Law of Comparative Advantage

Law of Comparative Advantage

Specialization leads to increased output

WHY?

What do we mean by "division of labor?"

Specialization

Adam Smith:

The Division of Labor = increased productivity and output

David Riccardo:

Nations also can specialize in the production of goods and services

Nations benefit from producing goods and services they are "better" at and freely trading with other nations

Comparative and Absolute Advantage

Absolute Advantage

- Implies that a product can be produced more efficiently (i.e. with fewer inputs)

Comparative Advantage

- Means that a person/firm/nation can produce the good with a lower opportunity cost

A Hypothetical Example

Labor Hours Needed to Produce a Unit of:

Country Wheat

Cloth

Portugal

10

20

England

20

60

Portugal has an ABSOLUTE ADVANTAGE in both products.

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