The theory of comparative advantage is one of the most popular trade theories in the field of international economics.
Why is comparative advantage more important for trade?
David Ricardo first presented this theory in his book Principles of Political Economy and Taxation in 1817. It gave answers to some weaknesses of Adam Smith’s absolute advantage theory. According to the Absolute advantage theory, if one country has the absolute advantage in both products, then mutually beneficial trade is not possible. However, under the theory of comparative advantage, it is possible.
Comparative advantage example
For instance, let us assume that there are two countries, A and B, both countries produce the same commodities, mobile phones, and laptops.
|Country A||Country B|
|Mobile phones per hour||6||1|
|Laptops per hour||4||2|
According to table 01, country A is more efficient in producing both commodities. Hence, country A has the Absolute advantage in both products, and country B has the absolute disadvantage in both products. As a result, trade will not take place between the countries.
According to the theory of comparative advantage, even if one country has an absolute advantage over the other country in the production of both commodities, there is still a basis for mutually beneficial trade. To do that, they need to calculate the magnitude of the absolute advantage. In the case of a less efficient country, that country must produce and export the commodity whose absolute disadvantage is small. And import the commodity in which absolute advantage is greater. According to David Ricardo, in the case of a less efficient country, the commodity with the smallest absolute disadvantage is the commodity with a comparative advantage over them. For the efficient producer, they have a comparative advantage in the commodity in which the Absolute advantage is higher.
For instance, using one labor hour, country B can produce one (01) mobile phone and two (02) laptops. When comparing the two items for country B, the absolute disadvantage is smaller for laptops and greater for mobile phones, or in other words, country B has a comparative advantage in laptops and a comparative disadvantage in mobile phones. Country A, they have a comparative advantage in mobile phones.
Now Country B can produce and export laptops and import mobile phones from country A. On the other hand, country A can export mobile phones and import laptops from country B.
Comparative Advantage and Opportunity Cost
The concept of Opportunity cost is the most widely used tool to explain comparative advantage. Opportunity cost is the value of the next best option to give up when making a decision. If a country can produce a product at a lower opportunity cost than another country, that country has a comparative advantage over that product. Therefore, a country should specialize in commodities which they have a comparative advantage and export it and import the commodity which has a comparative disadvantage.