Economics

The theory of comparative advantage was advanced by David Ricardo in the 19th century. The theory in economics refers to the ability of a region, nation, firm or individual being able to produce specific goods and services more efficiently than other parties. The party in question can produce other goods but is able to produce some specific goods at a lower opportunity cost than its counterparts. Thus, Ricardo suggested that the two parties should strive to produce those goods that they can produce at lower opportunity costs over other goods no matter how good they are at producing the other goods (Suranovic, 2007).

There are a lot of misconceptions as regards this theory it is often confused with the theory of absolute advantage which refers to the capability of a party to produce specific goods at absolute costs that are lower than others the theory is mostly presented mathematically the theory contradicts simple logic as seen from the results of models (Suranovic, 2007).

A simple illustration of the law of comparative advantage
Two countries A and B both produce wool and food. However, country A produces more wool and food than country B. Therefore, it has an absolute advantage in the production of both wool and food. However, it produces more wool than food.
Country wool food
A 15 30
B 10 15

The above is a table of the costs in terms of labour hours required to produce wool and food in countries A and B. The production of an extra unit of food by country A will mean less production of wool by 2 units. Therefore, the opportunity cost of 1 unit of food is 2 units of wool. In country B, production of an extra unit of food will lead to less production of wool by 1.5 units. Thus, the opportunity cost of 1 unit of food is 1.5 units of wool. Country B is better at the production of wool than food. It thus has a comparative advantage in the production of wool. Country A is better at the production of wool than food and thus has a comparative advantage in the production of wool. However, country B has an absolute advantage in the production of both commodities. It would be advantageous for both countries if they were to engage in trade.

Before After
Country wool food wool food
A 8 5 18 0
B 9 6 0 12
Total 17 11 18 12 (Mulligan, Hay  Brewer, n.d.).

Production Possibilities for A and B

Country A would give up production of food and thus would be able to produce 10 extra units of wool due to the opportunity cost of 2. Country B would give up production of wool and focus on food. It would then be able to produce 6 extra units of food due to the opportunity cost of 1.5. Clearly, total production of both countries would increase. By specializing, the overall benefit to the world economy on the production of both commodities would increase.

Assumptions however were made by Ricardo in the simple model.
There is free trade and barriers of trade are not present
Production costs do not change
The costs of transporting commodities is not considered
Both parties have full knowledge and are aware of the cheapest place to get goods internationally
The economies of scale are non existent... (Mulligan, Hay  Brewer, n.d.).

Most countries in joining free international trade fear they will be out-produced by other countries that have absolute advantage in certain areas. Thus, this would lead to alot of imports and very litttle exports. A disadvantage for them... (Investopedia, n.d.). Comparative advantage suggests specialization in production of certain goods for export and importing the rest despite their absolute advantage in production of all goods. This has been applied in international trade. During the industrial revolution, Britain outsourced production of food by importing food stuffs such as cheese and wine, but, it focussed on the production of manufactured foods which it exported.

The problem with the law of comparative advantage today is that it is affected by monetary policies and exchange rates.

In international trade, countries trade from different regions and different economies. There are countries that are economically developed compared to others. The value of their currencies in the international market is thus higher than other countries. Also, international trade is done in specific currencies that favour certain countries over others. Comparative advantage in such situations does not apply since developing countries lose out in trading with developed countries.

Take an example of trade between Kenya (a developing country in East Africa) and Britain (a developed country in Europe). The value of the British pound vs the Kenyan shilling is roughly 140 Kenya shillings for every 1 British pound. Kenya has a comparative advantage in the production of food stuffs. Britain has a comparative advantage in the production of machinery and manufactured goods. However, in the trade between the two countries, Kenya loses out since they have to pay more for the machinery due to the difference in the foreign currency exchange rates. Kenya is thus forced to pay more Kenya shillings to convert into British pounds to buy machinery from the UK. Britain doesnt pay as much for the food stuffs since its currency has more value than Kenyas currency in the international market. Therefore, the law in such a case fails to benefit both countries and one country ends up benefiting over the other despite the trade being done in a common currency i.e. British pound, the exchange rates heavily affect one country. Therefore, such monetary distortion affects the law. The law would be less affected  in a perfect world economy with no differences in foreign exchange rates Differences in the costs of factors of production also have an effect on the thoery.

In the economy of today, comparative advantage hardly applies due to existence of quotas, taxes and regional trade. There are a lot of countries that are able to produce a particular product. Therefore, there are options as to where such commodities can be bought. Factors such as transport costs and international relations affect the trade of such commodities. The perfect situation that Ricardo used does not exist.