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.

Production after specialization

If Country A specializes in Product x wholly and Country B specialized wholly in product Y then Country A will produce 400 units of product X as it allocates the whole 20 hours for the production of product X and will not produce any product Y. In the same time Country B will allocate 20 hours for the production of product Y and it produce 8 units per hour and there fore it produces 160 units of product Y. After specialization the total production of product X and product Y is now 560 units even though the production of product Y after specialization is 160 and if no trade no specialization is 184 units the production of product Y has increased more than the decrease in product Y and the total production has increased from 484 units to 560 units. That is specialization based on comparative advantage increases the total production of these commodities and there fore there is more efficient allocation efficiency of resources than not specializing producing two commodities in the two countries and not consider trade.

Trade in the ratio of product Y to product X in the ratio of 0.6

Say country A exports 200units in exchange of product Y in the ratio of 0.6 that is 120 units of product Y then if they trade in that terms then country A will have 200 units after exports and 120 units of product Y imported from country B. In country B it will have 200 units of product X imported from country A and in country B it will have 40 units of product Y after exporting 120 units out of 160 units of product Y. As well the total production of product X and product Y in country a will be 320 units and in Country B the total production of product x and Y will be 240 units, which is more than compared to the situation where they do not specialize and no trade occur between them.

One can see after trade the total production of X and Y increases and also the consumption of X and Y also increases due to price reductions of product X and Y and increase in production efficiency. As well, the utility also increases because the total consumption of X and Y consumed in the two countries. That is the trade benefits the two countries in terms of increased production level of product X and Y and also the consumption level after trade compared to before trade. As well, as the real income increases in two countries in aggregate and the welfare also increases if the market is perfectly competitive

Conclusion

The Ricardian Model of comparative advantage is a useful model even though its assumptions are very simplistic as it shed insights in to the benefits of trade to some extent why trade takes place in an economic sense and it explains what can happen if countries embark on trade even in real world situations under certain conditions. However, it cannot explain trade within industries and trade based on endowments and even if productivity differences do not exist between countries. That is the reason the new trade theories have been developed to explain some other patterns of trade. In addition, it only considers labor as a factor of production and do not take in to account capital and land and other environmental resources in to its factor of production. It also assumes constant opportunity cost which is rare in the real world and economies of scale and increasing returns to scale. Even in these situations comparative advantage can explain the importance of trade in terms of comparative productive efficiency and the importance of specialization and not to be too much protective which will not maximize consumer welfare and also produce productive inefficiency and waste of resources as well the importance of competitive markets to improve allocation of resources to maximize production by trading and specializing and having appropriate terms of trade.