. Demonstrated above, cooperation between the more able and the less able brings advantages to both. The law of association allows us to understand the progressive increase in human cooperation and the intensification of the division of labor.[1]
Assumptions
Comparative cost between countries is true under the assumption that capital and labor are immobile.[2][1] After Ricardo's publication, labor and capital increased in mobility, and countries with absolute advantages saw increases in migration and capital movements in the late 1800's. Towards the late 20th century capital and labor increasingly become less mobile. The mobility labor and capital can make it more advantageous for labor and capital to migrate in the case of absolute advantage rather than stay and trade under conditions of comparative advantage.[4]
References
- ↑ 1.0 1.1 1.2 Ludwig von Mises. VIII. Human Society, 4. The Ricardian Law of Association, Human Action, online version, referenced 2011-02-06.
- ↑ 2.0 2.1 2.2 David Ricardo Principles of Political Economy and Taxation, VII. On Foreign Trade, (Amherst, New York: Prometheus Books) 94-95
- ↑ Paul Samuelson, Economics (McGraw-Hill, 1973) p. 669
- ↑ Ludwig von Mises. VIII. Human Society, 4. The Ricardian Law of Association: Current Errors Concerning the Law of Association, Human Action, online version, referenced 2011-02-07.
External links
- Comparative advantage at Wikipedia
- Comparative Advantage by Donald J. Boudreaux at The Concise Encyclopedia of Economics
- On the Principles of Political Economy and Taxation, by David Ricardo. Complete, fully-searchable text at the Library of Economics and Liberty.
- Ricardo's Difficult Idea
- "Tire Trade Tirade" by Art Carden, October 2009
- "Gains From Trade: An Example" by Art Carden, September 2010
- "Gains From Trade With Extreme Differences" by Art Carden, September 2010
- "comparative advantage versus absolute advantage" by Gil Guillory, March 2005
- "Cooperation: How a Free Market Benefits Everyone" by Jeffrey A. Tucker, June 2008
- "Fundamental Economic Concept Lost in Translation" by Predrag Rajsic, February 2011
- "Understanding Comparative Advantage" by Stanley Schmidt, February 2013 (from the textbook "Life of Fred: Pre-Algebra II with Economics")
- Trade is Made of Win, Part 1: Wealth Creation (video)
- Trade is Made of Win, Part 2: Cooperation (video)
- Trade is Made of Win, Part 3: Conservation (video)
- 'When Ideas Have Sex' (video) with Matt Ridley (explains the comparative advantage at 5:05)
