Dr.

Ahmed El-Feqi Second: Ricardo (Comparative Advantage Theory)

Ch.3: Liberalism - Liberal view & freedom.

- Opposed to restriction on foreign trade.
Adam Smith: Absolute Advantage Theory - Free markets raise productivity & encourage innovation.
- Free international trade creates mutual advantage for all partners.
Philosophy:
- Free individual foster productive capacity. England Portugal
- Self- interest lead individual to specialization and division of labor. Cloth 4 7
wine 5 6
- - Specialization achieves productivity gains.
- Opposed to imposing restrictions on international trade.

The theory:
- Countries should specialize in goods in which they had an absolute advantage,
And export it to the trading partner.
- And import goods that the trading partner had an absolute advantage in it.
England Portugal
Cloth 3 hrs/ unit 7 hrs/ unit
wine 7 hrs/ unit 4 hrs/ unit
- Absolute advantage mean: the cost incurred to produce a unit of a product.
- From the above table:
- Cloth: England can produce it in 3 hrs, while Portugal produce it in 7 hrs.
- So, England needs less labor hours to produce a unit of cloth, This means:
The cost of cloth is cheaper in England (less cost).
- Then, England has absolute advantage in cloth.
- SO, England Specialize in producing cloth and export it to Portugal.
- England saves (gains) 4 labor hours when export 1 cloth and import 1 wine
From Portugal.
- Portugal will gain 3 labor hours from trade with England.
- Conclusion: International trade is mutual benefit for all countries.
1) To produce cloths: England needs 4 hrs & Portugal needs 7 hrs
So, England has absolute advantage in cloth
2) To produce wine :
England needs 5 hrs, Portugal needs 6 hrs
So, England has absolute Advantage in wine.
England has absolute advantage in both goods: cloth and wine
But, Depending on Comparative Advantage both countries still benefit from trade.
Comparative advantage means: relative efficiency across goods.
4
Or: The ratio between the cost of 1 unit of both goods in the same country ¿ 5
So, England has a comparative advantage in cloth than wine because the relative
cost in England is less than the relative cost in Portugal.
Then, England will specialize in cloth and export it to Portugal, then import
wine from Portugal.
- The Gains from trade:
- England will gain (save) 1 hour and Portugal gains 1 hour as well.
- So Ricardo concluded that if one country has absolute advantage in both goods,
then trade still in the interest of both countries.

Dr. Ahmed El-Feqi 1-

Masters in Economics, UEA, England