Economics
Comparative Advantage
Comparative advantage refers to a country's ability to produce goods or services at a lower opportunity cost than another country. This concept is based on the idea that countries should specialize in producing goods or services in which they have a comparative advantage, and then trade with other countries to obtain goods and services in which they have a comparative disadvantage.
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10 Key excerpts on "Comparative Advantage"
eBook - PDFInternational Economics and Business
Nations and Firms in the Global Economy
- Sjoerd Beugelsdijk, Steven Brakman, Harry Garretsen, Charles van Marrewijk(Authors)
- 2013(Publication Date)
- Cambridge University Press(Publisher)
Can we say anything specific about trading patterns between countries? The answer is yes. We start with the most famous part of the answer, by introducing the concept of Comparative Advantage . Countries are often said to benefit from competitive advantages , or to suffer from a lack of them. We also briefly discuss the notion of competitive advantage in relation to Comparative Advantage . 23 Not only commodities and services can be traded, but also capital. In this chapter, we focus on international trade in commodities and services, as listed on the current account (see Chapter 2). In Part III of this book we turn to capital fl ows. Learning objectives * Understanding the notion of Comparative Advantage * Understanding the causes of Comparative Advantage * Understanding the differences between competitive and Comparative Advantage * Understanding the empirical relevance of Comparative Advantage 3.2 Comparative Advantage: David Ricardo ’ s fundamental insight ............................................................................ The theory of Comparative Advantage is one of those ideas that separates economists from other people: it is a remarkable insight that, once understood, should remain in the toolbox of every economist. In the words of Paul Samuelson ‘ Comparative Advantage is one of the few ideas in economics that is true without being obvious ’ . 24 To avoid unnecessary complications we make a number of simplifying assumptions. There is only one factor of production: labour. This factor of production is perfectly mobile within countries, but cannot migrate across national borders. As a conse-quence the factor reward, in this case the wage rate, is therefore the same in di ff erent sectors within a country, but may di ff er between countries. Furthermore, markets are characterized by perfect competition. 25 This implies that we do not have to deal with strategic interactions between fi rms or consumers.
eBook - PDFInternational Trade and Agriculture
Theories and Practices
- Won W. Koo, P. Lynn Kennedy(Authors)
- 2008(Publication Date)
- Wiley-Blackwell(Publisher)
Each country can produce and consume more, indicating that trade is mutu- ally beneficial. However, the principle of absolute advantage cannot be generalized to explain all trade between nations. 2 David Ricardo introduced the principle of Comparative Advantage. He argued that even though one country has absolute advantage in the production of all commodities, the county should specialize in producing commodities in which it has greater advantage. The other country should specialize in producing the commodities in which it has a smaller disadvantage. In this case, both countries will produce and consume more by specializing in the produc- tion of one commodity and exchanging their output. Gottfried Haberler used the concept of opportunity cost to explain the principle of com- parative advantage. The opportunity cost of a commodity is defined as the amount of the other commodity that one must give up to produce an additional unit of the commodity. Haberler stated that a country has a Comparative Advantage in the production of a com- modity over the other country if its opportunity cost of the commodity is lower than that of the other country. 4 A country's PPF can be derived from its production function and the equilibrium condi- tion in its labor market. The PPF shows alternative combinations of two commodities that the country can produce by fully utilizing its resources (labor). The country's objective is to maximize the total value of output under the constraint of the PPF. The production equilibrium is obtained at the point at which the PPF intersects the highest income line. An income line associated with the production equilibrium point is known as the con- sumption possibilities frontier (CPF), implying that consumers in the country can consume at any point on the CPF. 5 The consumption equilibrium is obtained at the point at which the CPF is tangent to the highest attainable social indifference curve.
eBook - ePub- Noritsugu Nakanishi(Author)
- 2018(Publication Date)
- WSPC(Publisher)
Chapter 2
Basics of Comparative Advantage
When the relative price of a good in one country is lower than in other countries, the first country is said to have a Comparative Advantage in this good over other countries.1 Differences in the relative prices are, among others, the most important driving force of international trade. A country will export its products to foreign markets where prices are higher than in its own markets and, conversely, import goods and services from foreign markets where prices are lower than in its own markets. In this way, there emerges a trade pattern — a description of which country imports or exports what kind of goods and services. Therefore, the first step to examine the structure of international trade is to show how the differences in relative prices across countries are determined. In this chapter, we first introduce a simple trade model called the Ricardian model, which highlights the roles of the differences in production technology as one of the determinants of Comparative Advantage. Then, we extend and generalize it into several different directions.2.1Technology and Behavior of Firms
Consider a world economy consisting of two countries (A and B), two goods (good 1 and good 2), and one primary production factor called labor. Goods are produced by using only labor as inputs under constant-returns-to-scale (CRS) technologies. The production technology characterized by both a single production factor and CRS is called the Ricardian technology. Free entry–exit of firms is also assumed.For the moment, we concentrate on the situation in one of the countries. In general, production functions and other variables introduced below depend not only on the identities of goods but also on the identities of countries to which they belong. Unless necessary, we omit explicit indications of the identities of countries from the variables.
eBook - PDF- Dominick Salvatore(Author)
- 2012(Publication Date)
- Wiley(Publisher)
What is important is that both nations can gain from specialization in production and trade. (We will see in Section 2.6 how the rate at which commodities are exchanged for one another is determined and how the gains from trade are divided among the trading nations.) Table 2.1. Absolute Advantage U.S. U.K. Wheat (bushels/hour) 6 1 Cloth (yards/hour) 4 5 Chapter Two Comparative Advantage 37 Absolute advantage, however, can explain only a very small part of world trade today, such as some of the trade between developed and developing countries. Most of world trade, especially trade among developed countries, cannot be explained by absolute advantage. It remained for David Ricardo, with the law of Comparative Advantage, to truly explain the basis for and the gains from trade. Indeed, absolute advantage will be seen as only a special case of the more general theory of Comparative Advantage. 2.4 TRADE BASED ON Comparative Advantage: DAVID RICARDO In 1817 Ricardo published his Principles of Political Economy and Taxation, in which he presented the law of Comparative Advantage. This is one of the most important and unchallenged laws of economics, with many practical applications. In this section, we will define the law of Comparative Advantage and restate it with a simple numerical example. In the next section, we will prove it by demonstrating that both nations can indeed gain by each specializing in the production and exportation of the commodity of its Law of Comparative Advantage It pos- tulates that a nation should specialize in and export the com- modity in which its absolute disadvan- tage is smaller (this is the commodity of its comparative advan- tage), and should import the other commodity. Comparative Advantage. According to the law of Comparative Advantage, even if one nation is less efficient than (has an absolute disadvantage with respect to) the other nation in the production of both commodities, there is still a basis for mutually beneficial trade.
No longer available |Learn more- William Baumol, Alan Blinder, John Solow, , William Baumol, Alan Blinder, John Solow(Authors)
- 2019(Publication Date)
- Cengage Learning EMEA(Publisher)
Chapter 3 The Fundamental Economic Problem: Scarcity and Choice 49 produces 24 pounds of coconuts and 4 pounds of fish. We can think of points C and D as production points, because they show what Kim and Matt produce. But if they trade with each other, Kim and Matt are not limited to consuming what they person-ally produce. The red arrows represent the trade of 5 pounds of fish for 7 pounds of coconuts, which take Kim and Matt from their production points to their consumption points (labeled E and F). Notice that points E and F lie above Kim and Matt’s production possibilities frontiers. That’s the graphical depiction of the benefits of specialization and trade; it allows both people to consume bundles of goods that they aren’t capable of pro-ducing on their own. This is why economists generally believe that specialization and trade is a win-win proposition, whether between individuals or between countries. THE SURPRISING PRINCIPLE OF Comparative Advantage Even if one country (or one worker) is worse than another country (or another worker) in the production of every good, it is said to have a Comparative Advantage in making the good at which it is least inefficient —compared to the other country (or person). David Ricardo discovered that two countries can gain by trading even if one country is more efficient than another in the production of every commodity. Precisely the same logic applies to individual workers or to businesses. In determining the most efficient patterns of production and trade, it is Comparative Advantage that matters. Thus, a person (or country) can gain by buying a good from someone else even if the buyer could produce the good more efficiently than the seller. Such purchases make sense if they enable the buyer to specialize in producing those goods at which it is even more efficient . And the other, less efficient producer should specialize in selling the goods in whose production it is least inefficient .
eBook - PDF- David Shapiro, Daniel MacDonald, Steven A. Greenlaw(Authors)
- 2022(Publication Date)
- Openstax(Publisher)
By specializing in a good that it gives up the least to produce, a country can produce more and offer that additional output for sale. If other countries specialize in the area of their Comparative Advantage as well and trade, the highly productive country is able to benefit from a lower opportunity cost of production in other countries. 20.3 Intra-industry Trade between Similar Economies A large share of global trade happens between high-income economies that are quite similar in having well- educated workers and advanced technology. These countries practice intra-industry trade, in which they import and export the same products at the same time, like cars, machinery, and computers. In the case of intra-industry trade between economies with similar income levels, the gains from trade come from specialized learning in very particular tasks and from economies of scale. Splitting up the value chain means that several stages of producing a good take place in different countries around the world. 20.4 The Benefits of Reducing Barriers to International Trade Tariffs are placed on imported goods as a way of protecting sensitive industries, for humanitarian reasons, and for protection against dumping. Traditionally, tariffs were used as a political tool to protect certain vested economic, social, and cultural interests. The WTO has been, and continues to be, a way for nations to meet and negotiate in order to reduce barriers to trade. The gains of international trade are very large, especially for smaller countries, but are beneficial to all. Self-Check Questions 1. True or False: The source of Comparative Advantage must be natural elements like climate and mineral deposits. Explain. 2. Brazil can produce 100 pounds of beef or 10 autos. In contrast the United States can produce 40 pounds of beef or 30 autos.
eBook - PDF- Dominick Salvatore(Author)
- 2020(Publication Date)
- Wiley(Publisher)
The mercantilists believed that a nation could gain in international trade only at the expense of other nations. As a result, they advocated restrictions on imports, incentives for exports, and strict government regulation of all economic activities. 3. According to Adam Smith, trade is based on abso-lute advantage and benefits both nations. (The discussion assumes a two-nation, two-commodity world.) That is, when each nation specializes in the production of the commodity of its absolute advantage and exchanges part of its output for the commodity of its absolute disadvantage, both nations end up consuming more of both commodities. Absolute advantage, however, explains only a small portion of inter-national trade today. 48 Chapter 2 The Law of Comparative Advantage 4. David Ricardo introduced the law of comparative advan-tage. This postulates that even if one nation is less efficient than the other nation in the production of both commodities, there is still a basis for mutually beneficial trade (as long as the absolute disadvantage that the first nation has with respect to the second is not in the same proportion in both commodities). The less efficient nation should specialize in the production and export of the commodity in which its absolute disadvantage is smaller. (This is the commodity of its Comparative Advantage.) Ricardo, however, explained the law of Comparative Advantage in terms of the labor theory of value, which is unacceptable. 5. Gottfried Haberler came to the “rescue” by explaining the law of Comparative Advantage in terms of the opportunity cost theory. This postulates that the cost of a commodity is the amount of a second commodity that must be given up to release just enough resources to produce one additional unit of the first commodity. The opportunity cost of a commodity is equal to the relative price of that commodity and is given by the (absolute) slope of the production possibility frontier.
eBook - PDF- Dominick Salvatore(Author)
- 2019(Publication Date)
- Wiley(Publisher)
The mercantilists believed that a nation could gain in international trade only at the expense of other nations. As a result, they advocated restrictions on imports, incentives for exports, and strict government regulation of all economic activities. 3. According to Adam Smith, trade is based on abso- lute advantage and benefits both nations. (The discussion assumes a two-nation, two-commodity world.) That is, when each nation specializes in the production of the commodity of its absolute advantage and exchanges part of its output for the commodity of its absolute disadvantage, both nations end up consuming more of both commodities. Absolute advantage, however, explains only a small portion of inter- national trade today. 48 Chapter 2 The Law of Comparative Advantage 4. David Ricardo introduced the law of comparative advan- tage. This postulates that even if one nation is less efficient than the other nation in the production of both commodities, there is still a basis for mutually beneficial trade (as long as the absolute disadvantage that the first nation has with respect to the second is not in the same proportion in both commodities). The less efficient nation should specialize in the production and export of the commodity in which its absolute disadvantage is smaller. (This is the commodity of its Comparative Advantage.) Ricardo, however, explained the law of Comparative Advantage in terms of the labor theory of value, which is unacceptable. 5. Gottfried Haberler came to the “rescue” by explaining the law of Comparative Advantage in terms of the opportunity cost theory. This postulates that the cost of a commodity is the amount of a second commodity that must be given up to release just enough resources to produce one additional unit of the first commodity. The opportunity cost of a commodity is equal to the relative price of that commodity and is given by the (absolute) slope of the production possibility frontier.
eBook - ePubFour Central Theories of the Market Economy
Conception, evolution and application
- Farhad Rassekh(Author)
- 2016(Publication Date)
- Routledge(Publisher)
The demand function in this context represents the various units of imports a country is willing to exchange with her exports. 43 The farther the terms of trade is from a country's production cost of imports (measured in terms of forgone exports), the larger the gains from trade. This analysis implies that under free trade, a small (poor) country (that is, a price-taker in world markets) benefits more than a large (rich) trade partner because the terms of trade would be closer to the cost (price) ratio of the large country and thus (relatively) farther from that of the small country. 44 This result would be reversed if the large country imposed a tariff on its imports from the small country, against which the small country cannot retaliate because she imports too little. 45 This theory sowed the seeds of the optimum tariff argument. 46 4 Comparative Advantage and free trade The economic case for free trade rests on two deductively derived propositions: first, free trade leads countries to the production of the goods in which they have a Comparative Advantage; second, production based on Comparative Advantage results in efficient resource allocation. Hence free trade maximizes efficiency and the gains from trade. Indeed, the theory of Comparative Advantage provides a powerful case for free trade. 47 Historically, however, support for free trade did not always rest on Comparative Advantage. In fact, the classical economists from Ricardo to J. S. Mill usually invoked the theory of Comparative Advantage not to justify free trade but to explain why trade takes place among all countries. Moreover, when they did advance a case for free trade they often resorted to the type of arguments we encounter in the Wealth of Nations. Even Ricardo, in making a case for free trade, advanced an argument reminiscent of Smith's invisible-hand passage in the Wealth of Nations
eBook - PDF- Peter B. Kenen(Author)
- 2000(Publication Date)
- Cambridge University Press(Publisher)
Also G. D. A. MacDougall, “British and American Exports: A Study Suggested by the Theory of Comparative Costs,” Economic Journal , 61 (December 1951); reprinted in American Economic Association, Readings in International Economics (Homewood, Ill.: Richard D. Irwin, 1968), ch. 32. For a rigorous examination of the geographic and economic forces affecting Comparative Advantage and its evolution over time, see Paul Krugman, Geography and Trade (Cambridge, Mass.: MIT Press, 1991). QUESTIONS AND PROBLEMS (1) “As the government can affect Comparative Advantage by subsidizing fi rms to invest in raising productivity, the gains from trade are arti fi cial. Hence, no one should object when the government uses tariffs instead to protect those fi rms from foreign competition.” Comment. (2) “In the Ricardian model, the opening of trade raises the real wage in terms of the import good without reducing it in terms of the export good, so workers should favor trade. But workers facing import competition usually oppose trade, so something is wrong with the model.” Comment. (3) Using the following numbers for France and Germany and for grain and steel, derive a world transformation curve for those two countries: Workers Needed to Produce Number of Bushel Ton of Pair of Country Workers of Grain Steel Shoes France 100 2 5 4 Germany 160 4 10 6 Italy 60 5 20 1 Which country will export steel? Let the wage rate be $10 in both France and Germany before trade and suppose that the German wage is fi xed. What must happen to the French wage for both countries to specialize completely after trade is opened? (4) Using the numbers in (3) for Germany and Italy and for steel and shoes, calculate the relative price of steel in each country before trade and each country’s real wage in terms of steel and in terms of shoes. Let the relative price of steel be 4 pairs of shoes per ton of steel after trade is opened.
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