Macroeconomics

The Law of Comparative Advantage

Because the theory failed to understand the laws of absolute and comparative advantage, which advocates that trade, may not necessarily be a zero-sum game, mercantilists regulations were gradually removed in Britain in the course of the eighteenth century after the government has fully embraced Adam Smith’s concept of laissez-faire (Wikimedia Foundations, Inc).
The greatest challenge to mercantilism was Adam Smith’s theory of absolute advantage. It is said that Smith’s publication of the book The Wealth of Nation in 1776 has ended the rule of mercantilism as an economic philosophy. In contrast to the necessity of government control in the mercantilists’ philosophy, Adam Smith advocated the laissez-faire system, with limited government intervention in the economy.
Particularly, Smith believes that trade would be beneficial to both countries through specialization. In practical terms, when one country is more efficient than another country in the production of one commodity but is less efficient in the production of another, then both can gain by specializing in the commodity in which it has the absolute advantage. …
As trade is deemed beneficial to all, restrictions are discouraged and limited government intervention is advised.
An Unchallenged Theory
An enhancement and definitely a higher notch than the theory of absolute advantage is the law that says that one country can benefit from trade even if it is less efficient in the production of both commodities. It is the law of comparative advantage: an impetus for small nations to actively participate in the trade as it is believed to benefit both the big and the small countries.
Introduced by David Ricardo in 1817 through his book On the Principles of Political Economy and Taxation, comparative advantage posits that trade can create value for both countries even if one has the fewer resources in the production of all goods. Using the production possibilities frontier, Ricardo was able to prove this, achieving a significant breakthrough in the field of international economics. Practically, Ricardo believes that given the situation, both countries can still gain by having the less efficient country specialize in the production and exportation of the commodity in which its absolute disadvantage is smallest and import the product in which it has its greatest absolute disadvantage. The commodity in which one country has the least absolute disadvantage can be thought of as one in which it has a comparative advantage. The gains are realized as both countries specialize in the production of the commodity in which it has the least opportunity cost (Mankiw).
The Gains from Trade: A Simple Numerical Example
To facilitate understanding of the gains from trade, we cite the example from the Principles of Macroeconomics book of N. Gregory Mankiw.

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