Theory of Comparative Advantage

The comparative advantage law is one of the most important laws of economy, as it is useful for individuals as well as for nations, as well as for revealing many serious fallacies. Comparative advantage is the cornerstone of international trade theory. Origins of the theory Comparative advantage was first described by Robert Torrens in 1815 in an essay on the “Corn Laws”. He concluded it was England’s advantage to trade with Poland in return for grain, even though it might be possible to produce that grain at a lower cost in England than Poland. However the term is usually attributed to David Ricardo who explained it in his 1817 book “The Principles of Taxation and Political Economy”. To be simple, assumptions will initially refer to only two countries and two commodities like in absolute advantage theory. Trade can also rely on other causes, such as large-scale production and product differentiation. The theory of comparative advantage is an economic theory about the potential gains from trade for individuals, firms, or nations that arise from differences in their factor endowments. Moreover, the comparative advantage of nations may change over time as a result of technological change.

A question may arise here. If a country has absolute advantage in all products and the other country is absolutely less productive, then wouldn’t international trade occur? According to David Ricardo, there is no need to rely international trade on absolute advantages. The key word here is comparative, meaning ‘relative’ and ‘not necessarily absolute’. They both can gain by trading with each other as long as their relative disadvantages in making different goods are different. A country has a comparative advantage when it can produce a good at a lower opportunity cost than another country; alternatively, when the relative productivity between goods  is the highest compared with another country.