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David Ricardo: Trade
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To briefly review: David Ricardo discovered the principle of comparative advantage, the basis for free trade. Instead of striving for self-sufficiency, countries should focus on what they can do best and trade with one another for other wants. Ricardo showed that shared gains from trade would result from each country specializing in areas where it had comparative advantage.
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Using his example of two nations (Portugal and England) and two commodities (wine and cloth), Ricardo argued that trade would be beneficial even if Portugal held an absolute cost advantage over England in both commodities. Ricardo's argument was that there are gains from trade if each nation specializes completely in the production of the good in which it has a "comparative" cost advantage in producing, and then trades with the other nation for the other good. The main effect, Ricardo noted, is that overall income levels would rise in both nations.
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It is not possible to overstate the importance of Ricardo’s theorem. As Nobel Laureate Paul Samuelson observes, “This simple principle provides the unshakable basis for international trade.” Indeed, empirical studies show that free trade has been a major force for increased living standards and reduced poverty throughout the world.
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