The Supply & Demand Theory of Comparative Advantage

by Walter Johnson

There is no specific body of theory called "Supply and Demand Theory of Comparative Advantage." Instead, these two well-known concepts can be supplied to classical comparative advantage (CA) theory, which is normally strictly a supply side approach to international trade. Because CA is highly static, it does not take development into account. When supply and demand are analyzed within CA theory, the modern economy shows very different results than the classical approach.

David Ricardo

Famous economist David Ricardo first developed the concept of CA in the very beginning of the 19th century. The concept is simple: each country should specialize in producing that object, or group of objects, that it can make the best. If all the productive capacity of the country were to be aimed at that single product in which it was most skilled and efficient, international prices will be at their lowest possible. In general, this is a supply side argument, since "efficiency" here means making the product cheaper than all others. On the other hand, it does not entirely avoid demand, since it is assumed in the very word "advantage" that this product is something demanded on world markets.


Ricardo's theory was static and simple. These were its strengths and weaknesses: In the modern economy, states differ in terms of their size, power, resources and market. Comparative advantage makes little sense when comparing several states of varying levels of industry. Advanced states with large industrial sectors are likely to make almost everything of industrial importance better or more efficiently than poorer agricultural states. This seems to relegate most of the world to acting as raw material and labor suppliers to the far wealthier few.


When a larger and more powerful economy begins to invest and sell products in the poorer state, CA makes little sense. Economies of scale, among other things, assure the larger economy that it will always win any global competition. Demand turns out to be something created rather than answered. Poorer states with limited access to the industrial or technological goods of Europe or America seek to gain access to these goods since they are now associated with power and progress. What occurs is that a small elite connected to the poorer government create their own luxury market at the expense of the country as a whole. This process is called "dependent development" and suggests that CA is an approach that seeks to recreate the poorer country and bring it into the orbit of the powerful.


CA is about comparative technical abilities. In a world market marked by extreme inequalities, stressing "technical ability" is already to load the dice. Large, powerful and well financed firms and economies can easily flood the poorer parts of the world with their goods, values and lifestyle. Countries such as Iran, Belarus, Nigeria, China and even France have reacted vehemently to this "cultural imperialism." CA, when specifically applied to supply and demand, suggest taking advantage of global inequalities for the sake of remaking demand in the poorer states, as well as concentrating supply throughout the industrialized world.


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