Comparative Advantage and International Trade

In Ricardian model of International Trade the comparative advantage concept is the most misunderstood economic concept as it is not easy and intuitive to understand this concept because in normal sense we understand absolute advantage than comparative advantage.

However, it is an important concept in international trade economics to study the impact of trade on income and prices and the impact of trade on welfare effects to consumers and producers particularly if the markets are perfectly competitive and there exist different labor productivity across countries and they produce homogeneous products and labor is homogeneous within countries but heterogeneous to other countries and they are fully employed and they can be moved between industries without any cost and producers maximize profits and workers maximize utility. In addition the transport cost is zero.

Absolute advantage

In the context of normal meaning of absolute advantage is the actual labor productivity of producing a product or service per labor hour if labor is the only factor of production in the context of Ricardian model. That is it is not compared with the productivity of other countries and it is not a relative measure. Say country A is producing two goods X and Y and it produces per hour of labor 20 units of X and 10 units of Y and country B produces X and Y and it produces 10 units of X and 8 units of Y. In this situation country A has absolute advantage in the two products of X and Y because per unit of labor country A produces more units of X and y compared to country B and there fore country A has higher labor productivity in absolute terms compared to country B.

That is in this situation the actual labor used is compared to produce X and Y is compared between country A and country B. However if country A produces 20 units it has to forgo 10 units of y because it is using a unit of labor to produce X instead of Y and losing the opportunity to produce Y that is it is forgoing 10 units of Y. In other words to produce 1 unit of X it has to forgo 0.5 unit of Y in country A. But in Country B to produce 1 unit of X it has to forgo 0.8 units of Y. That is Country A has the least loss of product Y to produce X than Country B.

Therefore country A has a comparative advantage in producing product X. There fore country B has the comparative advantage in producing product Y as it has the least disadvantage. From this example one can see even if a country has absolute advantage in two products compared to another country one country can have the possibility to have comparative advantage in one product and any one country cannot have comparative advantage in two products and other don't have comparative advantage in either products. In essence comparative advantage is based on the principle of opportunity cost that is the cost of best opportunity forgone by doing an activity if resources are fully employed.

If say the two countries don't trade and they have 20 labor hours in country A and country B. In addition, they produce product X and Y in the two countries and allocate

In country A 10 hours for product X and 10 hours for product Y as it has demand for 10 hours of production demand for product X and product Y. In country B it allocates 12 hours to product X and 8 hours to product Y as it has demand for the same level of production. Then it country A fully specializes in producing X and country B fully specializing in product Y and exchange in the ratio of product Y to product X in the ratio of 0.6.

The production and consumption before trade

Based on the before trade production and consumption Country A will produce product X 200 units as it produces 20 units in one hour and 10 hours is used to produce product X. In the same manner Country A will produce 100 units of product Y as it produces 10 units per hour and used 10 hours of labor. In country B it allocates 12 hours of labor for the production of product X and in one hour country B produces 10 units. There fore country B produces 120 units of product X. As country B allocates 8 hours and in one hour it produces 8 units country B if no trade will produce 64 units. That is total production of product X is 320 units and Product y is 184 units and the total production of product X and product Y if no trade is 484 units. In addition, country A produces 300 units of product X and Y and country B produces 184 units of product X and product Y.