Comparative advantage

Published: 2021-06-29 18:00:05
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History First, Adam Smith, in 1776, first suggested the concept of absolute advantage as the basis for international trade in his publication “An Inquiry into the Nature and Causes of the Wealth of Nations”. Absolute advantage, as a principle, refers to the ability of an entity (like an individual, a firm, or a country) to produce a greater quantity of a commodity (product or service) than its competitors, by using the same amount of resources. Adam Smith, pointed out that all countries would have gains simultaneously if they, all, practiced free trade and specialized according to their absolute advantage. Second, Robert Torrens, in 1808, referred to the concept of comparative advantage as the loss from the closing of trade. In his words: “If I wish to know the extent of the advantage, which arises to England, from her giving France a hundred pounds of broad cloth, in exchange for a hundred pounds of lace, I take the quantity of lace which she has acquired by this transaction, and compare it with the quantity which she might, at the same expense of labour and capital, have acquired by manufacturing it at home. The lace that remains, beyond what the labour and capital employed on the cloth, might have fabricated at home, is the amount of the advantage which England derives from the exchange.”.Later, in 1815, Robert Torrens stated the principle of comparative advantage and trade. He articulated it in an article titled “Essay on the External Corn Trade”. Torrens starts the passage by analysing the basic idea of absolute advantage as described by Adam Smith, but, he also moves on to suggest that the simple intuition is not correct. Robert Torrens wrote,“… suppose that there are in England, unreclaimed districts, from which corn might be raised at as small an expense of labor and capital, as from the fertile plains of Poland. This being the case, and all other things the same, the person who should cultivate our unreclaimed districts, could afford to sell his produce at as cheap a rate as the cultivator of Poland: and it seems natural to conclude, that if industry were left to take its most profitable direction, capital would be employed in raising corn at home, rather than bringing it in from Poland at an equal prime cost, and at much greater expense of carriage. But this conclusion, however obvious and natural it may, at first sight, appear, might, on closer examination, be found entirely erroneous. If England should have acquired such a degree of skill in manufactures, that, with any given portion of her capital, she could prepare a quantity of cloth, for which the Polish cultivator would give a greater quantity of corn, then she could, with the same portion of capital, raise from her own soil, then, tracts of her territory, though they should be equal, nay, even though they should be superior, to the lands in Poland, will be neglected; and a part of her supply of corn will be imported from that country.”. This is the first detailed description of one of the major results occurring from the theory of comparative advantage. It makes apparent Torrens\’ understanding that countries might benefit from free trade while reducing or eliminating production of a good, in which it is superior, in terms of technology, at producing. David Ricardo, in 1817, established the idea of comparative advantage by using a compelling and simple numerical example, which can be found in his book “On the Principles of Political Economy and Taxation”. He describes the theory of comparative advantage, the theory that free trade between two or more countries could be mutually beneficial, even if one country has absolute advantage over the other countries in every aspect of the production. Duo to the fact that the idea of comparative advantage is not immediately intuitive, the most appropriate method of explaining it appears to be with a detailed numerical example as provided by David Ricardo. His example will be analyzed in detail on a following chapter. It was so important, that variations of it still are used in most international trade textbooks. Finally, the concept of comparative advantage became a crucial element of international political economy with the publication of Principles of Political Economy by John Stuart Mill in 1848. He described issues such as which countries tended to have greater benefits in a system of trade that is based on comparative advantage, which, according to Stuart Mill, is those with more elastic demands for other countries\’ goods. Definition of Comparative AdvantageThe theory of comparative advantage states that even when a country is able to produce all its good at lower costs than another country can, trade still benefits both countries, based on comparative costs. Ricardo’s writings demonstrated what has become known as:“… the principle of comparative advantage: a nation, like a person, gains from the trade by exporting the goods or services in which it has its greatest comparative advantage in productivity and importing those in which it has the least comparative advantage.”Comparative Advantage can be defined as the ability of a firm or individual to produce commodities or services at a lower opportunity cost than other enterprises or individuals. A comparative advantage provides a firm the ability to sell goods and services cheaper than its competitors and formulate stronger sales margins.It is important to note that a comparative advantage is not the same as an absolute advantage. Absolute advantage suggests that one is the best at something, while the comparative advantage relates more to the opportunity costs of the particular activity. Ricardo\’s AssumptionsDavid Ricardo explains his theory of comparative advantage with the help of specific assumptions that be found below:1. There are two countries and two commodities.2. There is a perfect competition both in commodity and factor market.3. The cost of production is expressed in terms of labour, meaning that the value of a commodity is measured in terms of labour required to produce it. Commodities are also exchanged on the basis of labour content of each good.4. Labour and natural resources are the only production factors.5. Labour is homogeneous in a particular country.6. Labour is perfectly mobile within the same country, but perfectly immobile between countries.7. There is free trade meaning that nothing restricts the movement of goods between countries.8. Production is subject to constant returns to scale.9. There is no technological change. The comparative cost theory is based on the assumptions of static theory.10. Trade between two countries is based on a barter system.11. Full employment exists in both countries.12. There is no transport cost. Ricardo\’s ExampleRicardo considers a world economy consisting of two countries, Portugal and England, which both produce two commodities of the same quality. In Portugal, it is possible to produce wine and cloth with less labor than England would need to produce the same quantities. However, the relative costs of producing those two commodities is different between the countries.Hours of work necessary to produce one unitCountry Cloth WineEngland 100 120Portugal 90 80England could commit 100 hours of labor to produce one unit of cloth, or produce 5/6 units of wine .Portugal could use 90 hours of labor in order to produce one unit of cloth, or produce 9/8 units of wine. Portugal possesses an absolute advantage in the production of cloth due to fewer labor hours, and England holds a comparative advantage due to the lower opportunity cost.Without trade, England requires 220 hours of work to make and consume a unit of cloth and a unit of wine, while Portugal needs 170 hours of work to make and consume the same amounts. England is relatively more efficient at producing cloth than wine, and Portugal is more efficient at producing wine rather than cloth. That\’s why, if each country specializes in the commodity for which it has a comparative advantage, then the global production of both commodities increases, for England can spend 220 labor hours to produce 2.2 units of cloth while Portugal is able to spend 170 hours in order to produce 2.125 units of wine. Furthermore, if both countries specialize in the above way and England trades one unit of its cloth for 5/6 to 9/8 units of wine produced in Portugal, then both countries can consume leastwise one unit each of cloth and wine, with 0 to 0.2 units of cloth and 0 to 0.125 units of wine are remaining in each respective country that can be either consumed or exported.So, if each country specializes in the good for which it holds comparative advantage, then the global production of both goods increases. Consequently, both England and Portugal are able to consume more wine and cloth, when they are under free trade rather than in autarky. A Ricardian Numerical ExampleThe example analyze how both countries will benefit from trade if they specialize in the good they have a comparative advantage and trade some of it for the other good.We set up an example so that one country (the US) can produce both goods cheaper, so it has an absolute advantage in both goods. Ricardo\’s interesting assumption was that a country can benefit from trade even if it is technologically inferior in producing every good.We make the assumption that the exogenous variables in the two countries take their numerical values as sawn in the next table.US aLC = 1 aLW = 2 L = 24France aLC* = 6 aLW* = 3 L* = 24We made the assumption that the U.S. has the absolute advantage in both cheese production and wine production because aLC(1) About Essay SauceEssay Sauce is the free student essay website for college and university students. We've got thousands of real essay examples for you to use as inspiration for your own work, all free to access and download. (adsbygoogle = window.adsbygoogle || []).push({}); ...(download the rest of the essay above)

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