LECTURE 3: ABSOLUTE AND COMPARATIVE ADVANTAGE
(ADAM SMITH VERSUS DAVID RICARDO)
A. ABSOLUTE ADVANTAGE (ADAM SMITH’S STORY)
BRITAIN PRODUCES 100 TONS OF CLOTH OR 50 BARRELS OF PORT WINE
PORTUGAL PRODUCES 100 BARRELS OF PORT WINE OR 50 TONS OF CLOTH
CAN THE TWO COUNTRIES GAIN FROM TRADE?
SMITH’S ANSWER WAS “YES” BECAUSE PORTUGAL MAKES MORE WINE THAN BRITAIN AND
BRITAIN MAKES MORE CLOTH THAN PORTUGAL.
B. COMPARATIVE ADVANTAGE
BRITAIN CAN NOW PRODUCE 200 TONS OF CLOTH OR 100 BARRELS OF PORT
PORTUGAL STILL PRODUCES 100 BARRELS OF PORT WINE OR 50 TONS OF CLOTH
CAN THE TWO COUNTRIES GAIN FROM TRADE?
ADAM SMITH WOULD HAVE NOT SEEN TRADE BETWEEN THE TWO COUNTRIES AS VIABLE, BUT
IT ACTUALLY OCCURRED. DAVID RICARDO ARGUED THAT TRADE WAS PERFECTLY VIABLE
BECAUSE EACH COUNTRY HAD A COMPARATIVE ADVANTAGE IN ONE OF THE TWO
COMMODITIES.
C. RELATIVE PRICE DIFFERENCES AS THE SOURCE OF POTENTIAL GAINS FROM TRADE.
D. GAINS FROM TRADE.
E. DISTRIBUTION OF THE GAINS FROM TRADE
PRODUCTION POSSIBLITIES FOR TWO COUNTRIES
(ABSOLUTE AND COMPARATIVE ADVANTAGE IN ONE COMMODITY)
COUNTRY
CLOTH
WINE
BRITAIN
200
50
PORTUGAL
50
100
PRODUCTION POSSIBLITIES FOR TWO COUNTRIES
(ABSOLUTE ADVANTAGE IN BOTH COMMODITIES BUTCAN THE COUNTRIES TRADE?)
COUNTRY
CLOTH
WINE
BRITAIN
600
150
PORTUGAL
50
100