Comparative Advantage Theory: An Economics Assignment Analysis

This economics assignment delves into the theory of comparative advantage, a fundamental concept in international trade, as proposed by David Ricardo. The essay begins by establishing the core principles of economics, including scarcity and resource allocation, and then introduces the concept of comparative advantage, distinguishing it from absolute advantage. It explains how countries can increase overall production by specializing in goods where they have a lower opportunity cost. The assignment uses Ricardo's example of England and Portugal to illustrate the benefits of specialization and trade, demonstrating how both countries can consume more goods through comparative advantage. The essay also presents a mathematical model to further explain the concept, discussing the relative demand and supply curves and the conditions for trade equilibrium. The assignment concludes by emphasizing the implications of the Ricardian model for resource allocation, production, and global trade efficiency. The essay highlights the importance of specialization, efficiency, and the benefits of international trade based on the comparative advantage.

Running Head: Theory of Comparative Advantage
Economics Assignment
Theory of Comparative Advantage

Theory of Comparative Advantage 1
Theory of Comparative Advantage
“Economics is the science which studies human behaviour as a relationship between ends
and scarce means which have alternative uses”- Lionel Robbins (Shizgal, 2012)
Humans have unlimited wants and desires. Fulfilling them is the utmost priority and the
purpose of all living beings. Satisfaction is attained only when the desires and wants are
fulfilled. This requires resources which are often scarce in nature. It is thus important to
identify and allocate the resources to their best possible use and with minimum wastage.
Scarcity concept can be applied almost everywhere. These resources need to be allocated to
the individuals, firms and society efficiently.
Scarcity raises the issue of what to produce with the given resources. There is
opportunity cost associated at every step of production and consumption. Given the level of
technology, resources must be allocated such that the consumers, producers and society can
maximise their satisfaction, profits and welfare respectively (Faccarello, 2015). Production of
commodities requires production factors like labour, land and capital. Land can be used for
buildings, parks, factories or housing. Capital can be put to numerous uses and so can the
labour. Each factor has alternate uses. Each country has its share of resources which it can
employ to produce the goods and services in demand and in the most efficient way possible.
Choices are made by all the people to put their resources to their best use. For example, a
worker has two choices, either he can work for the producer and earn wages or start farming
in his own land. He will choose the work which provides him more gains and efficiency. If
the wages are higher than the returns from farming, he will work for the producer and vice
versa.
Allocation of resources raises the issue of ‘what is to be produced’, ‘how is it to be
produced’ and ‘for whom is it to be produced’. ‘What to produce’ depends focuses on the
needs of the society for its welfare. It is the good in the demand. ‘How to produce’ revolves
around the factors of production available in abundance. It specifies whether the production
will be labour-intensive or capital-intensive. ‘For whom to produce’ is the subject of
distribution of the produce and incomes between various factors of production or the
individuals.

Theory of Comparative Advantage 2
Cost advantages can be of two types: absolute and comparative. Absolute advantage
can be used when one country is more productive and efficient in cost whereas comparative
advantage is in terms of other country, in relative magnitudes. Comparative advantage
principle can be used to increase the world output when each country produces the good that
it specialises in producing (Shahmansouri et al., 2013). Ricardo specified the goods each
country should produce have gains from trade based on the concept of comparative
advantage, with given technology (Lee et al., 2013). Countries should allocate their scarce
resources in the production of commodities, in which they possess comparative advantage in
the cost (Economics Online, 2018). This is the reason why countries specialise in certain
products and there is division of labour in international market.
Theory behind comparative advantage was given by English economist David
Ricardo in the 19th century. In case of free trade, he identifies two economies which produce
two goods from the given resources. Each economy specialises in the production of one of
the goods with its abundant factor of production. Due to this, they can produce one
commodity cheaper than the other country. This is because their relative productivities differ
in producing each good. Theory provided by Ricardo predicts that due to the differences in
factors of production and relative productivity, two economies specialise in different products
and economic activities (Costinot & Donaldson, 2012).
The concept given by David Ricardo is not directly intuitive and based on the
differences in the technological advancement and factor endowment. It can be elaborated
with the example given by Ricardo in his work. He hypothetically took a world economy
with only England and Portugal as countries (Isgut et al., 2015). Both of them produced two
goods using labour, which were cloth and wine. He presumed the labour productivity to be
different across the industries and nations. Unlike Adam Smith who assumed that each
country was more productive in one of the two goods, Ricardo assumed that Portugal
excelled in the production of both the goods. As per Adam, there would be no trade
advantage for England (Suranovic, 2018). Ricardo established a numerical evidence to prove
that world output could rise, given England specialised in one of the goods and the other
good was produced by Portugal.
Contrasting autarky, with suitable terms of trade, both countries could specialise in
the production of one of the goods and have greater quantities of each good in case of free
trade. He demonstrated that the specialised good will be based on the comparative advantage

Theory of Comparative Advantage 3
of the country which can be examined by the production costs in each country. Production
cost in terms of opportunity cost, of producing goods across the nations, is taken into
consideration (Gupta, 2015). Comparative advantage of wine will imply that the country is
able to produce it at a lower opportunity cost than the other. Opportunity cost will be defined
in the terms of cloth that will have to be forgone to produce an extra wine unit. Thus, if
England has a comparative advantage in the clot production, it implies that England can
produce one extra cloth unit by foregoing less units of wine, in comparison to Portugal
(Meoqui, 2016).
For example, when we take labour hours required to produce an extra unit of good as the
basis (Eaton & Kortum, 2012):
Cloth Wine
England 100 120
Portugal 90 80
Here, England can produce one cloth unit in 100 hours of labour or England can produce 5
6
wine units. On the contrary, Portugal produces one unit of cloth in 90 labour hours or it can
produce 9
8 wine units. Thus, the absolute advantage of cloth production lies with Portugal and
the comparative advantage lies with England, because of low opportunity cost (Faccarello,
2015). In autarky, England needs 220 hours to manufacture and consumer a unit of each
commodity while Portugal requires 170 hours for the same. From the given example,
England and Portugal are efficient in producing cloth and wine respectively. There will be
increase in production if both the countries produce the good they have comparative
advantage in. 2.2 cloth units can be produced by England and Portugal can produce 2.13
(approximately) units of wine. They both can then trade goods with each other. England can
trade a unit of cloth for Portugal’s wine. After trade, England and Portugal will be in the
excess of 0.2 cloth units and 0.13 wine units respectively. Both their consumption of the two
commodities have increased from free trade (Schumacher, 2013).
Ricardo provided a mathematical model for the general equilibrium in international
trade where differences in productivity lead to trade between the nations in the global

Theory of Comparative Advantage 4
economy (Donaldson, 2012). Classical model of Ricardo can be elaborated as the following
model:
There are two countries in the world, Home and Foreign which make only cloth and
wine. For simplicity, labour is the only production factor which is mobile only domestically.
This implies that the labour can switch or migrate between the two industries within the
domestic boundary (Colli, 2011). Here, L represents the labour in Home. aLC and aLW
represent the labour amount required in producing a cloth unit and a wine unit in Home
respectively. QC and QW are quantities of cloth and wine produced in Home. Similarly, for
Foreign we use a’LC and a’LW. The productivities of the two countries are not known in
advance. Also, their comparative cost advantages are not known. It is assumed that Home is
more efficient in cloth. We can represent the same as follows:
aLC / a’LC > aLW / a’LW
We can also state the same as follows, where Home has lower opportunity cost than wine, in
comparison to Foreign:
aLC / aLW > a’LC / a’LW
The relative prices of cloth in autarky can be aLC / aLW and a’LC / a’LW in the respective
countries. While in the case of free trade, cloth and wine prices in the world economy can be
denoted as PC and PW. Ricardo used relative demands and supplies of the two goods. That is,
he used the ratio of world cloth demand to that of wine (PC / PW). The relative price in the
world is determined by the interaction of relative demand (RD) and relative supply (RS)
curves of the world. Substitution effect can be represented in the relative demand curve,
which has a negative relationship with the relative price. For the relative supply curve which
represents relative price and relative quantity supplies,, there are five cases:
Case 1: PC / PW = aLC / aLW < a’LC / a’LW,
In this case, there is efficient wine production in Foreign because the wine industry wages
P’W / a’LW is greater than the wages in the cloth industry P’C / a’LC. Quantity to be supplied
can be extended or contracted because the workers in Home are indifferent about working in
either of the industries.
Case 2: PC / PW < aLC / aLW < a’LC / a’LW,
As per the above equation, both the countries are efficient or specialise in wine production.
Due to the similar reasons as in the first case, the quantity supplied in this case will be nil.
Case 3: aLC / aLW < PC / PW < a’LC / a’LW,

Theory of Comparative Advantage 5
According to this case, there is specialisation in wine in Foreign while Home is cost efficient
in the cloth production. Quantity that will be supplied here will be given by the ratio of cloth
production in the world economy to that of the wine, that is, L/aLC
L' /a ' LW .
Case 4: aLC / aLW < a’LC / a’LW < PC / PW,
There is cloth specialisation in both the countries and thus, the supplied quantity will tend to
infinity. Zero quantity of wine will be supplied in the world economy.
Case 5: aLC / aLW < a’LC / a’LW = PC / PW,
There will be cloth specialisation in the Home while in Foreign; the workers are indifferent
about working in the industries in the two sectors. Relative quantity supplied can vary
evidently.
Given the finite relative demand, relative price is constrained by the given inequality,
aLC / aLW ≤ PC / PW ≤ a’LC / a’LW. There will be a production constraint in the case of autarky,
which can be represented as, aLC QC + aLW QW ≤ L, which gives us cloth production possibility
curve (PPC) in Home as, QC = L/ aLC – (aLW / aLC) QW. In case of free trade, there will be
exclusive cloth production in Home. It will export some part of its produce to Foreign in
exchange for its wine, at the market prevailing rates. Largely, Home will consume the two
goods in the constraint, aLC QC + aLC (PW / PC) QW ≤ L. Home’s will consume cloth on the PPC
which will be written as, QC = L/ aLC – (PW / PC) QW ≥ L/ aLC – (aLW / aLC) QW. Similarly, we
can account for Foreign with the arguments.
Source: http://slideplayer.com/slide/5929886/

Theory of Comparative Advantage 6
Source: https://www.quora.com/How-does-the-law-of-increasing-costs-on-the-PPC-affect-
specialization-for-trade
Therefore, it can be established that the countries can expand their consumption in the
world economy by producing the good that they produce best to their abilities and resources.
Ricardian model helps explain how the scarce resources are produced, consumed and re-
allocated both within and across industries across the globe (FAN et al., 2013). The surplus
arising due to specialisation and efficiency can be traded with the surplus goods produced by
other countries, in which they specialise. This will lead to cost-efficiency in the global
economy. There will be efficient utilisation of resources in each country and the terms of
trade will improve.
References:
Colli, D., 2011. Immiserizing Growth and the Metzler. International Economic Journal,
26(01), pp.141-54.
Costinot, A. & Donaldson, D., 2012. Ricardo’s Theory of Comparative Advantage:Old Idea,
New Evidence. American Economic Review: Papers & Proceedings, 102(03), pp. 453–458.
Donaldson, A.C.a.D., 2012. Ricardo’s Theory of Comparative Advantage. [Online] Available
at: https://economics.mit.edu/files/7536 [Accessed 12 March 2018].
Eaton, J. & Kortum, S., 2012. Putting Ricardo to Work. Journal of Economic Perspectives.

Theory of Comparative Advantage 7
Economics Online, 2018. Comparative advantage. [Online] Available at:
http://www.economicsonline.co.uk/Global_economics/Comparative_advantage.html
[Accessed 12 March 2018].
Faccarello, G., 2015. Autopsy of a text: being an enquiry concerning Mr Ricardo’s principles
of international trade. The European Journal of theHistory of Economic Thought
(forthcoming).
FAN, H., LAI, E.L.-C. & QI, H.(., 2013. A Model of Trade with Ricardian Comparative
Advantage and Intra-sectoral Firm Heterogeneity.
Gupta, S.D., 2015. Comparative Advantage and Competitive. Athens Journal of Business and
Economics, 01(01).
Isgut, A., Ravishanker, G. & Rosenblat, T., 2015. The Basics of International Trade. [Online]
Available at:
https://www.researchgate.net/publication/23725244_The_Basics_of_International_Trade_A_
Classroom_Experiment [Accessed 11 March 2018].
Kurz, H.D. & Salvadori, N., eds., 2015. Comparative Advantage. In The Elgar Companion to
David Ricardo. Edward Elgar. pp.69-77.
Lee, E.J., Rhee, Y. & Lee, S.-U., 2013. Beyond Ricardian Model: An Optimal Commodity
Distribution Based on Absolute Advantage for Multi-Country Multi-Commodity.
International Journal of Business and Management, 08(14), pp.110-18.
Meoqui, J.M., 2016. Ricardo’s numerical example versus Ricardian trade model: A
comparison of two distinct notions of comparative advantage. World Economic Association.
Schumacher, R., 2013. Deconstructing the Theory of Comparative Advantage. World
Economic Review, 02, pp.83-105.
Shahmansouri, S., Esfahan, M.D. & Niki, N., 2013. Explain the Theory of Competitive
Advantage and Comparison. International Journal of Economy, Management and Social
Sciences, 02(10), pp.841-48.
Shizgal, P., 2012. Scarce Means with Alternative Uses: Robbins’ Definition of Economics
and Its Extension to the Behavioral and Neurobiological Study of Animal Decision Making.
Frontiers in Neuroscience, 06.

Theory of Comparative Advantage 8
Suranovic, S.M., 2018. The Theory of Comparative Advantage - Overview. [Online]
Available at: http://internationalecon.com/Trade/Tch40/T40-0.php [Accessed 12 March
2018].