Economics
Comparative Advantage vs Absolute Advantage
Comparative advantage refers to a country's ability to produce a good or service at a lower opportunity cost than another country, while absolute advantage refers to a country's ability to produce more of a good or service using the same amount of resources. Comparative advantage focuses on opportunity cost, while absolute advantage focuses on productivity.
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12 Key excerpts on "Comparative Advantage vs Absolute Advantage"
eBook - PDF- David Shapiro, Daniel MacDonald, Steven A. Greenlaw(Authors)
- 2022(Publication Date)
- Openstax(Publisher)
What is absolute advantage? What is comparative advantage? 9. Under what conditions does comparative advantage lead to gains from trade? 20 • Review Questions 497 10. What factors does Paul Krugman identify that supported expanding international trade in the 1800s? 11. Is it possible to have a comparative advantage in the production of a good but not to have an absolute advantage? Explain. 12. How does comparative advantage lead to gains from trade? 13. What is intra-industry trade? 14. What are the two main sources of economic gains from intra-industry trade? 15. What is splitting up the value chain? 16. Are the gains from international trade more likely to be relatively more important to large or small countries? Critical Thinking Questions 17. Are differences in geography behind the differences in absolute advantages? 18. Why does the United States not have an absolute advantage in coffee? 19. Look at Exercise 20.2. Compute the opportunity costs of producing sweaters and wine in both France and Tunisia. Who has the lowest opportunity cost of producing sweaters and who has the lowest opportunity cost of producing wine? Explain what it means to have a lower opportunity cost. 20. You just overheard your friend say the following: “Poor countries like Malawi have no absolute advantages. They have poor soil, low investments in formal education and hence low-skill workers, no capital, and no natural resources to speak of. Because they have no advantage, they cannot benefit from trade.” How would you respond? 21. Look at Table 20.9. Is there a range of trades for which there will be no gains? 22. You just got a job in Washington, D.C. You move into an apartment with some acquaintances. All your roommates, however, are slackers and do not clean up after themselves. You, on the other hand, can clean faster than each of them. You determine that you are 70% faster at dishes and 10% faster with vacuuming.
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.
- X. Zhang(Author)
- 1999(Publication Date)
- Palgrave Macmillan(Publisher)
5 Measuring Comparative Advantage The principle of comparative advantage has significant implications for the efficiency of resource allocation and economic growth. The term `compara- tive advantage' is often used interchangeably with `comparative cost' which is closely associated with the term `opportunity cost'. The opportunity cost of a commodity is the value of other commodities which must be forgone so that one extra unit of a commodity may be obtained. This is equivalent to what is expressed in the literature of comparative advantage as `relative price'±that is, the quantity of some commodity that must be given up in exchange for one unit of another commodity. In the classical case, the comparative advantage in a commodity is defined by the divergence between its autarkic and free trade relative prices. The classical definition of comparative advantage is useful for explaining the origins and patterns of trade, but this is not the only expression of comparative advantage. The same questions can also be posed, not in terms of a comparison between autarkic and free trade prices, but in the context of disturbances to an initial trading equilibrium (Jones and Neary 1984). For most, if not all, countries, autarky is non-existent and trade is a fact of life. For a majority of countries, on the other hand, trade is subject to various restrictions and does not flow freely. In such circumstances, a comparison between autarkic and free trade relative prices is not possible. This is by no means to say that the basic principle of comparative advantage is not applicable. In the context of improving resource allocation efficiency and exploiting gains from trade, the comparative advantage in a commodity can generally be defined by a comparison between its domestic opportunity cost and its relative border price.
eBook - PDF- Steven A. Greenlaw, David Shapiro, Daniel MacDonald(Authors)
- 2022(Publication Date)
- Openstax(Publisher)
A country has a comparative advantage when it can produce a good at a lower cost in terms of other goods. Countries that specialize based on comparative advantage gain from trade. 33.2 What Happens When a Country Has an Absolute Advantage in All Goods Even when a country has high levels of productivity in all goods, it can still benefit from trade. Gains from trade come about as a result of comparative advantage. 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. 33.3 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. 33.4 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.
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 - PDF- Dominick Salvatore(Author)
- 2014(Publication Date)
- Wiley(Publisher)
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. The first nation should specialize in the production of and export the commodity in which its absolute disadvantage is smaller (this is the commodity of its comparative advantage) and import the commodity Concept Check Can you state the law of comparative advantage in your own words? in which its absolute disadvantage is greater (this is the commodity of its comparative disadvantage). The statement of the law can be clarified by looking at Table 2.2. The only difference between Tables 2.2 and 2.1 is that the United Kingdom now produces only two yards of cloth per hour instead of five. Thus, the United Kingdom now has an absolute disadvantage in the production of both wheat and cloth with respect to the United States.
eBook - PDF- Dominick Salvatore(Author)
- 2019(Publication Date)
- Wiley(Publisher)
Most of the world trade, especially trade among developed countries, could not 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 to be 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 On the Principles of Political Economy and Taxation, in which he presented the law of comparative advantage. This is one of the most important and still unchallenged laws of economics, with many practical applications. In this section, we will first define the law of comparative advantage; then, we will restate it with a simple numerical example; finally, we will prove it by demonstrating that both nations can indeed TA B L E 2 .1 . Absolute Advantage U.S. U.K. Wheat (bushels/hour) 6 1 Cloth (yards/hour) 4 5 34 Chapter 2 The Law of Comparative Advantage gain by each specializing in the production and exportation of the commodity of its com- parative advantage. In Section 2.6A, we will prove the law graphically. 2.4A The Law of 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. The first nation should spe- cialize in the production and export of the commodity in which its absolute disadvantage is smaller (this is the commodity of its comparative advantage) and import the commod- ity in which its absolute disadvantage is greater (this is the commodity of its comparative disadvantage). The statement of the law can be clarified by looking at Table 2.2. The only difference between Tables 2.2 and 2.1 is that the United Kingdom now produces only 2 yards of cloth per hour instead of 5.
eBook - PDF- Dominick Salvatore(Author)
- 2020(Publication Date)
- Wiley(Publisher)
Most of the world trade, especially trade among developed countries, could not 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 to be 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 On the Principles of Political Economy and Taxation , in which he presented the law of comparative advantage. This is one of the most important and still unchallenged laws of economics, with many practical applications. In this section, we will first define the law of comparative advantage; then, we will restate it with a simple numerical example; finally, we will prove it by demonstrating that both nations can indeed TA B L E 2 .1 . Absolute Advantage U.S. U.K. Wheat (bushels/hour) 6 1 Cloth (yards/hour) 4 5 34 Chapter 2 The Law of Comparative Advantage gain by each specializing in the production and exportation of the commodity of its com-parative advantage. In Section 2.6A, we will prove the law graphically . 2.4A The Law of 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. The first nation should spe-cialize in the production and export of the commodity in which its absolute disadvantage is smaller (this is the commodity of its comparative advantage ) and import the commod-ity in which its absolute disadvantage is greater (this is the commodity of its comparative disadvantage ). The statement of the law can be clarified by looking at Table 2.2. The only difference between Tables 2.2 and 2.1 is that the United Kingdom now produces only 2 yards of cloth per hour instead of 5.
eBook - PDFInternational Trade and Agriculture
Theories and Practices
- Won W. Koo, P. Lynn Kennedy(Authors)
- 2008(Publication Date)
- Wiley-Blackwell(Publisher)
PART Pure Theory of I International Trade CHAPTER Classical Theory of 2 Comparative Advantage W 2.0 INTRODUCTION Consumers around the world benefit from trade. Without trade, someone in Anchor- age, Alaska, could not enjoy French wines and citizens of France could not eat Alaskan salmon. The factors that determine the pattern of trade between countries can be quite obvious. Greenland has difficulty producing bananas and must import them from elsewhere. But in many instances the factors that influence the pattern of trade are not so clear. In the case of two countries that can both produce wine and cheese, why does one country export wine and the other country export cheese? To analyze these issues, classical economists adopted the simplifying assumption of the labor theory of value to explain trade patterns between countries. This theory assumes that labor is the only factor of production and that in a closed economy the prices of all commodities are determined by their labor content. The classical the- ory of international trade is concerned with relative prices as opposed to absolute prices. Given this, goods are exchanged on the basis of the relative amount of labor used to produce goods. In this chapter, the principles of absolute advantage and comparative advantage are presented. In addition, the production equilibrium that maximizes national in- come, the consumption equilibrium that maximizes the country’s social utility, and the corresponding optimal trade flows are discussed. W 2.1 THE PRINCIPLE OF ABSOLUTE ADVANTAGE Adam Smith pioneered the concept that trade between two countries is based on abso- lute advantage. If one country produces a commodity more efficiently than another country and is less efficient in producing a second commodity than the other coun- try, then each country can benefit by specializing in the commodity that it produces
eBook - ePub- Noritsugu Nakanishi(Author)
- 2018(Publication Date)
- WSPC(Publisher)
A specializes in good 1, exports it, and imports good 2 instead. Conversely, country B specializes in good 2, exports it, and imports good 1. The equilibrium trade pattern becomes such that each country exports the good in which it has a comparative advantage over the other country.Absolute advantage: When aALj< aBLj, we say that country A has an absolute advantage in (the production of) good j over country B. This means that country A has more advanced production technology in good j than country B. It should be noted that the absolute advantage in good j neither implies nor is implied by the comparative advantage in good j. Actually, we can easily construct an example in which country B has absolute advantages in both goods, still country A has a comparative advantage in good 1 (i.e., both aAL1> aBL1and aAL2> aBL2hold, but, at the same time, aAL1/aAL2< aBL1/aBL2holds). As shown above, what determines the production and trade patterns is the comparative advantage; the notion of absolute advantage has nothing to do with their determination (as far as the international labor mobility is assumed away). Therefore, it can be the case that firms with higher technology in one country may lose competition against firms with lower technology in the other country and fail to survive in the trading world.Net export and net import: To show how the trade equilibrium price is determined, we introduce the concepts of the net export curve and the net import curve. For the moment, we concentrate our attention on country A. We regard that Fig. 2.2 illustrates the situation in country A. From now on, we focus on the quantities of good 1.If the world market price p happens to be equal to the autarkic equilibrium priceA, the consumption point will be and the consumption of good 1 be 1 in Fig. 2.2 . However, since international trade is allowed, the production point for p =Amay differ from ; it can be any point on segment y′y′′. If production occurs at y′ = (y′1 , 0), then the production of good 1, y′1 , exceeds the consumption, 1 . In this case, country A can export y′1 − 1 units of good 1 at the world market price. On the other hand, if production occurs at y′′ = (0, y′2 ′), the consumption of good 1, 1 , exceeds the production of good 1, which is zero. In this case, country A has to import all of 1
eBook - PDF- Rhona C. Free(Author)
- 2010(Publication Date)
- SAGE Publications, Inc(Publisher)
For example, consider the United States and Mexico. Suppose that one laborer using U.S. technol-ogy can produce a computer in 2 hours of work. That same person working with U.S. agricultural technology can harvest a bushel of corn in 1 hour. Now suppose that in Mexico, producing a computer takes a person 12 hours, and harvesting a bushel of corn takes 3 hours. In this example, Mexico is slower at producing both computers and corn. We say that the United States has an absolute advantage in producing both goods because it can produce each of them at a lower cost (measured in person-hours) than Mexico. Comparative Advantage In 1817, a British economist named David Ricardo turned this idea of absolute advantage on its head. Using a model with two countries and two goods, he demon-strated that even if one country has an absolute advantage in the production of both goods, both countries can still gain from trade as long as their relative productivities for each good differ. The implications of this insight were huge. A country does not have to be highly developed or technologically advanced to reap the benefits of the global economy. 411 412 . INTERNATIONAL ECONOMICS To see how this works, consider the example of the United States and Mexico described before. In this case, the United States is absolutely better at producing each good. However, relative productivities differ across the countries. In the United States, making one computer takes twice as long as harvesting a bushel of corn. So for each computer produced, the United States must forgo produc-tion of two bushels of corn. This tradeoff between the out-puts of each good is known as the opportunity cost of production. The opportunity cost of producing a computer in the United States is two bushels of corn, and the oppor-tunity cost of producing a bushel of corn in the United States is one half of a computer. However, in Mexico, the opportunity cost of producing a computer is much higher.
eBook - PDF- Elhanan Helpman(Author)
- 2011(Publication Date)
- Belknap Press(Publisher)
Comparative Advantage 17 Thus England would give the produce of the labour of 100 men, for the produce of the labour of 80. Such an exchange could not take place between the individuals of the same country. The labour of 100 Englishmen cannot be given for that of 80 Englishmen, but the produce of the labour of 100 Englishmen may be given for the pro-duce of the labour of 80 Portuguese, 60 Russians, or 120 East Indians. The difference in this respect, between a single country and many, is easily accounted for, by considering the difficulty with which capital moves from one country to another, to seek a more profitable employ-ment, and the activity with which it invariably passes from one province to another in the same country. (Ricardo, 1971, pp. 153–154) Ricardo then notes that under these circumstances it would be advan-tageous to move to Portugal the resources that England employs in the production of cloth in order to manufacture cloth in the more efficient country (i.e., the country with the absolute advantage in the manufactur-ing of cloth). But given the attachment of resources to countries, these efficiency gains cannot be realized. This discussion contains one of the most celebrated results in eco-nomics: patterns of specialization and trade are determined by comparative advantage and not by absolute advantage. 9 England exports cloth despite the fact that it takes more English workers than Portuguese workers to produce the same amount of cloth, because in England the use of labor in the production of cloth relative to the use of labor in the production of wine is 100 / 120 while in Portugal it is 90 / 80, and 90 / 80 is larger than 100 / 120. In other words, English workers are relatively more effi-cient in the production of cloth, while Portuguese workers are relatively more efficient in the production of wine.
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