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In this article we will discuss about the David Ricardo’s theory of comparative cost advantage. David Ricardo believed that the international trade is governed by the comparative cost advantage rather than the absolute cost advantage. A country will specialise in that line of production in which it has a greater relative or comparative advantage in costs than other countries and will depend upon imports from abroad of all such commodities in which it has relative cost disadvantage. Suppose ...
Jul 17, 2023 · The theory of comparative advantage is perhaps the most important concept in international trade theory. It is also one of the most commonly misunderstood principles. There is a popular story told among economists that once when an economics skeptic asked Paul Samuelson (a Nobel laureate in economics) to provide a meaningful and nontrivial result from the economics discipline, Samuelson quickly responded, “comparative advantage.”
- Overview
- Comparative advantage: A simplified example
- The bottom line
economic theory
Written byKarl Montevirgen
Karl Montevirgen
Karl Montevirgen is a professional freelance writer who specializes in the fields of finance, cryptomarkets, content strategy, and the arts. Karl works with several organizations in the equities, futures, physical metals, and blockchain industries. He holds FINRA Series 3 and Series 34 licenses in addition to a dual MFA in critical studies/writing and music composition from the California Institute of the Arts.
Fact-checked byThe Editors of Encyclopaedia Britannica
The Editors of Encyclopaedia Britannica
Picture two countries, country A and country B. Consumers in each country like to eat a mixture of rice cakes and banana bread.
In country A, the workforce could make 1,000 rice cakes, or they could bake 3,000 loaves of banana bread. Or, they could split the workforce in half, and make 500 rice cakes and 1,500 loaves of banana bread.
In country B, the same size workforce could also produce 1,000 rice cakes, but if they were to instead make only banana bread, they could only make 2,000 loaves. Or, if they split their workforce in half, they could produce 500 rice cakes and 1,000 loaves of banana bread.
In this example, if each country split their workforce between the production of rice cakes and banana bread, they would make, in total, 1,000 rice cakes and 2,500 loaves of banana bread.
But if country B were to make enough rice cakes for both nations (1,000), country A could make 3,000 loaves of banana bread, for a final total of 500 more loaves.
According to Ricardo, a properly structured international trade agreement could work out for both countries, even if country A is more efficient at making both banana bread and rice cakes.
The theory of comparative advantage supports free trade and specialization among countries. In other words, no matter how you slice it, comparative advantage, plus international trade, equals higher aggregate output.
But the issue gets more complex when you take into account real-life elements such as varying factors of production, limited resources, the state of a country’s labor and employment, and the ability of countries to construct mutually beneficial trade agreements.
Chapter 2. The Ricardian Theory of Comparative Advantage. This chapter presents the first formal model of international trade: the Ricardian model. It is one of the simplest models, and still, by introducing the principle of comparative advantage, it offers some of the most compelling reasons supporting international trade.
In other words, the Ricardian model is both one of the most misunderstood and one of the most compelling models of international trade. 2.1: The Reasons for Trade. 2.2: The Theory of Comparative Advantage- Overview. 2.3: Ricardian Model Assumptions. The Ricardian model shows the possibility that an industry in a developed country could compete ...
Jul 15, 2024 · Definition Vs. Absolute Advantage. Comparative advantage is an economic law, dating back to the early 1800s, that demonstrates the ways in which protectionism (or mercantilism as it was called at ...
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Aug 8, 2016 · David Ricardo’s theory of comparative advantage is now two centuries old, but it remains at the heart of economists’ theories of international trade. It also continues to provide the underlying economic ethic for liberal International Political Economy (IPE). Ricardo’s numerical illustration of the mutually shared gains from specialisation and trade involved complementary structures of comparative advantage being exhibited by a productively superior hypothetical ‘Portugal’ and a ...
