Comparative advantage: Difference between revisions
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'''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 an highest ''relative'' efficiency than one's trade 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''' 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 an highest ''relative'' efficiency than one's trade 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. | ||
==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'''. Unlike many contemporary examples, Ricardo uses labor to distinguish comparative advantage rather than quantity of goods (this distinction is novel, but not important). England can produce a certain quantity of cloth with 100 men for one year or a certain quantity of wine with 120 men for the same time. Portugal, on the other hand, may only require 80 men for one year to produce the same quantity of wine and 90 men for one year to produce the cloth (ignoring quality). Portugal, in [[Richardo's]] example, has a [[absoulate advantage]]: it makes both wine and cloth more efficiently than England. Yet, Ricardo concludes: | |||
<blockquote>"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."<ref name="Ricardo_comparative_advantage">[[David Ricardo]] [[Principles of Political Economy and Taxation]], VII. On Foreign Trade, (Amherst, New York: Prometheus Books) 94-95</ref></blockquote> | |||
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."<ref name="Ricardo_comparative_advantage"></ref> | |||
==Other Examples== | |||
For example, if country A can produce 50 cars or 1000 watches and country B can produce 200 cars or 2000 watches, it maximizes aggregate production if country A produce watches and country B produce cars, allowing for consumptions to jump from A (25, 500) and B (100, 1000) to, for example: | For example, if country A can produce 50 cars or 1000 watches and country B can produce 200 cars or 2000 watches, it maximizes aggregate production if country A produce watches and country B produce cars, allowing for consumptions to jump from A (25, 500) and B (100, 1000) to, for example: | ||
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Comparative advantage explains how trade can create value for both parties even when one can produce all goods with fewer resources than the other. The net benefits of such an outcome are called gains from [[trade]]. It is the main concept of the pure theory of international trade. | Comparative advantage explains how trade can create value for both parties even when one can produce all goods with fewer resources than the other. The net benefits of such an outcome are called gains from [[trade]]. It is the main concept of the pure theory of international trade. | ||
==References== | |||
{{reflist}} | |||
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[[Category:Economic concepts]] | [[Category:Economic concepts]] | ||
Revision as of 00:21, 7 February 2011
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 an highest relative efficiency than one's trade 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.
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. Unlike many contemporary examples, Ricardo uses labor to distinguish comparative advantage rather than quantity of goods (this distinction is novel, but not important). England can produce a certain quantity of cloth with 100 men for one year or a certain quantity of wine with 120 men for the same time. Portugal, on the other hand, may only require 80 men for one year to produce the same quantity of wine and 90 men for one year to produce the cloth (ignoring quality). Portugal, in Richardo's example, has a absoulate 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."[1]
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."[1]
Other Examples
For example, if country A can produce 50 cars or 1000 watches and country B can produce 200 cars or 2000 watches, it maximizes aggregate production if country A produce watches and country B produce cars, allowing for consumptions to jump from A (25, 500) and B (100, 1000) to, for example:
No trade) A (0, 1000) and B (150, 500)
1) A (50, 500) and B (100, 1000) - B sells 50 cars for 500 watches
2) A (25, 500) and B (125, 1000) - B sells 25 cars for 500 watches
Comparative advantage explains how trade can create value for both parties even when one can produce all goods with fewer resources than the other. The net benefits of such an outcome are called gains from trade. It is the main concept of the pure theory of international trade.
References
- ↑ 1.0 1.1 David Ricardo Principles of Political Economy and Taxation, VII. On Foreign Trade, (Amherst, New York: Prometheus Books) 94-95