📘 Theory of Comparative Advantage | 📅 1817 | 👤 David Ricardo

📢 Statement: “Nations should produce those goods for which they have the greatest relative advantage.”

📖 Definition:

The theory of Comparative Advantage was developed by David Ricardo in 1817, building on Smith’s ideas but adding a crucial dimension.
Unlike absolute advantage, comparative advantage is based on opportunity cost.

According to this theory, a country has a comparative advantage in producing a good if it has a lower opportunity cost in producing that good compared to another country, even if it does not have an absolute advantage in producing any good.

🧠 Key Concept:

A country should specialize in the production of the good that it can produce at the lowest opportunity cost and trade with other countries to obtain the goods they produce at the lowest opportunity cost.

⚖️ Opportunity Cost:

Opportunity cost refers to the cost of forgoing the next best alternative when choosing one option over another.
In the context of trade, it is the amount of one good that must be sacrificed to produce more of another good.

📊 Example to Illustrate Comparative Advantage:

Let’s consider the same two countries, Country A and Country B, with the following production capabilities:

• 🌾 Country A: 10 units of Wheat or 5 units of Cloth
  ➡️ Opportunity cost of 1 unit of Wheat = 0.5 units of Cloth

• 🧵 Country B: 6 units of Wheat or 4 units of Cloth
  ➡️ Opportunity cost of 1 unit of Wheat = 0.67 units of Cloth

📌 Analysis:
Even though Country A has an absolute advantage in producing both Wheat and Cloth, the opportunity cost of producing Wheat is lower in Country A (0.5 units of Cloth) compared to Country B (0.67 units of Cloth).

✅ Therefore:

• Country A has a comparative advantage in Wheat

• Country B has a comparative advantage in Cloth

🔁 Specialization and Trade Based on Comparative Advantage:

• Country A should specialize in Wheat production

• Country B should specialize in Cloth production

By trading Wheat for Cloth, both countries can end up with more of both goods than they could if they tried to produce both goods themselves.

🧩 Key Assumptions of Ricardo’s Model:

• 🌐 Two Countries (e.g., England and Portugal)

• 📦 Two Commodities (e.g., wine and cloth)

• 👷 One Factor of Production – Labor (only labor is considered for production, ignoring capital and land)

📌 The Theory Argues That:

✅ A country should specialize in producing and exporting goods in which it has a comparative advantage (i.e., lower opportunity cost),
❌ not necessarily an absolute advantage.

This specialization leads to:

• ⚙️ More efficient global production

• 🤝 Mutual gains from trade