Comparative advantage

Comparative advantage is an economic principle that explains why people, firms, and countries can often benefit from trade even when one party is more productive at producing every good or service. The principle states that greater gains from trade arise when each participant devotes a larger share of its labor and other productive resources to the activities with the lowest opportunity cost and obtains other goods and services through trade. Comparative advantage differs from absolute advantage, which concerns being more productive overall, and competitive advantage, which concerns outperforming rivals in a marketplace. A very early use of the term comparative advantage appears in An Essay on the External Corn Trade by Robert Torrens in 1815. David Ricardo developed the classical theory of comparative advantage in 1817 to explain why countries engage in international trade even when one country's workers are more efficient at producing every single good than workers in other countries. He demonstrated that if two countries capable of producing two commodities engage in the free market (albeit with the assumption that the capital and labour do not move internationally), then each country will increase its overall consumption by exporting the good for which it has a comparative advantage while importing the other good, provided that there exist differences in labor productivity between both countries. Widely regarded as one of the most powerful yet counter-intuitive insights in economics, Ricardo's theory implies that comparative advantage rather than absolute advantage is responsible for much of international trade.