Adam Smith And Ricardo's Theory Of Comparative Advantages

According to Colander, "The reason two countries trade is that trade can make both countries better off" (2004, p. 416). In economics, the theory of comparative advantage clarifies why it can be advantageous for two countries to trade, even though one of them may be able to produce every kind of item more cheaply than the other. What matters is not the absolute cost of production, but instead, the ratio between how easily the two countries can produce different kinds of goods. The basic idea of the principle of comparative advantage is that as long as the relative opportunity costs of producing goods differ among countries, then there are potential gains from trade.

Dave gives “The Theory of Comparative Advantage” a different name and calls it “The Roundabout Way to Wealth”.(p.10) He says that this theory deals with the idea that even a nation which is relatively poor at doing everything, still do some things relatively well. “And a nation that is really good at many things should still specialize in producing some items and import the rest”.(p.10) Time is the ultimate scarce resource. Investing time in doing something means having less time in doing

Define the concept of comparative advantage. How can a country gain or lose its comparative advantage in the production of a good?

Comparative advantage in economics is when a country can produce a good at a lower opportunity cost relative to other producers. It is because of this theory that output will increase because a producers within a country specializes Countries will gain the ability to maximize their efficiency and their labor force which facilitates mass-production of products, resulting in higher profits and international trade. This is because the economies of scale reduces overall cost, by producing more units. If the two countries moved towards protectionism and attempted to become self-sufficient then the production of goods would then

Nations trade with one another because it is mutually advantageous for both parties when one is more efficient at producing a certain good and at a lower cost, and the other is proficient at producing a different good or service more efficiently. This is based on Ricaro’s theory of comparative advantage.

However, it was apparent to economists that nations with similar resource endowments exchanged similar products with each other. Economists felt that trade explained solely by comparative advantage was an incomplete analysis of international trade. Furthermore, since the classical trade theory was unable to explain intraindustry trade, economists decided to expand on the classical trade theory by creating a new theory of trade (Carbaugh, 2011). The new theory states that economies of scale provide incentive for a country to specialize in a particular product (Carbaugh, 2011). Furthermore, based on economies of scale, nations with similar factor endowments will trade with each other as sometimes it is beneficial (Carbaugh, 2011). Arguments stemming from this new trade theory puts the economic case for free trade in doubt.

Which is cost difference determines the patterns of international trade. Absolute advantage is trade benefits when each country is at least cost producer of one of the goods being traded. In the 1800s, David Ricardo developed the theory of comparative advantage to measure gains from trades. This theory is based on comparative advantage and it states each nation should specialize in production of those goods for which its relatively more efficient with a lower opportunity cost.

Why is the work of Adam Smith considered so crucial in the development of economic thought?

The Ricardian trade model is a simple yet powerful theory that refutes common fallacies about the causations of trade flows. It illustrates that, instead of absolute advantage, it is comparative advantage that brings forth the gains from trade. Comparative advantage refers to the ability to produce a product at a lower opportunity cost than another. This ability is the result of

The country can maximize their wealth by putting the resources in the most competitive industries. Government created comparative advantage rather than free trade because now easier moves the production processes and the machines into countries that can produce more goods (Yeager & Tuereck, 1984). However, many countries now move to new trade theory suggests the ability firms to limit the number of competitors associated with economic scale (reduction of costs with a large scale of output) (Krugman, 1992). The comparative advantage occurs when two-way trade in identical products, it will useful where economic scale is important, but it will create problem with this model. As a result, government must intervene in international trade for protection to domestic firms (Krugman, 1990)

Comparative advantage is affected by the interplay between the resources available to a country (the relative abundance of factors of production) and the production technology (which affects the intensity through which the factors of production are used in the production process). What we understand from the Heckscher-Ohlin model is that international trade is by and large directed by the differences in resources or in other words, the existence of differences in economies’ resources is the cornerstone of trade.

The theory of comparative advantage explains the benefit of free trade. According to this theory by David Ricardo in the early 19th century, “Both countries will be better off if each specializes in the industry where it has a comparative advantage, and if the two trade with one another.” (Citation) International trade opens up markets to foreign supplier, and domestic companies need to improve their efficiency, boost productivity, and lower cost to increase competitiveness instead of enjoying monopolies or oligopolies that enabled them to keep prices well above marginal costs. On the other hand, international trade also offers domestic companies bigger demands and broader markets; therefore more jobs relevant to export have been created. Furthermore, jobs in the US supported by goods exports pay 13-18 percent more than the US national average (ustr.gov).

Adam Smith, author of The Wealth of Nations, shows support for free trade and emphasises it as a trade policy which ought to be adopted. Krugman and Obstfeld back Smith's support by stating that the efficiency of trade is increased by free trade and accumulates the national income of countries. Free trade is a theory which suggests that each nation benefits in specialising in an economic activity from which it gains absolute advantage, enjoying absolute superiority over other nations in a specif economical activity (Peng). With free trade follows opportunity, replacing regulation and growth of economic activity. (Rugmann and Collinson).

The concept of absolute advantage is one of the most fundamental areas of concern in the study of economics. In its basic meaning, absolute advantage refers to the ability of one individual or party to produce more of a particular good or service than other competitors given the same amount of resources. In this regard, absolute advantage becomes a very important aspect in the concept of international trade as it clearly defines the different areas where countries should specialize in order to maximize their productivity and enhance international trade. The principle of absolute advantage was first elucidated by Adam Smith in his study of international trade using labor and capital as the only factor inputs(Free, 2010).

Comparative advantage is a principle developed by David Ricardo in the early 19th century to explain the benefits of mutual trade (Carbaugh, 2008). Many underlying assumptions of comparative advantage depend on states of economic equilibrium and an absence of economy of scale. In reality, economies are dynamic and subject to innovation and interference; which has led to revised assumptions of return and competition (Krugman, 1987). These factors have created questions of free trade and governmental participation in an economy by the development of strategic trade policies. These new concepts do not replace the theory of comparative advantage; however, they further explain how trade can benefit a country's economy (Krugman, 1987).