Pdf comparative advantage and competitive advantage. Learn vocabulary, terms, and more with flashcards, games, and other study tools. Opportunity cost is the difference between the benefits and the costs of a choice. Scott french november, 2014 abstract this paper utilizes a manycountry, manyproduct ricardian trade model to evaluate the usefulness of measures of revealed comparative advantage rca in academic and policy analyses. You may have students read from the trade issuebbrief on the website or from a printed copy of the issue brief, depending on your preference and student access to computers.
Comparative advantage refers to an economys ability to produce goods and services at a lower opportunity cost than trade partners. Opportunity costs, absolute advantage and comparative. Deardorff the university of michigan this paper is the text of a lecture. Deardorff the university of michigan this paper is the text of a lecture given on november 20, 1997 to inaugurate the john w. The person or country that produces a good with a smaller quantity of inputs. While absolute advantage refers to the superior production capabilities of one entity versus another in a single area, comparative advantage introduces the concept of opportunity cost.
Multiple choice select the best answer of those given. Students many times have trouble understanding the opportunity cost concept, connecting opportunity cost to comparative advantage, and differentiating between absolute advantage and comparative advantage. The opportunity cost of roses in terms of computers is the number of computers that could be produced with the same resources as a given number of roses. Although adam smith understood and explained absolute advantage, one big thing he missed in the wealth of nations was the theory of comparative advantage. I think russia has the comparative advantage in titanium because the give up less wheat to make titanium, but im not totally sure. 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. Sources of ca causes of ca in theory can ca change. 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. Fantasy football, opportunity cost, and comparative advantage. In the context of a principles of economics class, students are required to read the international trade chapter before coming to lecture. Introduction to international trade boundless economics.
Benefits and costs of following comparative advantage. Comparative advantage is what a country produces for the lowest opportunity cost. Economics absolute advantage, comparative advantage, and opportunity costs. The theory of comparative advantage tca is introduced based on a textbook. Deconstructing the theory of comparative advantage world social. The companies that produce either copper or corn tell you that it takes 10 hours to mine a ton of copper and 20 hours to harvest a bushel of corn. Franks opportunity cost of producing one burger is 14 of a pizza.
Recall from earlier that marginal opportunity cost is sacrifice. Absolute advantage, comparative advantage, and opportunity costs. The ability of a party to produce a particular good or service at a lower marginal and opportunity cost over another. The benefits of buying its good or service outweigh the disadvantages. Nov 28, 2010 comparative advantage first let us define the comparative advantage which is the ability of a firm or individual to produce goods and or services at a lower opportunity cost than other firms or individuals. Definition of comparative advantage economics help. Economists routinely act as if three related key concepts division of labor, comparative advantage, and opportunity cost. In my view, the models of comparative advantage are too general to be dismissed. Levchenko2007 offers up a formal general equilibrium model of this. One determinant of the size of the gains from specialization is the difference in opportunity cost. Explain the concept of opportunity cost and explain why accounting profits and economic profits are not the same. Economics opportunity cost comparative advantage the year was 2010. This is implicit in some of the theoretical writings on comparative advantage, and can be made explicit quite easily.
An agent has a lower opportunity cost of carrying out an activity than another agent. Define comparative advantage, opportunity cost and specialization. But the fact is that there are either increasing costs or diminishing costs. 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. 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. When both producers specialize according to their comparative advantage, they. It differs from absolute and competitive advantage. The basis of exchange why do people exchange goods and services in the first place. International trade international trade simplified theory of comparative advantage. Theory of comparative cost by david ricardo definition and.
David ricardos theory of comparative cost advantage. The key difference between comparative advantage and absolute advantage is that comparative advantage is relative while absolute advantage is absolute value. As a result, even those who learn about comparative advantage often will confuse it with absolute advantage. The pretrade price of cloth in terms of wine in england is 100120, whereas in portugal it is 9080.
This notion is called international division of labor. The solution to a comparative advantageopportunity cost problem. Given the lack of conclusive evidence on viability of targeted industrial policies in sustainably influencing comparative advantage we exclude these policies as ones potentially hindering or reducing the gains from trade. Again for clarity, the cost of production is usually measured only in terms of labour time and effort. Study questions with answers lecture 3 comparative advantage and the gains from trade part 1. The answer is that we can all have more of every good and service if we specialize in the activities at which we are we are relatively most efficient. Comparative advantage, economic growth and free trade julio lopez gallardo abstract the paper has two objectives. How do i find the following 1 the opportunity cost for producing an orange in the u. You may have students read from the trade issuebbrief on the website or from a printed copy of the issue brief, depending on your preference and student access to. Opportunity cost and comparative advantage chapter 1. May 07, 2019 while absolute advantage refers to the superior production capabilities of one entity versus another in a single area, comparative advantage introduces the concept of opportunity cost.
In short, good contracting institutions are a source of comparative advantage in industries that intensively use relationshipspeci. Why not just produce our own food, cars, clothing, shelter, and the like. Theory of comparative cost by david ricardo definition. If the large scale of production reduces costs, the comparative advantage will be increased. Most of the credit for the theory is attributed to david ricardo, although it had been mentioned a couple years earlier by robert torrens. The principle of comparative advantage asserts that everyone is better off if each agent specialises in the activities for which they have a comparative advantage through trade, they can make gains from specialisation. David ricardo believed that the international trade is governed by the comparative cost advantage rather than the absolute cost advantage. Read this article to learn about the theory of comparative costs. It is quite common to see misapplications of the principle of comparative advantage in newspaper and journal stories about trade.
The volume of trade is shown by the shaded triangles. Study questions with answers university of michigan. Even if one country is more efficient in the production of. International trade simplified theory of comparative advantage.
Most of the credit for the theory is attributed to david ricardo, although it had been mentioned a. View test prep comparative advantage and opportunity cost from eco 3111 at university of ottawa. The following posting helps with an international economics problem. The first is to discuss whether developing countries can benefit by specializing according to their comparative advantage. Pdf the theory of comparative advantage how applicable is. This paper is based on an invited lecture, the author held at the university of applied sciences stralsund in may 2015. 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. Comparative advantage a country has a comparative advantage in producing a good if the opportunity cost of producing that good in terms of other goods is lower in that country than it. The solution to a comparative advantage opportunity cost problem using monetary units as the constant to create the table.
According to the theory of comparative advantage, which of the following is not a reason why countries trade. Mar 02, 2008 opportunity cost and comparative advantage. Note, this is different to absolute advantage which looks at the monetary cost of producing a good. Domestic institutions as a source of comparative advantage. A mathematician, stan ulam, once challenged paul samuelson to. An analysis for india and china amita batra zeba khan august 2005 the views expressed in the icrier working paper series are those of the authors and do not necessarily reflect those of the indian council for research on international economic relations icrier. A nation with a comparative advantage makes the tradeoff worth it. Pdf the theory of comparative advantage how applicable.
Nov 07, 2012 economics opportunity cost comparative advantage the year was 2010. 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. They will finish their chores sooner by specializing according to their comparative advantage. Balassa comparative advantage measures for select years 1985, 1992 and 2000, or 2005 from data similar to ours but at the sitc 4digit or hs 6digit product levels, they document that a countrys concentration in few products above a comparativeadvantage threshold is. A country will specialise in that line of production in which it has a greater relative or comparative advantage in costs than other countries and will depend upon imports from abroad of all such commodities. 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. Old idea, new evidence arnaud costinot and dave donaldson nber working paper no. 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 increase in economic welfare. Gregory mankiws principles of microeconomics, 2nd edition, chapter 1 p.
While absolute advantage refers to the superior production capabilities of one entity versus another in a single area, comparative advantage introduces the concept of. 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. Again for clarity, the cost of production is usually measured only in terms of labour. A comparative advantage gives a company the ability to sell goods and services at a lower price than its competitors and realize stronger. Determining comparative advantage voluntary trade between two individuals or two countries occurs if both parties feel that they will benefit. This means the opportunity cost of producing a ton of copper is 2 bushels of corn. Prompt students through the activity as outlined below. It appears that england has a comparative cost advantage in the. My comparative advantage today may be your comparative advantage next year. The second objective is to discuss if an economy that adopts a free market policy. Chapter 2 labor productivity and comparative advantage. Opportunity costs and comparative advantage youtube. If opportunity costs are equal in both nations and thus no comparative. An analysis for india and china amita batra zeba khan august 2005 the views expressed in the icrier working paper series are those of the authors and do not necessarily reflect those of the indian council for research on.
Instead, one must compare the opportunity costs of producing goods across countries. Comparative and absolute advantage and the production possibilities frontier1 instructional primer2 the ricardian principles of comparative and absolute advantage have shaped the discussion on trade for centuries, indeed they form the basis from which we understand why two nations engage in trade. Free trade and absolute and comparative advantage publish. Old idea, new evidence by arnaud costinot and dave donaldson the anecdote is famous. In this solution, opportunity costs and comparative advantage are demonstrated by an example using the production of copper and wheat in canada and chile. Opportunity cost is a direct implication of scarcity.
Comparative advantage is when a country produces a good or service for a lower opportunity cost than other countries. 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. Opportunity cost this concept of scarcity leads to the idea of opportunity cost. The opportunity cost of an action is what you must give up when you make that choice. Comparative advantage first let us define the comparative advantage which is the ability of a firm or individual to produce goods andor services at a lower opportunity cost than other firms or individuals. The law of comparative advantage describes how, under free trade, an agent will produce more. I missed the live draft in my fantasy football league, so the computers autodraft function took over and drafted the best player remaining whenever my turn came, regardless of position. Opportunity cost and comparative advantage packet 1.
The theory of comparative cost as applied to international trade is therefore, that each country tends to produce, not necessarily what it can produce more cheaply than an other country, but those articles which it can produce at the greatest relative advantage, i. Comparative and absolute advantage and the production. Comparative advantage from now on ca implies an opportunity cost associated with the production of one good compared to another. The person with the lower opportunity cost should perform the chore. Theory, empirical measures and case studies 61 that the autarky equilibriums are determined by ppf and cic. The next section develops absolute and comparative advantage in greater detail and relates them to trade. Absolute advantage, comparative advantage, and opportunity. On the other hand, if increased output is the result of increased cost of production the comparative advantage will be reduced, and in some cases it may even disappear. Dec 28, 2015 my comparative advantage today may be your comparative advantage next year. A comparative advantage gives a company the ability to sell goods and services at a lower price than its competitors and realize stronger sales margins. Aug 02, 2012 opportunity costs and comparative advantage. This explains why the ppc for a country is likely to be bowed out.
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