It can be seen that the world production of watches and phones is 310 and 70 respectively. If both countries only produce the good they have an absolute advantage in i.e. Bulgaria produces watches and Morocco phones, then the world output increases to 600 watches and 120 phones. Thus if the countries trade under free trade laws they will both be better off since they will have more goods for the same amount of labour hours.
Comparative advantage theory is a modification of the above absolute advantage theory. Ricardo analysed the trade patterns of two countries with one having an absolute advantage in both goods. This can be seen in the following example.
Again if it is assumed that both countries have 6000 hours of labour and divide those equally between the two goods then the output of the two countries looks like this.
Thus the world production is 63 1/3 units of cloth and 62 ½ units of wine. It can be seen the Portugal is more efficient at producing both goods and thus has an absolute advantage over England. However England is better at producing cloth than it is at producing wine. It has a comparative advantage or least comparative disadvantage in the production of cloth.
Now if England places all the labour hours in the production of cloth then it will produce 60 units of cloth. To increase the world total production Portugal must produce at least 3 1/3 units of cloth. That requires 300 labour hours. If Portugal then puts the other 5700 labour hours in the production of wine they will produce 71 ¼ units of wine. If then the two countries trade under free laws they will both be able to gain from this type of specialisation.
Both the absolute advantage and the comparative advantage theories are based on several assumptions. These are very strong and they make the theories less plausible in the real world. The assumptions are as follows.
It is clear that these assumptions are not always true in the real world. Thus in the real world due to these assumption trade does not always take place and so countries do not benefit from it. Another major assumption in both theories is free trade between the two countries. However this rarely happens in the real world. Countries impose tariffs on imports to provide a safe ground for the domestic producers of the same good. This increases the cost of the traded goods and thus breaking the theory.
The other main problem in the real world is the inequality of countries. Some countries do not have a direct say in who they trade with but rather must follow other countries. For example during the soviet era, the countries under the influence of the USSR could not freely trade with the “western countries”. This was based on political and ideological ideas rather than economic ones.
Another factor for countries to not benefit from trade are protectionist policies set up by a group of countries to protect their domestic producers. The European Union sets quotas and high tariffs on goods that come form outside the EU to provide the domestic producers with an advantage in the market. This presents a disadvantage to countries that can produce the goods cheaper but through the tariffs and quotas their goods become more expensive and thus they sell less and do not benefit from trade.
The two main trade theories of economics are the absolute advantage and the comparative advantage theories. Through these theories, countries can figure out what to produce and how much to produce and then how to trade. However in the real world the assumptions that these theories are based on do not work and thus countries do not benefit from trade. This being true trade still takes place in the world making in economically advantageous. Thus even if the theories do not function as smoothly as they should they still work. Countries trade with each other due to the fact that no single country can be self-sufficient and must trade with others to get some of the goods it cannot produce.
