Definitions and Basics

The Big Ideas of Trade, at Marginal Revolution University

Comparative Advantage, on Econlib

A person has a comparative advantage at producing something if he can produce it at lower cost than anyone else.

Having a comparative advantage is not the same as being the best at something. In fact, someone can be completely unskilled at doing something, yet still have a comparative advantage at doing it! How can that happen?….

Treasure Island: The Power of Trade. Part I. The Seemingly Simple Story of Comparative Advantage, by Russ Roberts on Econlib

We all have a good intuitive understanding of the power of trade. At the simplest level, if you have something I want and if I have something you want, and we trade we each other, we’re both better off.

So if I can knit and you can’t, and if you can grow corn and I can’t, it obviously makes sense for me to swap one of my sweaters for some of your corn. You and I might argue about the “price”—how many ears of corn one of my gorgeous sweaters is worth—but once the deal is done, you’re warmer and I’m on my way to being less hungry.

Trade seems simple.

Almost two hundred years ago, David Ricardo discovered something not so simple about trade that came to be called comparative advantage. Here is a story that will let us explore the mysteries of trade together.

Treasure Island: The Power of Trade. Part II. How Trade Transforms our Standard of Living, by Russ Roberts on Econlib

Being able to trade with others, whether it’s our neighbors across the street or our neighbors across the border, gives us the opportunity to rely on others for some or most of the goods and services we enjoy. And that reliance on others, in turn, allows even the poorest among us to have a standard of living that would be unimaginable under self-sufficiency.

Trade for the Win, Lesson Plan at AdamSmithWorks

This lesson allows students to experience the benefits of trade that Adam Smith wrote about in An Inquiry into the Nature and Causes of the Wealth of Nations. Students participate in a trade simulation that measures the variation in benefits received (utility) in a variety of rounds from no trade to free trade.

In the News and Examples

The Locavore’s Dilemma: Why Pineapples Shouldn’t Be Grown in North Dakota, by Jayson Lusk and E. Bailey Norwood at Econlib, January 2011.

A major flaw in the case for buying local is that it is at odds with the principle of comparative advantage. This principle, which economists have understood for almost 200 years, is one of the main reasons that the vast majority of economists believe in free trade. Free trade, whether across city, state, or national boundaries, causes people to produce the goods or services for which they have a comparative advantage and, thus, makes virtually everyone wealthier.

Trading countries both achieve gains from trade: Foreign Trade, or The Wedding Gown, by Jane Haldimand Marcet in John Hopkins’s Notions on Political Economy. 1831.

“Then I hope your honour will set us right,” replied Bob.—”Why,” said the landlord, “I maintain that, when two countries trade freely with each other, they are both gainers.”…

“This requires some explanation,” said the landlord, “which I will try to give you. Foreigners send over to us such goods as they can make or produce cheaper and better than we can; therefore, when we buy those goods, we get them cheaper or better than we could have made them ourselves.”… [par. 8.20]

Nye on Wine, War, and Trade, EconTalk podcast episode, May 2008.

John Nye of George Mason University talks with EconTalk host Russ Roberts about his book, War, Wine, and Taxes. The conversation covers the history of Britain and France’s trade policy, why the British drink beer and why Ricardo’s example of Britain trading wool for Portuguese wine is bizarre. Nye turns the traditional story on its head–he argues that France was more of a free trader than Britain and that the repeal of the Corn Laws was not the dividing line between Britain’s protectionist past and free trade future. At the end of the discussion, Nye emphasizes the importance of domestic free trade for economic growth.

A Little History: Primary Sources and References

“A Brief History of Comparative Advantage,” by Morgan Rose. Teacher’s Corner on Econlib, August 6, 2001.

For over 200 years, economists have touted an alternative approach in which specialization leads to wealth and self-sufficiency leads to poverty. In Book IV, Chapter 3, paragraph 31 of An Inquiry into the Nature and Causes of the Wealth of Nations (1789; 1st edition: 1776), Adam Smith showed how both parties can benefit from trade, but it was David Ricardo who is credited with what is commonly called “comparative advantage,” the idea that both parties can benefit from trade even if one of them is better at producing everything than the other….

Roberts on Smith, Ricardo, and Trade, EconTalk podcast episode, February 2010.

Russ Roberts, host of EconTalk, does a monologue this week on the economics of trade and specialization. Economists have focused on David Ricardo’s idea of comparative advantage as the source of specialization and wealth creation from trade. Drawing on Adam Smith and the work of James Buchanan, Yong Yoon, and Paul Romer, Roberts argues that we’ve neglected the role of the size of the market in creating incentives for specialization and wealth creation via trade. Simply put, the more people we trade with, the greater the opportunity to specialize and innovate, even when people are identical. The Ricardian insight masks the power of market size in driving innovation and the transformation of our standard of living over the last few centuries in the developed world.

Chapter 7, by David Ricardo, in On the Principles of Political Economy and Taxation on Econlib

To produce the wine in Portugal, might require only the labour of 80 men for one year, and to produce the cloth in the same country, might require the labour of 90 men for the same time. It would therefore be advantageous for her to export wine in exchange for cloth. This exchange might even take place, notwithstanding that the commodity imported by Portugal could be produced there with less labour than in England. Though she could make the cloth with the labour of 90 men, she would import it from a country where it required the labour of 100 men to produce it, because it would be advantageous to her rather to employ her capital in the production of wine, for which she would obtain more cloth from England, than she could produce by diverting a portion of her capital from the cultivation of vines to the manufacture of cloth. [par. 7.16 (See also pars. 7.13-7.15)]

Advanced Resources

Amy Willis, Most of the People, Most of the Time, and EconTalk podcast Extra, August 2021.

Munger makes the perhaps surprising claim that comparative advantage is an idea whose time has passed. Roberts says that David Ricardo‘s contribution has overshadowed Adam Smith‘s more important one. Explain what each means, and the extent to which you agree.

Kling on Patterns of Sustainable Specialization and Trade, EconTalk podcast episode, February 2011.

Arnold Kling of EconLog talks with EconTalk host Russ Roberts about a new paradigm for thinking about macroeconomics and the labor market. Kling calls it PSST–patterns of sustainable specialization and trade. Kling rejects the Keynesian approach that emphasizes shortfalls in aggregate demand arguing that the aggregate demand approach masks the underlying complexity of the recalculations that periodically take place in a dynamic economy. Instead, Kling invokes the mutual exploration between entrepreneurs and workers for profitable opportunities that pay well using the workers’ skills. This exploration takes time, involves trial and error, and can have false starts because businesses sometimes fail or employees are difficult to find or match with employment opportunities. Kling applies these ideas to the current crisis to explain why labor market recovery is so sluggish and what might policies might improve matters.

Related Topics

Trade, Exchange and Interdependence

Barriers to Trade

Balance of Trade and Balance of Payments

Division of Labor

Free Trade

International Trade

Opportunity Cost