Adam Smith comparative advantage

December 1, 2014
Charles Koch s Human

The theory of comparative advantage is perhaps the most important concept in international trade theory. It is also one of the most commonly misunderstood principles. [Click Here for a new, brief description of CA] There is a popular story told amongst economists that once when an economics skeptic asked Paul Samuelson (a Nobel laureate in economics) to provide a meaningful and non-trivial result from the economics discipline, Samuelson quickly responded with, "comparative advantage."

The sources of the misunderstandings are easy to identify. First, the principle of comparative advantage is clearly counter-intuitive. Many results from the formal model are contrary to simple logic. Secondly, the theory is easy to confuse with another notion about advantageous trade, known in trade theory as the theory of absolute advantage. The logic behind absolute advantage is quite intuitive. This confusion between these two concepts leads many people to think that they understand comparative advantage when in fact, what they understand is absolute advantage. Finally, the theory of comparative advantage is all too often presented only in its mathematical form. Using numerical examples or diagrammatic representations are extremely useful in demonstrating the basic results and the deeper implications of the theory. However, it is also easy to see the results mathematically, without ever understanding the basic intuition of the theory.

The early logic that free trade could be advantageous for countries was based on the concept of absolute advantages in production. Adam Smith wrote in The Wealth of Nations,

"If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage. " (Book IV, Section ii, 12)

The idea here is simple and intuitive. If our country can produce some set of goods at lower cost than a foreign country, and if the foreign country can produce some other set of goods at a lower cost than we can produce them, then clearly it would be best for us to trade our relatively cheaper goods for their relatively cheaper goods. In this way both countries may gain from trade.

The original idea of comparative advantage dates to the early part of the 19th century. Although the model describing the theory is commonly referred to as the "Ricardian model", the original description of the idea can be found in an Essay on the External Corn Trade by Robert Torrens in 1815. David Ricardo formalized the idea using a compelling, yet simple, numerical example in his 1817 book titled, On the Principles of Political Economy and Taxation. The idea appeared again in James Mill's Elements of Political Economy in 1821. Finally, the concept became a key feature of international political economy upon the publication of Principles of Political Economy by John Stuart Mill in 1848.

David Ricardo's Numerical Example

Because the idea of comparative advantage is not immediately intuitive, the best way of presenting it seems to be with an explicit numerical example as provided by David Ricardo. Indeed some variation of Ricardo's example lives on in most international trade textbooks today. (See

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Episode 34: Comparative Advantage & Trade
Episode 34: Comparative Advantage & Trade
absolute vs comparative advantage - Adam Smith (1723-1790)
absolute vs comparative advantage - Adam Smith (1723-1790)
Comparative Advantage
Comparative Advantage
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