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Ricardo’s Remarkable Idea

April 19th will be the 200th anniversary of the publication of David Ricardo’s On the Principles of Political Economy and Taxation.  My current column in the Pittsburgh Tribune-Review discusses the most famous innovation in economic analysis that was revealed in that book: the principle of comparative advantage.  A slice:

He [Ricardo] explained that a country’s ability to produce more of some good than can be produced elsewhere does not mean that country necessarily is that good’s most efficient producer. Efficiency in producing some good — say, cloth — is reflected not in how much cloth can be produced but, instead, in how many other goods must be sacrificed to produce cloth.

Assume (as Ricardo did) that the Portuguese can produce more wine and more cloth than the British can. Yet also recognize, along with Ricardo, that in each country, producing more wine means producing less cloth, and producing more cloth means producing less wine. What matters, said Ricardo, is the amount of wine Portugal gives up to produce more cloth compared to the amount of wine Britain gives up to produce more cloth.

Suppose producing an additional bolt of cloth causes Portuguese wine production to fall by four gallons, but causes British wine production to fall by only two gallons. Under these circumstances, the British produce cloth at a lower cost than the Portuguese do, even though Portugal is capable of producing absolutely more cloth than Britain is.

So if the British sell the Portuguese a bolt of cloth for, say, three gallons of wine, both gain. Producing the bolt of cloth cost the British only two gallons of wine, while they sell it for three gallons. The Portuguese get a bolt of cloth by sacrificing only three gallons of wine rather than sacrificing four gallons to produce the cloth themselves.

Ricardo’s brilliant insight reveals that the citizens of even the most economically advanced countries will always be able to find opportunities to gain from international trade.