Comparative Advantage and Gains from Trade

David Ricardo, one of the founding fathers of classical economics developed the idea of comparative advantage

Comparative advantage exists when

• Relative opportunity cost of production for a good or service is lower than in another country
• A country is relatively more productively efficient than another

Basic rule – specialise in the goods and services that you are relatively best at
This opens up important potential gains from specialisation and trade leading to a more efficient allocation of scarce resources.

Exam hint:

The comparative advantage model is simplistic and may not reflect the real world (for example, only two countries are taken into account). Most exports contain inputs from many different countries and products can travel across borders many times before a finished good or service is made available for sale to consumers. Businesses rather than countries trade (as a general rule). Most trade in services for example happens between cities rather than countries!