The theory of comparative advantage. THEORY OF COMPARATIVE ADVANTAGE We have just described absolute advantage which 2022-10-04
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The theory of comparative advantage is a key concept in international trade that explains how countries can benefit from specializing in the production of certain goods and services, and then trading those goods and services with other countries. The theory was first developed by economist David Ricardo in the early 19th century and has since become a fundamental principle of international economics.
According to the theory of comparative advantage, a country has a comparative advantage in the production of a particular good or service if it can produce that good or service at a lower opportunity cost than other countries. Opportunity cost refers to the next best alternative that must be given up in order to produce a particular good or service. For example, if a country has a large supply of cheap labor and a relatively small supply of capital, it may have a comparative advantage in the production of labor-intensive goods, such as clothing or shoes, because the opportunity cost of producing these goods is lower than in countries with a higher capital-labor ratio.
The theory of comparative advantage suggests that countries can benefit from specializing in the production of goods and services in which they have a comparative advantage and then trading with other countries that have a comparative advantage in different goods and services. This specialization and trade can lead to increased efficiency and economic growth for all countries involved.
One of the key insights of the theory of comparative advantage is that countries do not need to be the most efficient producers of a particular good or service in order to benefit from specializing in its production. Instead, they only need to be relatively more efficient than other countries. This means that even countries with relatively low levels of technology or productivity can still benefit from specializing in the production of certain goods and services and trading with other countries.
There are several factors that can influence a country's comparative advantage, including its natural resources, labor force, technology, and infrastructure. For example, a country with an abundance of oil reserves may have a comparative advantage in the production of oil, while a country with a highly educated and skilled labor force may have a comparative advantage in the production of technology-intensive goods and services.
The theory of comparative advantage has important implications for international trade policy. It suggests that free trade, or the absence of tariffs and other trade barriers, can lead to increased efficiency and economic growth for all countries involved. However, the theory also acknowledges that there may be distributional effects of trade, meaning that some groups within a country may benefit more from trade than others.
In conclusion, the theory of comparative advantage is a key concept in international trade that explains how countries can benefit from specializing in the production of certain goods and services and then trading those goods and services with other countries. By understanding and applying the principles of comparative advantage, countries can increase efficiency, promote economic growth, and improve the well-being of their citizens.
Theory of comparative advantage (int trade) Flashcards
It is more efficient for Portugal to export wine and trade it for cloth than to produce cloth domestically. A country will specialise in that line of production in which it has a greater relative or comparative advantage in costs than other countries and will depend upon imports from abroad of all such commodities in which it has relative cost disadvantage. It means you trade off saving 600 USD in order to earn 10,000 USD; this is a comparative advantage. In economics, Theory of Comparative advantage refers to the ability of a party to produce a particular good or service at a lower marginal and opportunity cost over another. In the above example, Portugal has an absolute superiority in both branches of production. In relative terms, however, country A has comparative advantage in specialising in the production and export of commodity X while country B will specialise in the production and export of commodity Y. Ricardo showed that the specialization good in each country should be that good in which the country had a comparative advantage in production.
What Is Comparative Advantage Theory? Benefits & Examples
Uses half of total resources per product when there is no foreign trade U. Why choose comparative advantage over absolute advantage? The following discussion clarifies this theory. It is responsible for making things that people need, such as food, clothing, and shelter; even services are provided by labor. In his example, Ricardo imagined two countries, England and Portugal, producing two goods, cloth and wine, using labor as the sole input in production. ADVERTISEMENTS: From the above cost ratios, it follows that country A has comparative cost advantage in the production of X and B has comparatively lesser cost disadvantage in the production of Y. Indeed, there is only one circumstance in which England would not have a comparative advantage in either good, and in this case Portugal also would not have a comparative advantage in either good. Simply put, comparative advantage is the ability to produce more with a given amount of resources than anyone else.
David Ricardo’s Theory of Comparative Cost Advantage
It is then mutually beneficial for both countries to specialize in goods following the principle of comparative advantage Levchenko and Zhang 2016. What Is Absolute Advantage? Comparative advantage example between Germany and Russia The comparative advantage example of Germany and Russia is based on skilled labor and natural resources. See David Ricardo, On the Principles of Political Economy and Taxation, McMaster University Archive for the History of Economic Thought, Elements of Political Economy. Thus the comparative costs principle confers gain upon both the countries. A comparative advantage gives a company the ability to sell goods and services at a lower price than its competitors and realize stronger sales margins. None of these misconceptions about comparative advantage is actually true. This confusion between these two concepts leads many people to think that they understand comparative advantage when in fact what they understand is absolute advantage.
Conditions that maximize comparative advantage do not automatically resolve trade deficits. It is a theory of benefit from the territorial division of labour. All in all, this condition is rather confusing. Finally, the theory of comparative advantage is all too often presented only in its mathematical form. Firms are assumed to maximize profit, while consumers workers are assumed to maximize utility.
As in our earlier example, it assumes that there are only two countries, each with a total of 100 units of resources available, and half of each used in each product. A lower opportunity cost means it has to forego less of other goods in order to produce it. Why comparative advantage is important Comparative advantage is a key concept in economics and the concept can be applied to any sector of the economy. It is also one of the most commonly misunderstood principles. On the basis of Table 2. It could acquire more wheat in trade than it could grow on its own. In other words, production is governed by constant returns to scale.
Portugal had the right conditions to make cheap wine. It takes 120 hours to produce 1 gallon of wine, but in those same 120 hours England can produce 1. Free trade can also increase competitive pressures which also help to reduce monopoly power and reduce prices for consumers. This means that England may nevertheless benefit from free trade even though it is assumed to be technologically inferior to Portugal in the production of everything. We have to make some assumptions to simplify the model, but the fundamental points Ricardo makes are still valid today.
Theory of comparative advantage: advantages and disadvantages
But you still get a housemaid so as to enable you to focus on your job which brings in more income for the household. Competitive advantage is what makes you more attractive to consumers than your competitors. Technology Technology can help companies and countries achieve a comparative advantage in specific sectors. Note this implies that raking takes the son almost two hours compared to one hour for the father. The concept of comparative advantage in economics is used to explain why some countries or groups of countries are better suited to produce specific goods or services than others. Comparative Advantage Versus Absolute Advantage Absolute advantage is anything a country does more efficiently than other countries.
Ricardo’s Comparative Advantage: A Basic Explanation
His criticism is based on an article. For example, the model assumes only two countries producing two goods using just one factor of production. The comparative advantage of Mexico and Canada Another comparative advantage example is between Mexico and Canada, where there is a difference in their types of natural resources as well as skilled labor. The comparative advantage theory considers opportunity cost in the sense that, before specializing or concentrating on what you do best, you have to weigh other opportunities that will forfeit. How does one achieve a comparative advantage? When considering the production of cloth, it takes the labour of 90 men. Calculating comparative advantage Assume both the USA and Saudi Arabia can produce crude oil and cars at different efficiencies.
THEORY OF COMPARATIVE ADVANTAGE We have just described absolute advantage which
She has a comparative advantage in the production of wine, since here her cost-difference is relatively greater than in the case of cloth. If signifies that country B has less comparative disadvantage in the production of Y commodity. If country A gives up OB quantity of Y and diverts resources to the production of X, it can produce OC 1 quantity of X, which is more than OB 1. In the real world, factors are not perfectly mobile, this limits specialization of production of one good in all countries Assumption of no transport costs unlikely to hold in the real world. Suppose its neighbor has no oil but lots of farmland and fresh water. Instead, we carry the logic of comparative advantage to the real world and ask how things would have to look to achieve a certain result maximum output and benefits.
The logic behind absolute advantage is quite intuitive. In the same manner, a country gains if it concentrates its resources on the commodities it can produce most efficiently. Country has to move its resources from the production of one good to the other in which it has comparative advantage in to benefit from trade. Recall that the opportunity cost of 1 barrel of wine in the United States is 1 piece of cloth. In the end, we should not say that the model of comparative advantage tells us anything about what will happen when two countries begin to trade; instead, we should say that the theory tells us some things that can happen. It states that there is a point in production where the increased output is no longer worth the additional input in raw materials.