Comparative advantage is the worker, firm, region, or country with the lowest opportunity cost of producing an output should specialize in that output. Project management, achieving competitive advantage download free eboks pdf. The theory of comparative advantage has been used to argue in favor of free trade. The law of comparative advantage describes how, under free trade, an agent will produce more.
If in a twocountry world country a can produce both goods x and y more cheaply, it is said to have an absolute cost advantage for both. Comparative advantage is a critical concept for free trade proponents. As a result, even those who learn about comparative advantage often will confuse it with absolute advantage. Thus if services trade were really just a disguised form of international factor movement, it would still be determined by the principle of comparative advantage. Comparative advantage overview, example and benefits. Opportunity cost and comparative advantage chapter 1. How does opportunity cost determine comparative advantage. Firstmover advantage reduces cost or enhances value. Pdfproject management, achieving competitive advantage. Below you will find a rundown of absolute advantage, comparative advantage and terms of trade.
The first is to discuss whether developing countries can benefit by specializing according to their comparative advantage. We then use the output table to determine the opportunity costs of producing each good. Suppose it takes 10 hours of labor to mine a ton of copper in zambia, and 20 hours of labor to harvest a bushel of corn. Free trade and absolute and comparative advantage publish. To determine who has a comparative advantage in producing a. Of course, the real world is a lot more complicated than our airplane and shoe example. In ricardos view the advantage that each country gets from free foreign. Opportunity cost and the production possibilities curve. For clarity of exposition, the theory of comparative advantage is usually first outlined as though only two countries and only two commodities were involved, although the principles are by no means limited to such cases. If they do something where they do not have an advantage over others, then they will not be nearly as successful because of the competition.
It is quite common to see misapplications of the principle of comparative advantage in newspaper and journal stories about trade. Calculate opportunity costs and comparative advantage. Along the same lines is the concept of comparative advantage. Benefits and costs of following comparative advantage alan v.
In this paper we show that demographic differences between countries are a source of comparative advantage in international trade. And such a price or range of prices will exist if comparative advantage existswhich is to say, if each person has a different cost of producing each good. Just remove tariffs and quotas and everyone will be better off. As important and simple as this concept is, however, it seldom seems to inform public discussions of international. The opportunity cost of an action is what you must give up when you make that choice. Finally, we determine which country as a comparative advantage in. That is surely not true, but it definitely is true of comparative advantage. The next section develops absolute and comparative advantage in greater detail and relates them to trade. Definition of comparative advantage economics help. In other words, if it costs both countries a and b 2 wheat to produce an additional tv, then trade would not benefit them. Comparative advantage and gains from trade combines the insights of comparative advantage and gains from trade to state that when two or more organizations can choose to freely trade the products goods or services created by their activities, each organization has the knowledge and incentives to concentrate on those activities where it has a comparative advantage. 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.
Introduction to comparative advantage it has been said that everythings relative. The second objective is to discuss if an economy that adopts a free market policy. Input approach to determining comparative advantage. The trade creation and trade diversion effects of customs unions free trade. In the context of a principles of economics class, students are required to read the international trade chapter before coming to lecture. An example of using inputs to calculate opportunity cost and then using opportunity costs to determine comparative advantage. Download the international trade bell ringer and make copies of bell ringer handout 2. Check to see if you are eligible for free downloads. Therefore india has a comparative advantage in producing textiles because it has a lower opportunity cost. Absolute advantage, comparative advantage, and opportunity. The theory of comparative advantage is attributed to political economist david ricardo, who wrote the book principles of political economy and taxation 1817. Example of comparative advantage from a table of data video. This is implicit in some of the theoretical writings on comparative advantage, and can be made explicit quite easily.
The law of comparative advantage describes how, under free trade, an agent will produce more of and consume less of a good for which they have a comparative advantage in an economic model, agents have a comparative advantage over others in producing a particular good if they can produce that good at a lower relative opportunity cost or autarky price, i. The key difference between comparative advantage and absolute advantage is that comparative advantage is relative while absolute advantage is absolute value. Papa john has a comparative advantage in the production. Opportunity cost and comparative advantage using an output.
Opportunity cost is a direct implication of scarcity. Comparative advantage, international trade, and fertility nber. Comparative and absolute advantage and the production. Opportunity cost and comparative advantage packet 1. Comparative advantage takes into account ones ability to produce something with the lowest marginal opportunity cost while absolute advantage is the ability to perform a task. This fundamental concept in explaining why countries engage in international trade and why they gain from trade can only be understood in terms of relative. Calculate the opportunity cost of producing one unit of a good in terms of another good. Opportunity cost this concept of scarcity leads to the idea of opportunity cost. Comparative advantage works as long as the above assumptions hold and the entities have different production costs. The uk has a comparative advantage in producing books. F11,q11,q15,q17,r14 abstract when asked to name one proposition in the social sciences that is both true and nontrivial, paul samuelson famously replied. In this video we use the ppcs for two different countries that each produce two goods in order to create an output table based on the data in the graph. If the uk produces a book, the opportunity cost is 14 0.
In the case of comparative advantage, the opportunity cost that is to say, the. The classical theory of the international trade, also known as the theory of comparative costs, was first formulated by ricardo, and later improved by john stuart mill, cairnes, and bastable. Opportunity cost and comparative advantage econ1101. An agent has a lower opportunity cost of carrying out an activity than another agent. Deardorff the university of michigan this paper is the text of a lecture given on november 20, 1997 to inaugurate the john w. Opportunity cost, trade and comparative advantage youtube.
Pdf comparative advantage and competitive advantage. Direct and indirect critiques oumar bouare aem following smiths advocacy of free trade and competition, david ricardo attempts to strengthen his theory of absolute advantage, which. What is important is the existence of at least one price that is mutually advantageous for both persons. Comparative advantage, opportunity cost, and outsourcing. Comparative advantage refers to an economys ability to produce goods. People succeed in life by specializing at what they do best.
John can produce 10 units of food per day, or 4 units of clothing. Project management, achieving competitive advantage abstract. With free trade, demand for w will rise in a and fall in b. Factories were closed, people were fired, and wages were cut. Comparative advantage and competitive advantage an economics perspective and a synthesisathens journal of business and economics, january 2015. Benefits and costs of following comparative advantage. When both producers specialize according to their comparative advantage, they increase the total amount of goods and services that are available for consumption. Running a world class purchasing organization this book is meant to be a timeless reference guide that will be used over and over to achieve excellence in purchasing. Students many times have trouble understanding the opportunity cost concept, connecting opportunity cost to comparative advantage, and differentiating between absolute advantage and comparative advantage. Since many skills are agedependent, population aging decreases the relative supply and increases the relative price of skills which depreciate with age. They will finish their chores sooner by specializing according to their comparative advantage. The relevance of ricardos comparative advantage in the 21st century voxeu ebook. One of the most powerful and straightforward economic concepts is comparative advantage.
Topics include how to calculate opportunity costs and determine who has comparative advantage based on opportunity cost. Population aging and comparative advantage sciencedirect. This is because female wages, and therefore the opportunity cost of children are. We demonstrate empirically that countries with comparative advantage in. International trade and comparative advantage lesson federal. The cost savings resulting from successfully dividing labor and automating production processes dwarf the considerations that made comparative advantage a useful concept in economics. Does free trade increase unemployment and lower wages. If you have an office space dedicated to a specific activity and you reconfigure the space to accommodate a new activity, the allocation of space to the new activity may come with an opportunity cost of reduced operational effi. Sweetland chair in international economics, in the department of economics of the university of michigan. Again for clarity, the cost of production is usually measured only in terms of labour time and effort. However, the opportunity cost of trying to keep paying for all that would have been hundreds of thousands of jobs lost. Instead, one must compare the opportunity costs of producing goods across.
Opportunity cost and comparative advantage the opportunity. Absolute and comparative advantage michigan state university. In my view, the models of comparative advantage are too general to be dismissed altogether in this manner. The person with the lower opportunity cost should perform the chore. Opportunity cost and comparative advantage 1 comparative advantage and the basis for trade 1. This means the opportunity cost of producing a ton of copper is 2 bushels of corn. Read this article to learn about the theory of comparative costs. The trade creation and trade diversion effects of customs unionsfree trade. This video covers an example of opportunity cost, trade and comparative advantage. When there is free trade, why do some countries remain poor at the. Comparative advantage vs absolute advantage video khan. Economics absolute advantage, comparative advantage, and opportunity costs.
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