David ricardos comparative advantage and developing countries. Comparative advantage notes two men live alone on an isolated island. Chapter 3 labor productivity and comparative advantage. Econ 101 comparative advantage notes people tend to specialize, particularly in large industrialized societies people tend to focus on a few things, not everything specializing makes us better off mutual self interest we could not make a fraction of the things we consume on a daily basis if we were given no help, machines, instructions, etc. Study questions with answers university of michigan. Explain how international trade creates interdependent relationships between countries. The ricardian model empirics lecture 6 notes pdf 7. Pdf on may 1, 2015, gilbert faccarello published comparative. That is the industry in which we say that it has a comparative advantage. Comparative advantage determines which country will specialize in which good. U the disparity between production and consumption reflects the gains from trade. Mar 19, 2016 determining comparative advantage voluntary trade between two individuals or two countries occurs if both parties feel that they will benefit. To survive they must undertake a few basic economic activities like water carrying, fishing, cooking and shelter construction and maintenance. This additive spatial concentration index has much better properties than the widely used herfindahl index, which aggregates squared shares herfindahl 1950.
The person or country that has the smaller opportunity cost of producing a good is said to have a comparative advantage in producing that good. Suppose that australia and brazil have the outputs per worker in producing sleds and clarinets shown in the table at the right. O cloth o wine o assume each country has different resources that vary in quantity and quality to produce these 2 goods. It can be argued that world output would increase when the principle of comparative advantage is applied by countries to determine what goods and services they should specialise in producing. In this case, country b has the absolute advantage in producing both products, but it has a comparative advantage in trucks because it is relatively better at producing. Comparative advantage, international trade, and fertility glmlic. Gregory mankiws principles of microeconomics, 2nd edition, chapter 3. Fall term 2019 comparative advantage study questions with answers page 1 of 7 9 study questions with answers lecture 3 comparative advantage and the gains from trade part 1. Mar 05, 2020 some comparative advantage isnt inherent, but acquired. The advantage that comes about, thanks to trade based on this specialization, is obvious and needs not further discussion. Comparing outcomes without and with specialization 3. Winter term 20 comparative advantage study questions with answers page 3 of 6 8 6.
This exercise allows students to practice with the economic concepts of absolute and comparative advantage, and determine who should specialize in a goods production based on these basic economic concepts. Note that the principle of comparative advantage follows directly from the notion of opportunity costs. In theory, the gain from trade can be measured only with the use of autarky prices, which. What was missing from the chapter 3 analysis was how the international. Note the unit labor requirements for the uc compared to the us above.
He is also, faster, better, more productive at everything. Lecturenote 12 internationalt radeand the principle. You can hire an hour of babysitting services for less than you would make doing an hour of plumbing. Comparative advantage one person has a comparative advantage over another if his\her opportunity cost of performing a task is lower than the other persons opportunity cost that is, comparative advantage refers to relative productivity. Some comparative advantage isnt inherent, but acquired. The ricardian continuum model university of oxford. Benefits and costs of following comparative advantage. Example of comparative advantage from a table of data. To explain how countries decide what products to import and export, economists use the concepts of absolute and comparative advantage a nation has an absolute advantage if its the only source of a particular product or can make more of a product with the same amount of or fewer resources than other countries a comparative advantage exists when a country can produce a.
Both of these points are routinely made in the most elementary introductory. If its cheaper for mexico to produce crude oil than it. We sometimes refer to this as dynamic comparative advantage. Gains from international trade are only static and, as heckscher notes, dynamic changes are completely disregarded. Gains from trade and the law of comparative advantage. The goods and services that are relatively cheaper to produce and have the relatively lower price, or financial assets that have a relatively more advantageous riskreturn profile, are those in which a country has comparative advantage. The theory of comparative advantage states that a country should specialise in the production of good or service in which it has lower opportunity cost and it should import commodities which have a higher opportunity cost of production. Comparative advantage and competitive advantage atiner.
Absolute and comparative advantage absolute advantage. This column introduces a new ebook in which leading analysts assess the contemporary relevance of ricardos principle of comparative advantage. Suppose a developing economy that, up to a certain year, has not produced and traded according to its comparative advantage. Table 2 reports some summary statistics for the female labor needs of exports. Explain the gains of trade created when a country specializes.
Note that trade based on comparative advantage does not contradict adam smiths notion of advantageous trade based on absolute advantage. The gains from trade will also be illustrated using a simple. Using all its resources, country a can produce 30m cars or 6m trucks, and country b can produce 35m cars or 21m trucks. A country must have a comparative advantage in production of a good, rather than an absolute advantage, to guarantee continued production in free trade. We saw that the united states has an absolute advantage in the production of both goods in terms of the unit labor requirements, this means that ac advantage in both goods says nothing about either the gains from trade or the pattern of trade. In this note, we summarize the theory and apply it to the case of the united. Nov 03, 20 theory of absolute and comparative advantage 1. Comparative advantage even a country that is the most or least efficient producer of all goods still can benefit from trade. By the principle of comparative advantage, countries with di erent opportunity costs of producing di erent goods should be able to bene t from trading with each other. According to the theory of comparative advantage, which of the following is not a reason why countries trade. Definition of comparative advantage economics help. Note also that it is not an accident which good home is importing.
Incorporating stochastic comparative advantage into the counterfactual analysis of changes in trade costs, we document the transitory nature of policy effects. Since ricardos exposition, the distinction between absolute and comparative advantage has been taught as one of. When both producers specialize according to their comparative advantage, they. The theory of comparative advantages the main conclusion of the theory of comparative advantages is that countries can gain always from trade because what matters are comparative advantages and not absolute advantages. Presents several criticisms of the heckscherohlin theory, including wassily leontiefs empirical demonstration that the nature of u. Comparative advantage, economic structure and growth.
International trade and comparative advantage lesson. Absolute and comparative advantage to understand why certain countries import or export certain products, you need to realize that every country or region cant produce the same products. The cost of labor, the availability of natural resources, and the level of knowhow vary greatly around the world. Evidence from japan bernhofen and brown 2005 main idea this paper provides an empirical assessment of the comparative advantage gains. In home under autarky, the opportunity cost of making one more unit of shelter at the margin is p s. The assignment model approach empirics lecture 7 notes pdf 1. International trade and the principle of comparative advantage.
By doing something or getting an early start, a country may become the lowopportunitycost producer of a good. The gains from trade are only based on comparative advantage, not on absolute advantage. Comparative advantage is what you do best while also giving up the least. Absolute and comparative advantage introduction to. For the uc has an absolute disadvantage in both industries, but nonetheless, it can gain from trade by specializing in the industries where its disadvantage is, in some sense, smaller.
It explains regional specialisation in the production of commodities. Nov 06, 2014 absolute and comparative advantage o what follows is an analysis of 2 economiescountry a and country b. Explain the principle of comparative advantage and how it. From the perspective of a less developed country, the developed countries superior technology need not imply that ldc industries cannot compete in international markets. Suppose for example we have two countries of equal size, northland and. Reciprocal absolute advantage is just a special case of comparative advantage iii.
May 24, 2006 note that the sitc1 classification only contains ten very aggregate commodity groups, which in general is too aggregate for a meaningful empirical analysis of comparative advantage. If its cheaper for mexico to produce crude oil than it is for the u. Discusses david ricardos theory of comparative advantage and the refinement of his model. Sup pose an acre of land in canada can produce either 1 unit of wheat or 2 units of corn. The benefits of buying its good or service outweigh the disadvantages. Improving comparative advantages against main competitors is the key to acquiring higher levels of competitiveness in the fastglobalizing world. Aug 23, 2020 in economics, absolute advantage refers to the superior production capabilities of an entity while comparative advantage is based on the analysis of opportunity cost.
Absolute and comparative advantage powerpoint, notes, and practice. The principle of comparative advantage, introduced in chapter 3, can be used in international trade. If as in smiths example, england were more productive in cloth production and portugal were more productive in wine, then we would say that england has an absolute advantage in cloth production while. Comparative advantage is when a country produces a good or service for a lower opportunity cost than other countries. As james heckman and bo honore 1990 have shown, if general distributions of worker skills are allowed, the roy modeland hence ricardos theory of comparative advantage has no empirical content. The theory of comparative advantage states that if countries specialise in producing goods where they have a lower opportunity cost then there will be an. B there is always an industry in which a country has a comparative advantage, while another country has a comparative advantage in the other industry. Absolute advantage dont confuse absolute and comparative advantage just because the u.
This table reports the summary statistics for f n lx and fertility. An economics perspective and a synthesis by satya dev gupta there is a considerable amount of controversy about the models of comparative advantage and its applicability to international business, in particular as a guide to the success of nations andor firms in international markets. Calculate the opportunity cost of producing one unit of a good in terms of another good. Quantifying comparative advantage lets quantify comparative advantage with an imaginary example. Even a rich, developed country with an absolute advantage in both goods will have a comparative advantage in only one good the good where its absolute advantage is larger. Pdf the theory of comparative advantage explained ian. In this case, both developed and developing countries and the world at large gains from trade. Note that, if the pattern of specialization and the capitaloutput ratio did not. The model comparative advantage comparative advantage international di erences in technology. Comparative advantage is a term associated with 19th century english economist david ricardo ricardo considered what goods and services countries should produce, and. If permitted to trade, a country will export the goods in which it has a comparative advantage. A country will not be economically stable if it will have to import every commodity it needs from other countries. International trade theory chapter 2 the law of comparative. Lecture notes international economics i economics mit.
Comparative advantage is an economys ability to produce a particular good or service at a lower opportunity cost than its trading partners. His comparative advantage trade theory advocates in favour of a free trade, the. Ricardos development of the principle of comparative advantage. Comparative advantage means that a producer has a lower opportunity cost b. Describe how factors of production influence the exports and imports of countries. The ricardian theory of comparative advantage 2012 book archive. Study questions with answers lecture 3 comparative advantage. Ricardo demonstrated that for two nations without input factor mobility, specialization and trade could result in increased total output and lower costs than if each nation tried to produce in isolation. Lecturenote 12 internationalt radeand the principle comparative. We saw that the united states has an absolute advantage in the production of both. Discusses david ricardos theory of comparative advantage and the refinement of his model developed by eli heckscher and bertil ohlin. A nation with a comparative advantage makes the tradeoff worth it.
Should a tari on steel be imposed on foreign countries. Time spent producing cars is time taken away from producing bread, and vice versa. The theory of comparative advantage is a core tool in explaining the patterns of and gains from international trade. Suranovic 2015 commenting on the benefits of comparative advantage notes that, it creates welfare improvements in both countries involved in trade individually and collectively. Note that when we discuss gains from trade, the opportunity cost is not. Gains from trade and the law of comparative advantage empirics lecture 5 notes pdf 6. It can be defined as a belief that can guide behaviour or a wellsubstantiated explanation of some aspect of the natural world. In economics, a comparative advantage occurs when a country can produce a good or service at a lower opportunity cost opportunity cost opportunity cost is one of the key concepts in the study of economics and is prevalent throughout various decisionmaking processes. Example of comparative advantage from a table of data video.
The chapter examines the historical process of how the comparative advantage theory developed from james and john stuart mill to the modern theory, by way of viners real cost approach, haberler. As james heckman and bo honore 1990 have shown, if general distributions of worker skills are allowed, the roy modeland hence ricardos theory of comparative advantage has. Free trade and absolute and comparative advantage publish. For example, if youre a great plumber and a great babysitter, your comparative advantage is plumbing. The principle of comparative advantage 200 years on. Explain the principle of comparative advantage and how it leads to specialization and gains from trade. A developing economy, in subsaharanafrica, may have a comparative advantage in producing primary products metals, agriculture, but these products have a lowincome elasticity of demand, and it can hold back an economy from diversifying into more profitable industries, such as manufacturing. On the measurement of comparative advantage springerlink. Define absolute advantage, comparative advantage, and opportunity costs. The heckscherohlin model theory, part i lecture 8 notes pdf 9. David ricardo made one of the enduring contributions to the analysis of international trade with the publication in 1817 of his on the principles of political economy and taxation. The absolute and comparative advantages are of utmost importance to countries these days because they define the selfreliance of the countries.
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