Comparative advantage and international trade

Comparative advantage exists when a country has a margin of superiority in the production of a good or service i.e. where the opportunity cost of production is lower.

The basic theory of comparative advantage was developed by David Ricardo

Ricardo's theory of comparative advantage was further developed by Heckscher, Ohlin and Samuelson who argued that countries have different factor endowments of labour, land and capital inputs. Countries will specialise in and export those products which use intensively the factors of production which they are most endowed.

If each country specialises in those goods and services where they have an advantage, then total output and economic welfare can be increased (under certain assumptions). This is true even if one nation has an absolute advantage over another country.

Worked example of comparative advantage

Consider the data in the following table:

To identify which country should specialise in a particular product we need to analyse the internal opportunity cost for each country. For example, were the UK to shift more resources into higher output of personal computers, the opportunity cost of each extra PC is four CD players. For Japan the same decision has an opportunity cost of two CD players. Therefore, Japan has a comparative advantage in PCs.

Were Japan to reallocate resources to CD players, the opportunity cost of one extra CD player is 1/2 of a PC. For the UK the opportunity cost is 1/4 of the PC. Thus the UK has the comparative advantage in CD players.