Theory of Comparative Advantage

Only available on StudyMode
  • Download(s) : 406
  • Published : August 1, 2008
Open Document
Text Preview
Theory of Comparative Advantage

Historically, nations have been trading with each other for hundreds of years for profit or because they do not have enough resources (land, labor and capital) to satisfy all the needs of consumers.

For example, Japan has a highly skilled labor force that use technologically advanced equipment to produce cars and electrical equipment; however it does not have its own oil fields. Saudi Arabia has large supplies of oil, but lacks the built capital to produce cars and electrical equipment.

Trade between Saudi Arabia and Japan will allow both countries to obtain goods and services that they cannot produce themselves. Specialization and trade can then deliver higher living standards to all countries as resources are being used more efficiently.

Definition of Comparative Advantage

To illustrate the concept of comparative advantage requires at least two goods and at least two places where each good could be produced with scarce resources in each place. The example drawn here is from Ehrenberg and Smith (1997), page 136. Suppose the two goods are food and clothing, and that "the price of food within the United States is 0.50 units of clothing and the price of clothing is 2 units of food. [Suppose also that] the price of food in China is 1.67 units of clothing and the price of clothing is 0.60 units of food." Then we can say that "the United States has a comparative advantage in producing food and China has a comparative advantage in producing clothing. It follows that in a trading relationship the U.S. should allocate at least some of its scarce resources to producing food and China should allocate at least some of its scarce resources to producing clothing, because this is the most efficient allocation of the scarce resources and allows the price of food and clothing to be as low as possible.

Theory of comparative advantage
Adam Smith's theory of absolute advantage is a simple explanation of the benefits of...
tracking img