OPPapers.com

Model Of International Trade

THEORY OF COMPARATIVE ADVANTAGE (1817)
 Introduced by Adam Smith, David Ricardo and John Stuart Mill.
 David Ricardo created a systematic explanation for this theory in his book On the Principles of Political Economy and Taxation in 1817.
 He suggested that comparative advantage exists when a country has a margin of superiority in the production of a good or service.
 This concept focuses on labor costs more than other aspects of production. It was because Ricardo thinks that these other production aspects, such as land and capital, either were no significance or were so evenly distributed overall that they always operated in a fixed proportion, except for labor costs.
 The theory states that a country should concentrate efforts on producing goods that have comparative advantage over other country, rather than absolute advantage, and then export those goods in exchange for goods that command advantage in their native countries.
 Example:
Labor Costs per Unit (in Hours)
Country Hand Calculator Bottle of Wine
United States 6 8
Italy 30 15

 Refer to the data above, if looking at the absolute advantages, U.S. seems to have lower production costs in both hand calculator and wine than Italy.
 But if according to the comparative advantage, U.S. is more specialize in hand calculator while Italy is more specialize in wine.
 Hence, under this theory, if both the countries go free trade, than U.S. should focus on the production of hand calculator and exchange it with wine from Italy.
 The rationale for seeking comparative advantage is to increase productivity

Assumption of Comparative Advantage Theory
There are a few assumptions underlying the concept of this theory:
• Perfect occupational mobility of factors of production – resources used in one industry can be switch into another industry without any loss of efficiency.
• Constant returns to scale – (e.g. doubling the input in each country leads to a...