Ricardo argued that in national markets absolute advantage prevails, but in international markets comparative advantage operates.
He gives the example of England & Portugal, where Portugal has an absolute advantage in both wine & cloth:
100 labour years on cloth
120 labour years on wine
80 labour years on wine
90 labour years on cloth
Portugal is assumed to be 50% more productive producing wine & 11% more productive producing cloth than England.
If Portugal specialises in wine & England cloth:
Portugal can spend 170 labour years producing wine
England 220 labour year producing cloth
If half of wine consumed in Portugal & other half exported for cloth:
Portugal consumes 85 labour years of wine, an increase of 6.25%
Portugal consumes half of the English cloth, 110 years, an increase of 11%
England consumes 110 years of cloth, up 10%
England consumes half of Portugal’s wine, 85 years, up 6.25%
Ricardo assumes profits tend to equalise in home markets but not on the world market.
How does the inefficient English cloth industry drive the Portuguese one out of business?
Ricardo is assuming money is neutral.
If England has higher prices, free trade will result in a trade deficit.
Gold will flow to Portugal.
According to the QTM this will increase prices in Portugal & result in trade balancing.
If the QTM is correct comparative advantage trumps absolute advantage.
Liberal free trade ideology rests upon:
1. Say’s Law
2. Comparative Advantage
Currency v Banking Schools
The crises of 1825 & 1837 were preceeded by external drains on gold that forced the BofE to increase r.
The Currency School argued that the drain of gold wasn’t depressing prices & wages & so restoring trade balance because of the over-issue of paper currency.
Hence the Bank Act of 1844 to tie the issue of paper currency to the quantity of gold.
The act was suspended in 1847, 1857 & 1866 because prices were not sensitive to gold, r were.
It takes recessions to lower prices.
Banking legislation cannot prevent crises.
The Banking School argued the money supply reacts to changes in prices, it doesn’t cause them.
If more commodities produced the money supply increases.
Similarly Keynes argued there was no need to worry about inflation if there was spare capacity.