COMPARATIVE ADVANTAGE: DAVID RICARDO

The most basic concept in the whole of international trade theory is the principle of comparative advantage, first introduced by David Ricardo in 1817. It remains a major influence on much international trade policy and is therefore important in understanding the modern global economy. Comparative advantage is the ability of a firm or individual to produce goods and/or services at a lower opportunity cost than other firms or individuals. A comparative advantage gives a company the ability to sell goods and services at a lower price than its competitors and realize stronger sales margins. David Ricardo stated in his theory of comparative advantage that a country should specialize in producing and exporting products in which it has a comparative advantage and it should import goods in which it has a comparative disadvantage. Out of such specialization, it will accrue greater benefit for all.

Assumptions

Ø  There are two countries and two commodities

Ø  One country has absolute advantage in both commodities and the second country has in another commodity

Ø  Technology is assumed to be constant

Ø  Labour is the only factor of production

Ø  labour is homogeneous, that means each unit of labour produces same level of output

Ø  Technology is assumed to  be constant

Ø  value of a commodity is measured in terms of its labour content

Ø  There is no technological improvement

Ø  Labour  is  perfectly  mobile  within  the  country  but  perfectly  immobile  between  the countries. It means that workers are free to move between industries within the nation but migration to other countries is impossible.

Ø  A system of barter prevails

Ø  Zero transportation cost

Example:

Table 2: Output per hour (kg)

Country	Wheat	Tea
India	10	10
Burma	4	5

In this example Indian labourers are capable of producing both wheat and tea in absolute

advantage. Burma is disadvantageous in both cases. But still there is a possibility for trade. Burma has  fewer  disadvantages  in  tea  than  wheat.  So  it  is  its  comparative  advantage.  If  India concentrates in wheat it is capable of producing more than two fold wheat, but in tea it can produce only two fold than Burma. Although India has an absolute advantage in the production of both tea and wheat, India has a comparative advantage only in the production of wheat. This is because its advantage in wheat is comparatively greater than its advantage in tea. In this situation India can concentrate on wheat and Burma on tea and both can benefit from trade.

In this theory there are several assumptions that limit the real-world application. The assumption that countries are driven only by the maximization of production and consumption and not by issues out of concern for workers or consumers is a mistake.