The Comparative Advantage Theory: the Essence, the Importance and Disadvantages

A rule of international specialization, depending on absolute advantage, excluded countries without absolute advantage from international trade. The D. Ricardo's work "On the Principles of Political Economy and Taxation" (1817) developed the absolute advantage theory and proved that the existence of absolute advantage in the national production of any commodity is not a necessary precondition for the development of international trade: the international exchange is possible and desirable in the presence of comparative advantages.

D. Ricardo's theory of international trade is based on the following preconditions:

• free trade;

• fixed costs of production;

• absence of international labor mobility;

• absence of transportation costs;

• lack of technical progress, i.e. the technological level of each country remains unchanged;

• full employment;

• there is one factor of production (labor).

Comparative advantage theory states that if countries specialize in the production of the commodities that have relatively lower costs in comparison with other countries, a trade will be mutually beneficial for both countries, regardless of whether the production in one of them is more effective than in the other one. In other words, the basis for emergence and development of international trade can be exclusively a difference in relative costs of production of the commodities, regardless of the absolute amount of these costs.

In the D. Ricardo's model, domestic prices are determined only by cost, i.e. by supply conditions. But the world prices may also be determined by the world demand, which was proved by the English economist John Stuart Mill. In his work "Principles of Political Economy", he showed at what price the exchange of goods between countries is carried out.

In free trade, exchange of goods is carried out in such a proportion of prices that is set somewhere between the existing relative prices of goods within each of the trading countries. The final level of prices, i.e. the world prices, of mutual trade will depend on the level of world demand and supply for each of these products.

According to J.S. Mill's theory (the reciprocal demand theory), the price of imported goods is determined by the price of the goods, which should be exported, to pay for imports. Therefore, the final proportion of prices in trade is determined by domestic demand for goods in each trading country.

Thus, this theory is the basis of determining the price of goods, taking into account the comparative advantage.

But its drawback is that it can be applied only to the countries of approximately the same size, when domestic demand in one of them can affect the price level in the other one.

In the specialization of countries in trade of goods, in production of which they have comparative advantage, countries can benefit from the trade (the economic effect).

A country benefits from the trade, as instead of its goods it can get more needful foreign goods from abroad than on the domestic market. Benefits from the trade are both the saving of labor costs and the growth of consumption.

The importance of the comparative advantage theory is the following:

• the balance of aggregate demand and aggregate supply was first described. The cost of goods is determined by the ratio of aggregate demand and supply for them, both domestically and from abroad;

• the theory is true regarding any quantity of goods and any number of countries, as well as for the analysis of trade between different entities. In this case, country specialization in some goods depends on the ratio of wage levels in each country;

• the theory based the existence of benefits from trade for all countries, taking part in it;

• there become possible to develop foreign economic policy on the scientific foundation.

The limitation of the comparative advantage theory is in that presuppositions, on which it is based. It does not take into account the impact of foreign trade on income distribution within a country, fluctuations in prices and wages, international capital movements. Also, it does not explain the trade between almost identical countries, none of which has no a relative advantage over another, it takes into account only one factor of production - the labor.

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