Theory of Comparative Advantage
David Recardo | International Trade
In 1817,David Ricardo formulated the classical theory of international trade which is popularly known as the Theory of Comparative Costs or Advantage to explain why countries engage in international trade even when one country’s workers are more efficient at producing every single good than workers in other countries.
Comparative advantage is an economic law referring to the ability of any given economic actor to produce goods and services at a lower opportunity cost than other economic actors.The theory of comparative advantage is perhaps the most important concept in international trade theory.Ricardo considered what goods and services countries should produce, and suggested that they should specialise by allocating their scarce resources to produce goods and services for which they have a comparative cost advantage.
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He demonstrated that if two countries capable of producing two commodities engage in the free market, then each country will increase its overall consumption by exporting the good for which it has a comparative advantage while importing the other good, provided that there exist differences in labor productivity between both countries.Widely regarded as one of the most powerful yet counter-intuitive insights in economics, Ricardo’s theory implies that comparative advantage rather than absolute advantage is responsible for much of international trade.