Theory of absolute and comparative advantage in international trade. Comparative Advantage 2022-10-12
Theory of absolute and comparative advantage in international trade Rating:
4,8/10
1925
reviews
The theory of absolute and comparative advantage is a fundamental concept in the field of international trade. It explains how and why countries engage in trade with one another and how this trade can be mutually beneficial.
The theory of absolute advantage refers to a country's ability to produce a good or service more efficiently than any other country. This means that the country can produce the good or service at a lower cost, in terms of the resources (such as labor, capital, and raw materials) used to produce it. A country with an absolute advantage in a particular good or service has a competitive advantage in the global market and can sell its products at a lower price, making them more attractive to foreign buyers.
The theory of comparative advantage, on the other hand, refers to a country's ability to produce a good or service at a lower opportunity cost than any other country. Opportunity cost is the cost of foregone opportunities, or the value of the next best alternative that must be given up in order to produce a particular good or service. A country has a comparative advantage in a good or service if it can produce it at a lower opportunity cost than any other country, even if it is not the most efficient producer of that good or service.
One of the key insights of the theory of comparative advantage is that trade can be mutually beneficial for countries even if one country has an absolute advantage in every good and service. This is because countries can still specialize in the production of goods and services in which they have a comparative advantage, and then trade with other countries for the goods and services that they need. This specialization leads to increased efficiency and productivity, resulting in lower costs and prices for consumers and higher profits for producers.
The theory of absolute and comparative advantage has important implications for international trade policy and globalization. It suggests that countries can benefit from engaging in trade with one another, even if one country has an absolute advantage in every good and service. This has led to the expansion of international trade and the increasing integration of global markets.
However, it is important to note that the theory of absolute and comparative advantage is not without its criticisms. Some argue that it does not fully capture the complexity of international trade, as it does not take into account factors such as transport costs, tariffs, and other trade barriers. Others argue that it does not adequately address issues of inequality and the distribution of the benefits of trade. Despite these criticisms, the theory of absolute and comparative advantage remains a cornerstone of international trade theory and continues to be widely studied and applied.
8 Theories of International Trade: Explained, PPT Available
The gains from trade for the two trading countries can be shown through Table 2. In this, both countries should supply production advantages to each other. International trade professionals calculate both absolute advantages and comparative advantages to help determine which entity offers the lowest production costs for the highest profit. Strategy, Structure, Rivalry- How many Competitors and what structure they are using in the sale, marketing, etc 4. They have a significant impact on how and why countries and enterprises allocate resources to the creation of specific items. Comparative advantage is distinct in that it considers the opportunity costs associated with producing multiple types of goods with limited resources.
Absolute vs. Comparative Advantage: Key Differences
According to the modern theory of comparative advantage, China should mainly produce and export labor intensive products, while imports of capital intensive products. The Bottom Line The idea of absolute advantage was developed by Scottish economist Adam Smith, who explained how countries can profit by only specializing in the goods and services they can produce efficiently. Innovation can be represented in a new product design, new production process, or a new marketing strategy. When the demand grows, that country should move production factories to a developing country to meet demands at less cost. This economical insight into farming in early 18 th Century was the cornerstone of the law of absolute advantage. Companies achieve competitive advantage from acts of innovation. As an example, if Japan and Italy can both produce automobiles, but Italy can produce sports cars of a higher quality and at a faster rate with greater profit, then Italy is said to have anabsolute advantagein that particular industry.
Absolute vs. Comparative Advantage: What’s the Difference?
Similarly net gain to country B is +10 units of Y. These economic policies can help determine how countries, companies or businesses choose to manufacture and trade for products. Ricardo suggests while producing the costs should be checked carefully and compared and then the product asking comparatively less cost should be produced. Under the assumption between the two elements of capital and labor, factor density can be measured by the capital labor ratio used in production. Initially, economists developed International Trade Theories Absolute Advantage Theory Absolute advantage theory was proposed by Scottish social scientist Adam smith in 1776. Behavior and motivation of buyers are the significant factors to consider in domestic business and knowledge of basic causes and nature of business is more emphasized in international business or trade.
He believes that success in international trade comes from the four interrelated components, which are factor conditions, demand conditions, related and supporting industries, and firm strategy structure, and rivalry. On the other hand, Doug might take longer to mow yards than other people would take. How does comparative advantage lead to gains from trade? It suggests a nation should specialize its production in the product in which it gets absolute cost advantage and ignore in which it gets absolute disadvantage. He explained, there is always not necessary to have factor endowments or structures to have international trade it may occur without it but having economies of scale. Later on, when demand for the product grows country will undertake foreign direct investment in other countries and open several manufacturing plants to meet the request. This is because the concept of absolute advantage concentrates mainly on maximizing production with the same resources available without accounting for the possibility of cost reduction. International Trade Theories Absolute Comparative and Competitive Advantage.
There is a limited amount of wealth i. It also puts a state in a profitable and superior strategic business position in the global markets OU, 2010. David Ricardo solved this problem by introducing the theory of comparative advantage, which states that a country should specialize and export those goods and services for which it is relatively more productive than other countries are and import those goods and services for which other countries are relatively more productive than it is Griffin et al. To be accurate it its claims, the theory of comparative advantage only holds true if the value of the goods traded is of a similar nature. And in the following paragraphs, I am going to introduce what is international trade, other possible benefits of trading globally and the bottom line.
Theory of Absolute Advantage and Comparative Advantage
Alternatively, if all the resources are used in the production of Y, it is possible to produce OB quantity of Y. However, when determining a comparative advantage, they also take opportunity cost into account. But so long as the theory of comparative advantage limits the evaluation of a product to production costs it will not accurately predict which trade in goods result in benefits. This research aids governments in avoiding the creation of products with little or no market demand, resulting in losses. Exports start to decline.
It says that initially new products will be produced and exported from the home country of its innovation. If each country has at its disposal 2 man-days and 1 man-day is devoted to the production of each of the two commodities, the respective production in two countries can be shown through the hypothetical Table 2. There are two problems in this theory. Examples of countries that adopted import based industries are countries of Latin America while countries that adopted Export oriented Industries are countries of East Asia. Having a comparative advantage in X, Country A sacrifices less of Y than Country B.
Another problem with the general application of this theory is the limitation on sources of value for a good. The essay states that comparative advantage can be a reason for international trade; however there are still problems with its implication in practice. Undoubtedly, the slogans of self- reliance and protectionism have been raised from time to time, but the self-reliance has eluded all the countries even up to the recent times. Example: If Germany and France both produce automobile engines, business analysts identify which country has the best manufacturing results according to time, quality and profit. Let's say Worker A produces 60 glue sticks and 25 large foam pads per hour and Worker B produces 20 glue sticks and 35 foam pads per hour. And, where originally the new product is originated, their people find it cheaper and beneficial to use foreign same products over their domestic country.
International Trade Theories Absolute Comparative and Competitive Advantage
Even though the comparative advantage is very useful for explaining the reasons of trade and the increases welfare of the trading partners by trade, this theory is still incomplete. What if one country had an absolute advantage in both products? The theory must assume efficient transportation, efficient labor and ready capital. Therefore, the absolute advantage to produce wine is France because one hour of labor produces two bottles in France, but Japan only produces one. An absolute advantage encourages specialization in an area where the entity exhibits exceptional production capabilities regarding the quality of the product and the total manufacturing time. Porter also concluded that their home environment is the most forward-looking, challenging, and dynamic so that nations succeed in particular industries. Economic effectiveness Calculating a comparative advantage tells economists and financial professionals which production option offers a more solution.
