Other Resources

The first simplifying assumption is that there is only one resource: labor. When Ricardo originated the comparative advantage theory of international trade, most economists accepted the "labor theory of value," that is, the hypothesis that "natural" prices are proportional to the labor costs of the different goods. However, modern economics recognizes that there are at least 3 "factors of production," no one of which determines the price by itself.

For our purposes, this really is nothing more than a simplifying assumption. In fact, the existence of more than one kind of resource strengthens the comparative advantage theory. Remember, it is differences in relative costs that makes trade mutually beneficial. Why do the costs differ from one country to another? In the example of Britain and Portugal, differences in climate provide the answer. But another answer is that different countries have resources in different proportions -- some with more investment per worker, for example, and some with less. That might be one explanation for differences in costs in manufacturing industries, such as cars and bulldozers in the U. S. and Japan example.

Some of the most important and successful twentieth century research in international trade economics has shown that different resource endowments can be the primary basis for mutually beneficial international trade.

Exact Prices