The Beechmont Crest Guide to Economics
Comparative Advantage
Since the earliest days of trade between nations, some countries excelled at manufacturing certain goods, while their trading partners were more efficient at making others.
In the 1700s, for example, Great Britain distinguished itself as a manufacturer of textiles. Great Britain was one of the first nations to be transformed by the Industrial Revolution, and it had the factories and expertise needed to manufacture textiles efficiently. It could make more cloth at a lower unit price than could any of its European neighbors.
On the other hand, Great Britain was not known for its wine production. The climate and soil of Great Britain do not lend themselves to grape harvesting and winemaking. Other European countries---namely France, Portugal and Italy---were able to make wine more efficiently than the British.
In the 1817 book On the Principles of Political Economy and Taxation, British economist David Ricardo formalized these principles in the theory of comparative advantage. Comparative advantage has become the basis of the global economy and international trade.
Here is the basic idea: imagine two countries that manufacture digital cameras and DVD players. Below are the quantities that each country can make of each commodity per day. (The numbers are small for simplicity’s sake.)
digital cameras DVD players
Country A: 10 50
Country B: 50 10
When Country A and Country B each produce both goods for their home market, their combined output is 60 digital cameras and 60 DVD players.
But suppose that they agree to specialize. This makes sense: Country A is much better at making DVD players, while Country B does a better job of cranking out digital cameras. With specialization, their combined output will be 100 digital cameras and 100 DVD players.
Country A has what economists call an absolute advantage in the manufacturing of DVD players: it can produce more of them at a lower cost than its trading partner, Country B. And Country B enjoys a similar absolute advantage in digital cameras.
This simple model demonstrates the production and prosperity gains that are possible when countries specialize in the goods and services to which they are best suited.