Comparative Advantage

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Assignment 1:
Comparative Advantage

Eco 305 – International Economics

David Ricardo introduced the law of comparative advantage. This theory proposed that even if one nation is less efficient than the other nation in the production of both commodities; there is still a basis for mutually beneficial trade. This is as long as the absolute disadvantage that the first nation has with respect to the second is not in the same proportion in both commodities. The less efficient nation should specialize in the production and export of the commodity, which its absolute advantage is less. This is the commodity of its comparative advantage. David Ricardo made a brilliant and lasting contribution to economic thought by showing that even if one nation is more efficient than another in producing all commodities, trade between the two nevertheless can be mutually beneficial. His theory of comparative costs is now known as the law of comparative advantage.

When a country trades with other countries it’s consumptions possibilities are greater. The population of a country will have a larger gross domestic product to consume and invest if it focuses on the production of goods in which it has a comparative advantage and trades for the goods it maintains a comparative disadvantage. A country has a comparative advantage in the production of any good that it can produce with a smaller sacrifice of some alternative good or goods, that is, at a lower opportunity cost, than can the rest of the trading world. For example: In terms of the number of units of labor and capital necessary to produce a thousand gallons orange juice, country A may use 3 times more of each than other countries. Yet if country A must give up 500 hundred loaves of bread for 1000 gallons of orange juice and can trade the 1000 gallons of orange juice for more than 500 million loaves of bread, country A has a comparative advantage in producing orange juice. Therefore specialization and exchange help a country increase the volume of goods and services available for their people to consume. It benefits any country to specialize in producing those things in which it has a comparative advantage and to trade for goods in which it experiences a comparative disadvantage.

The reasons that every country has a comparative advantage in the production of some goods and comparative disadvantages in the production of others is that countries differ in their respective resource endowments and in their states of technology. Some countries are short on certain mineral deposits such as copper, oil, and coal, but they may have relatively large quantities of good capital equipment and high levels of technological know-how. Japan for example, will likely have a comparative advantage in the production and sale of goods embodying high technology and good stocks of capital with which to work. Some countries have vast quantities of good agricultural land while others do not. Some are particularly well suited in terms of climate, terrain, and soil to grow outstanding wine grapes. Some excel in coffee production, and others in growing tea. A beef industry seldom thrives in densely populated, mountainous countries. Some countries have high literacy rates. In others the bulk of the population may be illiterate. All these differences, and many more, confer on each country or region of a country certain comparative advantages and disadvantages that make specialization and exchange worthwhile.

The international movement of productive factors is moving global economies to become more open. In recent times, nations have chased the benefits of free trade through the reduction international trade restrictions around the globe. The World Trade Organization (WTO) has been important in minimizing the barriers to trade between member countries. The nations of Western Europe formed the European Union (EU), and the United States entered into the North...
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