When asked by mathematician Stanislaw Ulam whether he could name an idea in economics that was both universally true and not obvious, economistPaul Samuelson’s example was the principle of comparative advantage. That principle was derived byDavid Ricardo in his 1817 book, Principles of Political Economy and Taxation. Ricardo’s result, which still holds up today, is that what matters is not absolute production ability but ability in producing one good relative to another.
Reckoned in physical output—for example, bunches of bananas produced per day—a producer’s efficiency at growing bananas depends on the amounts of other goods and services he sacrifices by producing bananas (instead of other goods and services) compared with the amounts of other goods and services sacrificed by others who do, or who might, grow bananas. Here is a straightforward example.
Ann and Bob are the only two people on an island. They use only two goods: bananas and fish. (The assumption of two persons and two goods is made only to make the example as clear as possible; it is not essential to the outcome. The same holds for all subsequent assumptions that I make using this example.)
If Ann spends all of her working time gathering bananas, she gathers one hundred bunches per month but catches no fish. If, instead, she spends all of her working time fishing, she catches two hundred fish per month and gathers no bananas. If she divides her work time evenly between these two tasks, each month she gathers fifty bananas and catches one hundred fish. If Bob spends all of his working time gathering bananas, he gathers fifty bunches. If he spends all of his time fishing, he catches fifty fish. Table 1 shows the maximum quantities of bananas and fish that each can produce.
If Ann and Bob do not trade, then the amounts that each can consume are strictly limited to the amounts that each can produce.