Comparative Advantage
Adam Smith (1776) was the first who argued for free trade based on
absolute advantage. This implies if each nation would produce the product
which they can make best. Absolute advantage allows an entity to produce
a greater quantity of the same good or service with the same constraints
than another entity. Absolute advantage is the ability of an individual,
company, region, or country to produce a greater quantity of a good or
service with the same quantity of inputs per unit of time, or to produce the
same quantity of a good or service per unit of time using a lesser quantity
of inputs, than its competitors.
David Ricardo (1817) made arguments for the comparative advantage. He
argued if the countries are not best at producing anything, the free trade
argument still hold and the country should produce that commodity in
which their comparative disadvantage is less.
Comparative advantage is contrasted with absolute advantage. Absolute
advantage refers to the ability to produce more or better goods and
services than somebody else. Comparative advantage refers to the ability
to produce goods and services at a lower opportunity cost, not necessarily
at a greater volume or quality.
However, comparative advantage measures opportunity cost instead of
actual cost. In other words, it measures what a country has to give up to
produce a certain good or service. For example, if a country is skilled at
making both cheese and chocolate, they may determine how much labor
goes into producing each good.
Comparative Advantage = Quantity of Good A for Country X / Quantity of
Good B for Country X. This formula will help us calculate the opportunity
cost for product A; similarly, we need to calculate the opportunity cost for
product B.
England can produce one unit of cloth using 15 labour hour and one unit of
wine using 30 labor. Portugal can produce one unit of cloth using 10 labor
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