Table 4.1

Absolute Advantage and the Gains from Trade

			Resources Required to Produce 1 Ton of Cocoa and Rice
			Cocoa		Rice
	Ghana		10		20
	South Korea		40		10
			Production and Consumption without Trade
			Cocoa		Rice
	Ghana		10.0		5.0
	South Korea		2.5		10.0
	Total production		12.5		15.0
			Production with Specialization
			Cocoa		Rice
	Ghana		20.0		0.0
	South Korea		0.0		20.0
	Total production		20.0		20.0
			Consumption after Ghana Trades 6 Tons of Cocoa for 6 Tons of South Korean Rice
			Cocoa		Rice
	Ghana		14.0		6.0
	South Korea		6.0		14.0
			Increase in Consumption as a Result of Specialization and Trade
			Cocoa		Rice
	Ghana		4.0		1.0
	South Korea		3.5		4.0

Comparative Advantage

David Ricardo took Adam Smith's theory one step further by exploring what might happen when one country has an absolute advantage in the production of all goods.⁴ Smith's theory of absolute advantage suggests that such a country might derive no benefits from international trade. In his 1817 book Principles of Political Economy, Ricardo showed that this was not the case. According to Ricardo's theory of comparative advantage, it makes sense for a country to specialize in the production of those goods that it produces most efficiently and to buy the goods that it produces less efficiently from other countries, even if this means buying goods from other countries that it could produce more efficiently itself.⁵ While this may seem counterintuitive, the logic can be explained with a simple example.

Assume that Ghana is more efficient in the production of both cocoa and rice; that Ghana has an absolute advantage in the production of both products. In Ghana, it takes 10 resources to produce one ton of cocoa and 13 ¹/₃ resources to produce one  Figure 4.2

The Theory of Comparative Advantage

ton of rice. Thus, given its 200 units of resources, Ghana can produce 20 tons of cocoa and no rice, 15 tons of rice and no cocoa, or any combination in between on its PPF (the line GG' in Figure 4.2). In South Korea, it takes 40 resources to produce one ton of cocoa and 20 resources to produce one ton of rice. Thus, South Korea can produce 5 tons of cocoa and no rice, 10 tons of rice and no cocoa, or any combination on its PPF (the line KK' in Figure 4.2). Again assume that without trade, each country uses half of its resources to produce rice and half to produce cocoa. Thus, without trade, Ghana will produce 10 tons of cocoa and 7.5 tons of rice (point A in Figure 4.2), while South Korea will produce 2.5 tons of cocoa and 5 tons of rice (point B in Figure 4.2).

In light of Ghana's absolute advantage in the production of both goods, why should it trade with South Korea? Although Ghana has an absolute advantage in the production of both cocoa and rice, it has a comparative advantage only in the production of cocoa: Ghana can produce 4 times as much cocoa as South Korea, but only 1.5 times as much rice. Ghana iscomparatively more efficient at producing cocoa than it is at producing rice.

Without trade, the combined production of cocoa will be 12.5 tons (10 tons in Ghana and 2.5 in South Korea), and the combined production of rice will also be 12.5 tons (7.5 tons in Ghana and 5 tons in South Korea). Without trade, each country must consume what it produces. By engaging in trade, the two countries can increase their combined production of rice and cocoa, and consumers in both nations can consume more of both goods.