COMPARATIVE ADVANTAGE THEORY

Abstract

Comparative advantage is an economic theory developed by a British economist David Ricardo in his book Principles of Political Economy and Taxation (1817). It states that a country engages in production of goods and services that has a lower opportunity cost. It is ability to produce goods and services at a lower opportunity cost. Ricardo’s comparative advantage theory argues in favour of a free trade model and it is a notion implied to defend trade liberalization. Protection is seen as interference in the free play of market forces. Comparative advantage theory does not compare between the costs of production in money terms, as generally understood, in domestic and foreign markets,  rather between real costs (in terms of labour time and other resources) of different commodities at home. Unlike the neoclassical economists, David Ricardo based his arguments on the labour theory of value.   Free trade has been a powerful policy for international organisations such as the IMF, the World Bank and WTO (World Bank, 2002; WTO, 2015).  Ricardo used two country static models, where Portugal was assumed to be a more efficient producer of cloth than England, but the country is also more efficient in wine production. According to him, Portugal and England would gain by a division of labour in which each country produced and specialised in the goods in which it had greater comparative advantage. Even though England was relatively less efficient than Portugal in both goods, following free trade would mean that Portugal would focus on the production of wine and England on cloth production. This theory implies that a country that has comparative advantage in the production of certain goods and services gains efficiency and profitability.