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 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 in 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. Portugal, in Richardo's example, has a 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."[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] 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.
References
- ↑ 1.0 1.1 David Ricardo Principles of Political Economy and Taxation, VII. On Foreign Trade, (Amherst, New York: Prometheus Books) 94-95
Links
- Principles of Political Economy and Taxation by David Ricardo (Google Books)