David Ricardo and Comparative Advantage
The Theory of Comparative Advantage
David Ricardo, working in the early part of the 19th century, realised that absolute advantage was a limited case of a more general theory. Consider Table 1. It can be seen that Portugal can produce both wheat and wine more cheaply than England (ie it has an absolute advantage in both commodities). What David Ricardo saw was that it could still be mutually beneficial for both countries to specialise and trade.
Country Wheat Wine Cost Per Unit In Man Hours Cost Per Unit In Man Hours England 15 30 Portugal 10 15
In Table 1, a unit of wine in England costs the same amount to produce as 2 units of wheat. Production of an extra unit of wine means foregoing production of 2 units of wheat (ie the opportunity cost of a unit of wine is 2 units of wheat). In Portugal, a unit of wine costs 1.5 units of wheat to produce (ie the opportunity cost of a unit of wine is 1.5 units of wheat in Portugal). Because relative or comparative costs differ, it will still be mutually advantageous for both countries to trade even though Portugal has an absolute advantage in both commodities.
Portugal is relatively better at producing wine than wheat: so Portugal is said to have a COMPARATIVE ADVANTAGE in the production of wine. England is relatively better at producing wheat than wine: so England is said to have a comparative advantage in the production of wheat.
Table 2 shows how trade might be advantageous. Costs of production are as set out in Table 1. England is assumed to have 270 man hours available for production. Before trade takes place it produces and consumes 8 units of wheat and 5 units of wine. Portugal has fewer labour resources with 180 man hours of labour available for production. Before trade takes place it produces and consumes 9 units of wheat and 6 units of wine. Total production between the two economies is 17 units of wheat and 11 units of wine.
C o u n t r y Production Before Trade After Trade Wheat Wine Wheat Wine E n g l a n d 8 5 18 0 P o r t u g a l 9 6 0 12 T o t a l 17 11 18 12
If both countries now specialise, Portugal producing only wine and England producing only wheat, total production is 18 units of wheat and 12 units of wine. Specialisation has enabled the world economy to increase production by 1 unit of wheat and 1 unit of wine.
The simple theory of comparative advantage outlined above makes a number of important assumptions:
There are no transport costs.
Costs are constant and there are no economies of scale.
There are only two economies producing two goods.
The theory assumes that traded goods are homogeneous (ie identical).
Factors of production are assumed to be perfectly mobile.
There are no tariffs or other trade barriers.
There is perfect knowledge, so that all buyers and sellers know where the cheapest goods can be found internationally.
David Ricardo's Principles
David Ricardo first published his theory in On The Principles of Political Economy and Taxation, 1817.
L o c a t i o n On the Principles of Political Economy and Taxation URL Notes local copy local copy this is 740k long The Library of Economics and Liberty Chapter 1 conveniently formatted into Chapters, has searching! McMaster University 2Mb enourmous PDF
The 3rd and final edition, of 1821, is probably the more useful. All of the above are 3rd Edition.
Birthplace London, England.
Posts Held Stockjobber and loan contractor, 1793-1814; Country landowner, 1814-23.
Offices and Honours Founder Member, Geological Soc.; MP Portarlington, Ireland, 1819-23; Founder, Polit. Econ. Club, 1821.
Publications Books: 1. The High Price of Bullion (1810); 2. Essay on the Influence of a Low Price of Corn on the Profits of Stock (1814); 3. On the Principles of Political Economy and Taxation (1817); 4. On Protection to Agriculture (1822); 5. Plan for the Establishment of a National Bank (1824); 6. David Ricardo: Works and Correspondence , 11 vols, eds. P. Sraffa and M. H. Dobb(CUP, 1951-73).
Career Successor to Adam Smith's pre-eminent position in British economics, his influence continued to dominate the aims and methods of the discipline throughout the nineteenth century. Despite his own considerable practical experience, his writings are severely abstract and frequently difficult. His chief emphasis was on the principles of diminishing returns in connection with the rent of land, which he believed also regulated the profits of capital. He attempted to deduce a theory of value from the application of labour, but found it difficult to separate the effects of changes in distribution from changes in technology. The questions thus raised about the labour theory of value were taken up by Marx and the so-called `Ricardian socialists' as a theoretical basis for criticism of established institutions.
Ricardo's law of rent was probably his most notable and influential discovery. It was based on the observation that the differing fertility of land yielded unequal profits to the capital and labour applied to it. Differential rent is the result of this variation in the fertility of land. This principle was also noted at much the same time by Malthus, West, Anderson, and others. His other great contribution, the law of comparative cost, or comparative advantage, demonstrated the benefits of international specialisation of the commodity composition of international trade. This was at the root of the free trade argument which set Britain firmly on the course of exporting manufactures and importing foodstuffs. His success in attaching other economists, particularly James Mill and McCulloch, to his views largely accounted for the remarkable dominance of his ideas long after his own lifetime. Though much of this was eventually rejected, his abstract method and much of the theoretical content of his work became the framework for economic science at least until the 1870s.
Secondary Literature M. Blaug,`Ricardo, David', International Encyclopedia of the Social Sciences , D. L. Sills(ed.)(Macmillan and Free Press, 1968), vol. 13; M. Blaug, Ricardian Economics. A Historical Study (Greenwood Press, 1973); B. Gordon, Political Economy in Parliament, 1819-23 (Barnes & Noble, 1977); S. Hollander, The Economics of David Ricardo (Univ. Tronto Press, 1979).
Try the Ricardo Page at McMaster University, which include a portrait and some of his other essays.
The Library of Economics and Liberty is worth a visit.
These details were all cribbed off of the Internet, and were produced by AC Mulligan, Rod Hay at McMaster University (Canada), Tony Brewer at University of Bristol (Britain), and others.