THEORY OF COMPARATIVE ADVANTAGE

For clarity of exposition, the theory of comparative advantage is usually first outlined as
though only two countries and only two commodities were involved, although the principles are
by no means limited to such cases. Again for clarity, the cost of production is usually measured
only in terms of labor time and effort; the cost of a unit of cloth, for example, might be given as
two hours of work. The two countries will be called A and B; and the two commodities produced,
wine and cloth. The labor time required to produce a unit of either commodity in either country is
as follows:

cost of production (labour time)

country A

country B

wine (1 unit)

1 hour

2 hours

cloth (1 unit)

2 hours

6 hours

As compared with country A, country B is productively inefficient. Its workers need more time to
turn out a unit of wine or a unit of cloth. This relative inefficiency may result from differences in
climate, in worker training or skill, in the amount of available tools and equipment, or from
numerous other reasons. Ricardo took it for granted that such differences do exist, and he was
not concerned with their origins.
Country A is said to have an absolute advantage in the production of both wine and cloth
because it is more efficient in the production of both goods. Accordingly, As absolute advantage
seemingly invites the conclusion that country B could not possibly compete with country A, and
indeed that if trade were to be opened up between them, country B would be competitively
overwhelmed. Ricardo, who focused chiefly on labour costs, insisted that this conclusion is
false. The critical factor is that country Bs disadvantage is less pronounced in wine production,
in which its workers require only twice as much time for a single unit as do the workers in A,
than it is in cloth production, in which the required time is three times as great. This means,
Ricardo pointed out, that country B will have a comparative advantage in wine production. Both
countries will profit, in terms of the real income they enjoy, if country B specializes in wine
production, exporting part of its output to country A, and if country A specializes in cloth
production, exporting part of its output to country B. Paradoxical though it may seem, it is
preferable for country A to leave wine production to country B, despite the fact that As workers
can produce wine of equal quality in half the time that Bs workers can do so.
The incentive to export and to import can be explained in price terms. In country A (before
international trade), the price of cloth ought to be twice that of wine, since a unit of cloth requires
twice as much labor effort. If this price ratio is not satisfied, one of the two commodities will be
overpriced and the other underpriced. Labor will then move out of the underpriced occupation
and into the other, until the resulting shortage of the underpriced commodity drives up its price.
In country B (again, before trade), a cloth unit should cost three times as much as a wine unit,
since a unit of cloth requires three times as much labor effort. Hence, a typical before-trade
price relationship, matching the underlying real cost ratio in each country, might be as follows:

Price of wine per unit

country A

country B

$5

Price of cloth per unit

$10
3
The absolute levels of price do not matter. All that is necessary is that in each country the ratio
of the two prices should match the laborcost ratio.
As soon as the opportunity for exchange between the two countries is opened up, the difference
between the winecloth price ratio in country A (namely, 5:10, or 1:2) and that in country B
(which is 1:3) provides the opportunity of a trading profit. Cloth will begin to move from A to B,
and wine from B to A. As an illustration, a trader in A, starting with an initial investment of $10,
would buy a unit of cloth, sell it in B for 3, buy 3 units of Bs wine with the proceeds, and sell
this in A for $15. (This example assumes, for simplicity, that costs of transporting goods are
negligible or zero. The introduction of transport costs complicates the analysis somewhat, but it
does not change the conclusions, unless these costs are so high as to make trade impossible.)
So long as the ratio of prices in country A differs from that in country B, the flow of goods
between the two countries will steadily increase as traders become increasingly aware of the
profit to be obtained by moving goods between the two countries. Prices, however, will be
affected by these changing flows of goods. The wine price in country A, for example, can be
expected to fall as larger and larger supplies of imported wine become available. Thus As wine
cloth price ratio of 1:2 will fall. For comparable reasons, Bs price ratio of 1:3 will rise. When the
two ratios meet, at some intermediate level (in the example earlier, at 1:21/2), the flow of goods
will stabilize.