This section needs additional citations for verification.
Intl Trade - Comparative vs. Absolute advantage and comparative advantage are two important concepts in international trade that largely influence how and why nations devote limited resources to the production of particular goods.
They describe the basic economic benefits that countries get from trading with one another. Absolute Advantage Though it is not economically feasible for a country to import all of the food needed to sustain its population, the types of food a country produces can largely be affected by the climate, topography and politics of the region.
Spain, for example, is better at producing fruit than Iceland. The differentiation between the varying abilities of nations to produce goods efficiently is the basis for the concept of absolute advantage. If Japan and the United States can both produce cars, but Japan can produce cars of a higher quality at a faster rate, then it is said to have an absolute advantage in the auto industry.
In this example, the U. When economists refer to specializationthey mean the increase in productive skill that is achieved from focused repetition in producing a good or service.
A country specializes when its citizens or firms concentrate their labor efforts on a relatively limited variety of goods. Historically, specialization arose as a result of different cultural preferences and natural resources.
Whereas absolute advantage refers to the superior production capabilities of one nation versus another, comparative advantage is based on the concept of opportunity cost.
The opportunity cost of a given option is equal to the forfeited benefits that could have been gained by choosing the alternative. If the opportunity cost of choosing to produce a particular good is lower for one nation than for others, then that nation is said to have a comparative advantage.
Assume that both France and Italy have enough resources to produce either wine or cheese, but not both. France can produce 20 units of wine or 10 units of cheese. Say Italy can produce 30 units of wine or 22 units of cheese.
Since neither nation can produce both items, the most efficient strategy is for France to specialize in wine production because it has a comparative advantage and for Italy to produce cheese.
International trade can enable both nations to enjoy both products at reasonable prices because each is specialized in the efficient production of one item. A Little History Adam Smith was the first economist to systematically extend the benefits of specialization to separate nations.
Smith only described specialization and international trade as they related to absolute advantages: England can produce more textiles per labor hour and Spain can produce more wine per labor hour, so England should export textiles and import wine.
Ricardo, borrowing from an essay written by Robert Torrens inexplained how nations could benefit from trading even if one of them had an absolute advantage in producing everything. In other words, if the United States was more productive in every way than China, it would still behoove the U.
The reason for this is opportunity cost.
2)Comparative advantage is a theory suggested by David Ricardo that International trade should be based on nation's comparative advantages and each country should specialize on their own advantages skills or resources/5(4). World Economic Review 2: , 83 the theory of comparative advantage are especially crucial for trade policies that are derived from this theory, This theory dominates international economics or, more precisely, the theory of international trade. It is widely praised and has been vaunted as the “deepest and most beautiful. Essay on Challenging Comparative Advantage - Comparative advantage is a principle developed by David Ricardo in the early 19th century to explain the benefits of mutual trade (Carbaugh, ).
Implications of Comparative Advantage Consider a hypothetical situation where the U. China can produce 50 televisions or 10 cars. This example highlights why there is almost always an economic incentive for two entities, including entire nations, to engage in trade.
This is especially important for less-developed countrieswho are not shut out of international markets because they lack the superior technology and capital infrastructure of wealthy nations.
The Bottom Line Comparative advantage leads to more income for countries.So, let's explore this concept of comparative advantage using some examples from everyday life.
For example, Sally can either produce 3 term papers in one hour or bake 12 chocolate chip cookies. American Economic Review: Papers & Proceedings , (3): – ing Ricardo’s famous example, if English work-ers are relatively better at producing cloth than wine compared to Portuguese workers, England 1 In line with Ricardo’s theory of comparative advantage.
If Nation A is in comparative advantage in the production of cloths then the fruit wine production it is giving up to produce another unit of cloth is less than that of Nation B. The theory of comparative advantage when applied to modern business scenario, we consider two countries producing two goods using labor as the only factor of production.
Difference between Comparative advantage and Competitive advantage Comparative advantage: In economics, the law of comparative advantage refers to the ability of a party (an individual, a firm, or a country) to produce a particular good or service at a lower opportunity cost than another party/5(3).
Theory of Comparative Advantage Read the required journal articles by Schumacher () and Palley () regarding the theory of comparative advantage. In a critical essay, compare and contrast Smith’s original theory as indicated in the Schumacher () article. Comparative advantage is an economic term that refers to an economy's ability to produce goods and services at a lower opportunity cost than that of trade partners.