International Trading

Explain the basis for trade according to David Ricardo? How are the gains from trade generated? Do you think that David Ricardo’s law of comparative advantage is superior to Adam Smith’s theory of absolute advantage? Why or why not?

David Ricardo was one of the most influential of the classical economists. Perhaps his most important contribution was the law of comparative advantage, a fundamental argument in favor of free trade among countries and of specialization among individuals.
The purpose of this essay is to explain the basis for trade according to David Ricardo. Also, this essay will discuss how the gains from trade generated are. And I believe that David Ricardo’s law of comparative advantage is superior to Adam Smith’s theory of absolute advantage, and this essay will explain the reason.
Comparative advantage is the basis for trade. It is possible for one country to have absolute advantages in many goods but still trade in these goods.
Ricardo’s law of comparative advantage is superior to Smith’s theory of absolute advantage because Smith’s theory of absolute advantage theory did not apply free trade to implement economic growth and increase benefits for people life quality.
Smith’s theory of absolute advantage ignores role of free trade and focus on absolute advantage of a nation. However, David Ricardo’s comparative advantage makes full use of law of free trade to realize role of free trade. Based on the theory of comparative advantage, two nations need to use free trade to realize comparative advantage (Chang, 2002). A nation needs to use principle of free trade to win absolute advantage. David Ricardo worked in the early part of the 19th century. He realized that absolute advantage was very limited case of a more general theory.
Comparative advantage may help country use free trade to win maximum productivity and maximum profit.
For example, Portugal can produce both wine and wheat more cheaply than England. Portugal has an absolute advantage in both commodities (Chang, 2008). David Ricardo thinks that comparative advantage could be mutually beneficial for both countries. Both countries may specialize and trade different product and service. Following table shows the comparative advantage of David Ricardo.

Table 1
Country Wheat Wine Cost Per Unit In Man Hours Cost Per Unit In Man Hours
England 15 30
Portugal 10 15

This table shows a unit of wine in England costs the same amount to produce as 2 units of wheat. Production of an extra unit of wine means foregoing production of 2 units of wheat. 2 units of wheat is the opportunity cost of a unit of wine. However, in Portugal, a unit of win costs 1.5 units of wheat to produce. 1.5 units of wheat in Portugal is the opportunity cost of a unit of win. Two nations has mutually advantages because of different comparative costs (Hardwick & Lagnmead, 1990). Portugal has an absolute advantage in both commodities. Portugal has more comparative advantages in producing wine than wheat. Portugal has comparative advantage for producing wine. England is relatively better at producing wheat than wine. England has a comparative advantage to produce wheat.

Based on table 2, free trade may produce comparative advantage. Costs of production are as set out in Table I. If in England, people need to spend 270 man hours available for production. Trade may bring comparative advantage to two nations (O’Sullivan & Sheffrin, 2003). England may produce and consume 8 units of wheat and 5 units of wine. Portugal has fewer labor resources with 180 man hours of labor available for production because of comparative advantage. Before trade takes place it produces and consumes 9 units of wheat and 6 units of wine. Total production between the two economies is 17 units of wheat and 11 units of wine.

Table 2
C o u n t r y Production Before Trade After Trade Wheat Wine Wheat Wine
E n g l a n d 8 5 18 0
P o r t u g a l 9 6 0 12
T o t a l 17 11 18 12

(Ronald, 1987)

If both countries now specialize, Portugal producing only wine and England producing only wheat, total production is 18 units of wheat and 12 units of wine. Specialization has enabled the world economy to increase production by 1 unit of wheat and 1 unit of wine. Theory of comparative advantage is based on some assumptions. When there are no transport costs, comparative advantage will produce from two nation’s absolute advantage (Ronald, 1987). There are no tariffs or other trade barriers for comparative advantage acquirement. There is perfect knowledge. All buyers and sellers know where the cheapest goods can be found internationally because factors of production are assumed to be perfectly mobile. Costs are constant and there are no economies of scale and there are only two economies producing two goods.

Nations may use free trade to win comparative advantage. Portugal may give up producing wheat to produce wine. From free trade, Portugal may produce import wheat from England because producing wine is comparative advantage. England may give up producing wine and export wheat to Portugal in order to win different comparative advantage and win different benefits (Ronald, 1987). From free trade, two nations may gain high productivity. Two countries’ citizen and people also may improve their life quality from free trade. Two countries may gain rapid economic growth from trade. Free trade may help nations to realize free flow of goods and services.

In conclusion, David Ricardo’s comparative advantage makes full use of law of free trade to realize role of free trade. Two nations need to use free trade to realize comparative advantage. A nation needs to use principle of free trade to win absolute advantage. All buyers and sellers know where the cheapest goods can be found internationally because factors of production are assumed to be perfectly mobile. Costs are constant and there are no economies of scale and there are only two economies producing two goods. Nations may use free trade to win comparative advantage.

References:

Chang, H.J (2002). Kicking Away the Ladder: Development Strategy in Historical Perspective, Paris: Anthem Press.
Chang, H.J (2008). Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism, London: Bloomsbury Press.
Hardwick, K & Langmead, G (1990). An Introduction to Modern Economics - 3rd Edn, London: London Press
O 'Sullivan, A & Sheffrin, S.M (2003). Economics. Principles & Tools. London: London Press
O 'Sullivan, A & Sheffrin, S. M. (2003) Economics: Principles in Action. The Wall Street Journal: Classroom Edition (2nd ed.). New Jersey: Pearson Prentice Hall: Addison Wesley Longman.
Ronald F (1987). "Comparative advantage," The New Palgrave: A Dictionary of Economics, 1 (1): 514-17.

References: Chang, H.J (2002). Kicking Away the Ladder: Development Strategy in Historical Perspective, Paris: Anthem Press. Chang, H.J (2008). Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism, London: Bloomsbury Press. Hardwick, K & Langmead, G (1990). An Introduction to Modern Economics - 3rd Edn, London: London Press O 'Sullivan, A & Sheffrin, S.M (2003). Economics. Principles & Tools. London: London Press O 'Sullivan, A & Sheffrin, S. M. (2003) Economics: Principles in Action. The Wall Street Journal: Classroom Edition (2nd ed.). New Jersey: Pearson Prentice Hall: Addison Wesley Longman. Ronald F (1987). "Comparative advantage," The New Palgrave: A Dictionary of Economics, 1 (1): 514-17.