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Old Sunday, December 17, 2006
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Qurratulain Qurratulain is offline
Economist In Equilibrium
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Interpreting the Theory of Comparative Advantage

The garden story offers an intuitive explanation for the theory of comparative advantage and also provides a useful way of interpreting the model results. The usual way of stating the Ricardian model results is to say that countries will specialize in their comparative advantage good and trade them to the other country such that everyone in both countries benefit. Stated this way it is easy to imagine how it would not hold true in the complex real world.

A better way to state the results is as follows. The Ricardian model shows that if we want to maximize total output in the world then,

first, fully employ all resources worldwide;

second, allocate those resources within countries to each country's comparative advantage industries;

and third, allow the countries to trade freely thereafter.

In this way we might raise the wellbeing of all individuals despite differences in relative productivities. In this description, we do not predict that a result will carry over to the complex real world. Instead we carry the logic of comparative advantage to the real world and ask how things would have to look to achieve a certain result (maximum output and benefits). In the end we should not say that the model of comparative advantage tells us anything about what will happen when two countries begin to trade; instead we should say that the theory tells us some things that can happen.
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