Comparative Advantage

 

Vocabulary

benefit	prosperity	competition
fortune	compare	stock exchange
mutual	delegate	self-sufficiency
restrict	postulate	demonstrate
regard	well-being	preposterous
focus	commodity	proposition
prime	emphasis	opportunity
delve	absolute	concentrate
unit	relevant	stress (2)
profit	foster (2)	determine
desire	yield (2)	advantage
lens	eliminate	outsource

 

David Ricardo

David Ricardo was the leading British economist of the early 1800’s. He helped establish the theories of classical economics, which stress economic prosperity through free trade and free competition.

Born in London in 1772, Ricardo made a fortune on the stock exchange while still in his 20s. He served in Parliament from 1819 until his death in 1823.

Comparative Advantage

Ricardo wrote much on economics, but is perhaps best known for his Theory of Comparative Advantage among nations.

This theory postulates that specialization in a free, open market fosters economic well-being; while self-sufficiency in a closed or restricted market does not.

Preposterous

When it first came out, his proposition was regarded as preposterous (many still feel this way today).

However, through his research, Ricardo demonstrated that free trade between two countries can be mutually profitable, even when one country is more productive than the other in every commodity that is being exchanged.

England and Portugal

Ricardo used trade between England and Portugal as a prime example. Portugal could produce both wheat and wine more cheaply than England, giving Portugal an absolute cost advantage in both commodities.

Delving deeper into the economics of these two countries, Ricardo found that one unit of wine in England cost the same amount to produce as two units of wheat, whereas in Portugal, the production cost of one unit of wine was the same as 1.5 units of wheat.

Lost Opportunity

Even though Portugal could produce wheat more cheaply than England, every unit of wheat it produced cost the country the opportunity to make a higher profit by producing one unit of wine.

This is known as a lost opportunity cost.

From this perspective, Portugal had a comparative cost advantage in the production of wine; England had a comparative advantage in the production of wheat.

Mutually Beneficial

Ricardo went on to show how both countries could benefit by trading these two commodities with each other, with Portugal concentrating on the production of wine, and England emphasizing wheat.

But how is all of this relevant to modern business?

The Management of Business

As in national economics, the more you invest any of your business’s resources (the time, money and energy of your employees, your physical plant and equipment, your intellectual capital and the like) in activities where another company has a comparative advantage, the greater the loss-of-opportunity cost.

Don’t do this.

Instead, concentrate on your company’s comparative advantage or potential comparative advantage.

Application in Your Life

Ricardo’s Law is equally relevant at the personal level. It is important for you to determine your highest-value tasks — the 20 percent of things you do that yield 80 percent of your desired results.

And then focus on these high-value tasks while delegating, outsourcing (or even eliminating) the rest (the bottom 80%).

A second lens through which to view this principle is that of your hourly rate. Anything you do which you could pay someone less than your desired hourly rate leads to a lost opportunity cost.

Action Exercise

Which (20%) of your products or services represent the highest return on investment (80%) of your business’s resources? These represent your business’s areas of comparative advantage.

Focus and concentrate 80% your resources on them.

Questions

1. David Ricardo was a full-time, university economics professor. True or false?

2. Did he come up with just one idea or theory in this lifetime? What was he most famous for?

3. Everyone agreed (and still do) with Ricardo’s Law of Comparative Advantage. Is this right or wrong?

4. What example did he use for this theory?

5. What did Ricardo suggest England and Portugal and other nations do?

6. Can Ricardo’s Law be applied to modern businesses?

7. This can be practical on a personal level. Yes or no?

 

A. Give examples of comparative advantage between two countries.

B. What are some of your town, city and country’s comparative advantage?

C. Do you agree or disagree with the Law or Theory of Comparative Advantage? I completely agree. I agree somewhat. In the middle. Yes and no. Perhaps. I somewhat disagree. I totally disagree. Are there any negative aspects of it?

D. Does your company have a comparative advantage? What is it?

E. What are your comparative advantages at work or your business?

F. How could your country, company or you utilize Ricardo’s theory?