The Concept of Comparative Advantage

The Concept of Comparative Advantage
On Valentine’s Day, 1996, which happened to fall less than a week before the crucial
February 20 primary in New Hampshire, Republican presidential candidate Patrick
Buchanan stopped at a nursery to buy a dozen roses for his wife. He took the occasion to
make a speech denouncing the growing imports of flowers into the United States, which
he claimed were putting American flower growers out of business. And it is indeed true
that a growing share of the market for winter roses in the United States is being supplied
by imports flown in from South American countries, Colombia in particular. But is that a
bad thing?
The case of winter roses offers an excellent example of the reasons why international
trade can be beneficial. Consider first how hard it is to supply American
sweethearts with fresh roses in February. The flowers must be grown in heated greenhouses,
at great expense in terms of energy, capital investment, and other scarce
resources. Those resources could be used to produce other goods. Inevitably, there is a
trade-off. In order to produce winter roses, the U.S. economy must produce fewer of
other things, such as computers. Economists use the term opportunity cost to describe
such trade-offs: The opportunity cost of roses in terms of computers is the number of
computers that could have been produced with the resources used to produce a given
number of roses.
Suppose, for example, that the United States currently grows 10 million roses for sale
on Valentine’s Day and that the resources used to grow those roses could have produced
100,000 computers instead. Then the opportunity cost of those 10 million roses is 100,000
computers. (Conversely, if the computers were produced instead, the opportunity cost of
those 100,000 computers would be 10 million roses.)
Those 10 million Valentine’s Day roses could instead have been grown in Colombia. It
seems extremely likely that the opportunity cost of those roses in terms of computers
would be less than it would be in the United States. For one thing, it is a lot easier to grow
February roses in the Southern Hemisphere, where it is summer in February rather than
winter. Furthermore, Colombian workers are less efficient than their U.S. counterparts at
making sophisticated goods such as computers, which means that a given amount of
resources used in computer production yields fewer computers in Colombia than in the
United States. So the trade-off in Colombia might be something like 10 million winter
roses for only 30,000 computers.
This difference in opportunity costs offers the possibility of a mutually beneficial
rearrangement of world production. Let the United States stop growing winter roses and
devote the resources this frees up to producing computers; meanwhile, let Colombia grow
those roses instead, shifting the necessary resources out of its computer industry. The
resulting changes in production would look like Table 3-1.
Look what has happened: The world is producing just as many roses as before, but it is
now producing more computers. So this rearrangement of production, with the United
States concentrating on computers and Colombia concentrating on roses, increases the
size of the world’s economic pie. Because the world as a whole is producing more, it is
possible in principle to raise everyone’s standard of living.
CHAPTER 3 Labor Productivity and Comparative Advantage: The Ricardian Model 25
26 PART ONE International Trade Theory
The reason that international trade produces this increase in world output is that it
allows each country to specialize in producing the good in which it has a comparative
advantage. A country has a comparative advantage in producing a good if the opportunity
cost of producing that good in terms of other goods is lower in that country than it is
in other countries.
In this example, Colombia has a comparative advantage in winter roses and the
United States has a comparative advantage in computers. The standard of living can
be increased in both places if Colombia produces roses for the U.S. market, while the
United States produces computers for the Colombian market. We therefore have an
essential insight about comparative advantage and international trade: Trade between
two countries can benefit both countries if each country exports the goods in which it
has a comparative advantage.
This is a statement about possibilities, not about what will actually happen. In the real
world, there is no central authority deciding which country should produce roses and
which should produce computers. Nor is there anyone handing out roses and computers to
consumers in both places. Instead, international production and trade are determined in the
marketplace, where supply and demand rule. Is there any reason to suppose that the potential
for mutual gains from trade will be realized? Will the United States and Colombia
actually end up producing the goods in which each has a comparative advantage? Will the
trade between them actually make both countries better off?
To answer these questions, we must be much more explicit in our analysis. In this chapter
we will develop a model of international trade originally proposed by the British economist
David Ricardo, who introduced the concept of comparative advantage in the early
19th century.1 This approach, in which international trade is solely due to international
differences in the productivity of labor, is known as the Ricardian model.