Question

Remember the goal: You want to prove Ricardo’s assertion that by specializing in their area of comparative advantage and trading, two countries (or individuals) can both end up better off. You can prove this if you can show that after specializing and trading, each country consumes at least as much of both products, and more of at least one product.

You do this in a three-step process.

Step 1: Figure out which country has the comparative advantage in which product – you do this by figuring out the opportunity cost of each product for each country. The country with a lower opportunity cost for a particular product has the comparative advantage in that product.

• Remember that the opportunity cost of increasing production of one product by one unit is measured by the amount of the other product that must be sacrificed.

Step 2: Have each country specialize in producing the product in which it has the comparative advantage.

• Make sure that after specialization, the total production of each product is at least as much as it was before specialization. (In other words, for each product, add together the amounts produced by the two countries. The pre-specialization total can’t be larger than the post-specialization total for either product.)

Step 3: Propose a trade between the two countries that results in both countries having at least as much to consume of each product as they did originally, and more of at least one of the products.

Answer 1

In 1817, Ricardo published his Principles of Political Economy and Taxation, in which he presented the law of comparative advantage. This is one of the most important and still unchallenged laws of economics, with many practical applications.

The Law of Comparative Advantage

According to the law of comparative advantage, even if one nation is less efficient than ( has an absolute advantage with respect to ) the other nation in the production of both commodities, there is still a basis for mutually beneficial trade. The first nation should specialize in the production and export of the commodity in which its absolute disadvantage is smaller ( this is the commodity of its comparative advantage ) and import the commodity in which its absolute disadvantage is greater ( this is the commodity of absolute disadvantage ).

comparative Advantage wheat cloth (bushels I hour) hands I have ) U.S. 6 4 U.K. 1 2

As we can see that the U.K has an absolute disadvantage in the production of both wheat and cloth with respect to the United States.

However, since U.K. labor is half as productive in cloth but six times less productive in wheat with respect to the U.S., the U.K. has comparative advantage in cloth. On the other hand, the US has comparative advantage in both with respect to U.K., but more comparative advantage in wheat. According to the law of comparative advantage, both nations can gain if the U.S. specializes in the production of wheat and exports some of it in exchange for British cloth. ( U.K. is specializing in production and exporting of cloth. )

To show that both nations can gain, suppose the US could exchange 6W for 6C with the UK. The US would then gain 2C ( or save 1/2 hour of labor time ) since the US could only exchange 6W for 4C domestically. To see that the UK would also gain, note that the 6W that UK receives from US would require six hours to produce in the U.K. The UK could instead use these six hours to produce 12C and give up only 6C for 6W from the US. Thus, the U.K. would gain 6C or save three hours of labor time.

Thus, we can see that both the nations can gain from mutual trade even if UK is inefficient in producing both the commodities than the US.