ABSOLUTE AND COMPARATIVE ADVANTAGE

MERCANTILISM
Mercantilism is a theory developed by the merchants; hence the
name. It rests on the role of a strong state in supporting (state-granted)
monopolies and protecting shipping and trading lanes. Mercantilism
encourages exports and discourages imports. Gold and silver are used to
keep score of the game played between nation-states, and represent the
wealth of the nation.
ABSOLUTE ADVANTAGE THEORY
Adam Smith, 1776
Adam Smith, The Wealth of Nations, London, 1776. The theory of
absolute advantage was advanced to buttress Smith's argument that if
there was no government involvement in trade, and if each individual was
left to do what in his or her own best interest, then there would be more
goods and services available, prices would be reduced, and the wealth of
each nation, measured as the welfare of the citizens, would increase.
Smith's theory was offered to replace mercantilism.
The Theory of Absolute Advantage and the Theory of Comparative
Advantage rest on very strong assumptions, as follows:
(1) Two countries, two commodities - assumed in both
theories. The theories are obvious for this case. The three-by-three case
(and those beyond) cannot be established analytically, and it is not even
clear how the principle should be formalized. (See p. 3 of Ronald Jones,
"The Positive Theory of International Trade," Handbook of International
Economics, R. Jones and P. Kenen (eds.), 1984.)
(2) Efficiency objective - The Absolute and Comparative
Advantage theories assume that total world production, and therefore
efficiency, is the objective. Efficiency is not always a country goal.
(3) Zero Transportation Costs - both theories presume that
transportation costs between and within countries are zero.
(4) Factor Mobility/Immobility - both theories presume that
resources are absolutely mobile within a country and absolutely immobile
between countries.
(5) Full employment - Both theories assume full employment in
each country.
These are very strong assumptions.

The USUAL EXAMPLE - PART 1

Suppose we have a two country world composed of Sweden and
Colombia. Suppose, as per the text, there are two goods in this world,
engines and coffee. The production rate table is as follows:
(hrs./unit)
Engines
Coffee

Sweden
10
300

Colombia
200
50

Suppose, further, that each country has 6,000 hours of labor. Finally,
suppose that each country follows a crude form of mercantilism and
devotes half of its labor resource to each good. Then the production in
each country is as follows:
Sweden 3000 hrs./(10 hrs./engine) = 300 engines
3000 hrs./(300 hrs./kg.) = 10 kg. of coffee
Colombia
3000 hrs./(200 hrs./engine) = 15 engines
3000 hrs./(50 hrs./kg.) = 60 kg. of coffee
Thus, world production is 315 engines and 70 kg. of coffee.
Now, suppose that each country is enlightened by Smith and pursues
its absolute advantage. Clearly, Sweden has an absolute advantage in
engines and Colombia has an absolute advantage in coffee. Then Sweden
would devote all of its labor resource to engines and Colombia all of its
labor resource to coffee. Then production in each country is as follows:
Sweden 6000 hrs./(10 hrs./engine) = 600 engines
0 hrs./(300 hrs./kg.) = 0 kg. of coffee
Colombia 0 hrs./(200 hrs./engine) = 0 engines
6000 hrs./(50 hrs./kg.) = 120 kg. of coffee
Thus, world production is increased form 315 to 600 engines and from 70
kg. to 120 kg. of coffee. Clearly, world production has increased and each
country can be made better off if trade is free.
This example is arbitrary in that the division of the labor resource
into halves was arbitrary. Here is an exercise. Show that if Sweden
allocates s% of its labor to engines and (1-s)% to coffee, and if Colombia
allocates (1-c)% of its labor to engines and c% to coffee, then total world

production is maximized at s = 1 and c = 1, i.e., at the Absolute Advantage

solution. (Hint: Use linear programming.)
Smith is correct. If government got out of the business of
supporting inefficient production (e.g., coffee in Sweden and engines in
Colombia) and left each decision maker to his or her own devices, then
world production would increase. Indeed, in our example, it nearly doubles
in each good.
Sources of absolute (and comparative) advantage
Natural - climatic, resource endowment, etc. The British
import tea for this reason; Idaho has a natural (absolute) advantage in
producing Idaho trout, Idaho white pine, and Idaho potatoes.
Acquired - a technique or process technology. The Swiss have
an acquired (absolute) advantage in mechanical watches, the Belgians in
chocolate and beer, the Japanese in electronic watches, the Germans in
machine tools, the Americans and Europeans in airplanes, etc.)
COMPARATIVE ADVANTAGE THEORY
David Ricardo, 1817
See David Ricardo, The Principles of Political Economy and Taxation,
London, 1817. The theory of comparative advantage advances and refines
Smith's theory of absolute advantage. Ricardo agreed with Smith's view
that if there was no government involvement in trade, and if each
individual was left to do what is in his or her own best interest, then
there would be more goods and services available, prices would be
reduced, and the wealth of each nation would increase. Ricardo's
comparative advantage theory extends Smith's view to the case where one
of the two countries has an absolute advantage in both commodities, and
shows that even here trade is good for both countries.
As noted above, Ricardo's Comparative Advantage Theory rests on
the same very strong assumptions that underlie Smith's Absolute
Advantage Theory.

THE USUAL EXAMPLE - PART 2

The following is a variation on the example advanced by Ricardo.
(Reference: David Ricardo, The Principles of Political Economy and
Taxation, London: J. M. Dent & Sons, Ltd., date not listed, p. 82.) Suppose

England and Portugal each have 6,000 hours of labor available, and the
production possibilities are as follows:
(hrs./unit)
Cloth
Wine

England
100
120

Portugal
90
80

Notice that Portugal has an absolute advantage in both commodities.

First, suppose, in the style of mercantilism, that the countries
(arbitrarily) allocate half of their 6,000 hours of labor to each good. Then
we have the following:
England 3000 hrs./(100 hrs./cloth) = 30 units of cloth
3000 hrs./(120 hrs./wine) = 25 units of wine
Portugal 3000 hrs./(90 hrs./cloth) = 33 1/3 units of cloth
3000 hrs./(80 hrs./wine) = 37 1/2 units of wine
Thus, world production is 63 1/3 units of cloth and 62 1/2 units of wine.
Clearly, Portugal is more efficient than England in the production of
both cloth and wine. Note, however, that Portugal's greater efficiency is
not the same in both commodities. Rudely put, one English laborer is
worth 90/100 (= 0.9) of a Portuguese laborer in the production of cloth,
and 80/120 (= .66) of a Portuguese laborer in the production of wine.
Thus, although English workers are less efficient than Portuguese workers
in the production of both goods, the English workers are less worse in the
production of cloth than they are in the production of wine. (Put
differently, the degree of efficiency of the Portuguese workers is greater
in the production of wine than in the production of cloth.) Thus, England
has a comparative advantage in the production of cloth, and Portugal has a
comparative (and absolute) advantage in the production of wine. This is
summarized as follows: England has a comparative advantage in the
production of cloth because 90/80 > 100/120, i.e., because
hrs.
unit of cloth

hrs.
Portugal

hrs.
unit of wine

Portugal

>

unit of cloth

England

hrs.
unit of wine

England

This can also be stated as follows: England has a comparative advantage

in the production of cloth because 90/100 > 80/120, i.e., because
hrs.
unit of cloth

hrs.
Portugal

hrs.
unit of cloth

England

>

unit of wine

Portugal

hrs.
unit of wine

England

(Note that the second inequality is simply a restatement of the first. Note
also that the first inequality compares ratios taken within the countries,
whereas the second compares ratios taken across the countries. See Akira
Takayama, International Trade, p. 111.)
Now, suppose that the goal is to increase total world production
(i.e., cloth and wine). If England put all of its labor into the production of
cloth, then we would have
6000 hrs./(100 hrs./cloth) = 60 units of cloth
from England. In order to maintain the previous level of world production
of cloth (i.e., 63 1/3 units of cloth), it is necessary for Portugal to
produce at least 3 1/3 units. Thus, Portugal must allocate at least 300
hours of labor (300 = 3 1/3 times 90) to the production of cloth. If
Portugal allocates the remaining 2700 hours of labor to the production of
wine, then we have
5700 hrs./(80 hrs./wine) = 71 1/4 units of wine from Portugal.
Therefore, the world total of cloth and wine is 63 1/3 units of cloth, as
we had before, and 71 1/4 units of wine, which is an increase of 8 3/4
units of wine.
Clearly, if we allocate slightly more than 300 hours of labor in
Portugal to the production of cloth and the remaining hours to the
production of wine, then we can increase the total world production of
both cloth and wine by having England produce to its comparative
advantage. Therefore, Ricardo's extension of Smith's analysis holds. That
is, even if one country is dominated in the production of both goods by the
other country, both countries can be made better off if they engage in free
trade and the dominated country produces to its comparative advantage.

This example, like the absolute advantage example, is arbitrary in

that the division of the labor resource into halves was arbitrary. Here is
another exercise. Show that if Portugal allocates p% of its labor to cloth
and (1-p)% to wine, and if England allocates (1-e)% of its labor to cloth
and e% to wine, then total world production is maximized at e = 1, i.e., at
the comparative advantage solution. (Hint: Use linear programming.)