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In economics, the law of comparative advantage refers to the ability of a person or a country to produce a particular good or service at a lower marginal and opportunity cost over another. Even if one country is more efficient in the production of all goods (absolute advantage in all goods) than the other, both countries will still gain by trading with each other, as long as they have different relative efficiencies.[1][2][3]
For example, if, using machinery, a worker in one country can produce both shoes and shirts at 6 per hour, and a worker in a country with less machinery can produce either 2 shoes or 4 shirts in an hour, each country can gain from trade because their internal trade-offs between shoes and shirts are different. The less-efficient country has a comparative advantage in shirts, so it finds it more efficient to produce shirts and trade them to the more-efficient country for shoes. Without trade, its opportunity cost per shoe was 2 shirts; by trading, its cost per shoe can reduce to as low as 1 shirt depending on how much trade occurs (since the more-efficient country has a 1:1 trade-off). The more-efficient country has a comparative advantage in shoes, so it can gain in efficiency by moving some workers from shirt-production to shoe-production and trading some shoes for shirts. Without trade, its cost to make a shirt was 1 shoe; by trading, its cost per shirt can go as low as 1/2 shoe depending on how much trade occurs.
The net benefits to each country are called the gains from trade.
Origins of the theory
Comparative advantage was first described by David Ricardo who explained it in his 1817 book On the Principles of Political Economy and Taxation in an example involving England and Portugal.[4] In Portugal it is possible to produce both wine and cloth with less labor than it would take to produce the same quantities in England. However the relative costs of producing those two goods are different in the two countries. In England it is very hard to produce wine, and only moderately difficult to produce cloth. In Portugal both are easy to produce. Therefore while it is cheaper to produce cloth in Portugal than England, it is cheaper still for Portugal to produce excess wine, and trade that for English cloth. Conversely England benefits from this trade because its cost for producing cloth has not changed but it can now get wine at a lower price, closer to the cost of cloth. The conclusion drawn is that each country can gain by specializing in the good where it has comparative advantage, and trading that good for the other.
However, it is also worth mentioning that R. Torrens was an actual pioneer in the field of theoretical basis for the theory of comparative advantage. In 1815 he published 'An Essay on the External Corn Trade' which involved critical elements of the law of comparative advantage.
[edit]Modern Theories
Classical comparative advantage theory was extended in two directions: Ricardian theory and Heckscher-Ohlin-Samuelson theory (HOS theory). In both theories, the comparative advantage concept is formulated for 2 country, 2 commodity case. It can easily be extended to the 2 country, many commodity case or many country, 2 commodity case[5]. But in the case with many countries (more than 3 countries) or many commodities (more than 3 commodities), the notion of comparative advantage looses its facile features and requires totally different formulation[6]. In these general cases, HOS theory totally depends on Arrwo-Debreu type general equilibrium theory but gives few information other than general contents. Ricardian theory was formulated by Jones' 1961 paper [7], but it was limited to the case where there are no traded intermediate goods. In view of growing outsourcing and global procuring, it is necessary to extend the theory to the case with traded intermediate goods. This was done by Shiozawa's 2007 paper [8]. Until now, this is the unique general theory which accounts traded input goods.————————from ｗｉｋｉｐｅｄｉａ
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