Comparative advantage
Comparative advantage in an economic model is the advantage over others in producing a particular good. A good can be produced at a lower relative opportunity cost or autarky price, i.e. at a lower relative marginal cost prior to trade.[1] Comparative advantage describes the economic reality of the gains from trade for individuals, firms, or nations, which arise from differences in their factor endowments or technological progress.[2]
David Ricardo developed the classical theory of comparative advantage in 1817 to explain why countries engage in international trade even when one country's workers are more efficient at producing every single good than workers in other countries. He demonstrated that if two countries capable of producing two commodities engage in the free market (albeit with the assumption that the capital and labour do not move internationally[3]), then each country will increase its overall consumption by exporting the good for which it has a comparative advantage while importing the other good, provided that there exist differences in labor productivity between both countries.[4][5] Widely regarded as one of the most powerful[6] yet counter-intuitive[7] insights in economics, Ricardo's theory implies that comparative advantage rather than absolute advantage is responsible for much of international trade.
If , then Foreign specializes in wine, for the wage in the wine sector is greater than the wage in the cloth sector. However, Home workers are indifferent between working in either sector. As a result, the quantity of cloth supplied can take any value.
If , then both Home and Foreign specialize in wine, for similar reasons as above, and so the quantity of cloth supplied is zero.
If , then Home specializes in cloth whereas Foreign specializes in wine. The quantity of cloth supplied is given by the ratio of the world production of cloth to the world production of wine.
If , then both Home and Foreign specialize in cloth. The quantity of cloth supplied tends to infinity as the quantity of wine supplied approaches zero.
If , then Home specializes in cloth while Foreign workers are indifferent between sectors. Again, the relative quantity of cloth supplied can take any value.
Haberler's opportunity costs formulation[edit]
In 1930 Austrian-American economist Gottfried Haberler detached the doctrine of comparative advantage from Ricardo's labor theory of value and provided a modern opportunity cost formulation. Haberler's reformulation of comparative advantage revolutionized the theory of international trade and laid the conceptual groundwork of modern trade theories.
Haberler's innovation was to reformulate the theory of comparative advantage such that the value of good X is measured in terms of the forgone units of production of good Y rather than the labor units necessary to produce good X, as in the Ricardian formulation. Haberler implemented this opportunity-cost formulation of comparative advantage by introducing the concept of a production possibility curve into international trade theory.[18]