Comparative and Absolute Advantage [ Biz/ed Virtual Developing Country ]


Theories

The Principle of Comparative and Absolute Advantage

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In order to understand how international trade increases the welfare of its citizens we need to consider why trade takes place. To do this the principles of absolute and comparative advantage should be considered.

The Principle of Absolute Advantage

A country has an absolute advantage over it trading partners if it is able to produce more of a good or service with the same amount of resources or the same amount of a good or service with fewer resources. In the case of Zambia, the country has an absolute advantage over many countries in the production of copper. This occurs because of the existence of reserves of copper ore or bauxite. We can see that in terms of the production of goods, there are obvious gains from specialisation and trade, if Zambia produces copper and exports it to those countries that specialise in the production of other goods or services.

The Principle of Comparative Advantage

David Ricardo (1772-1823), in his theory of comparative costs suggested that countries will specialise and trade in goods and services in which they have a comparative advantage. It is easy to see that if countries have an absolute advantage there are advantages to trade. However, what happens if one country has an absolute advantage over its trading partners in the production of a number of goods. Specialisation and trade can still result in there being welfare gains made from trade.

A country has a comparative advantage in the production of a good or service that it produces at a lower opportunity cost than its trading partners. Some countries have an absolute advantage in the production of many goods relative to their trading partners. Some have an absolute disadvantage. They are inefficient in producing anything, relative to their trading partners. The theory of comparative costs argues that, put simply, it is better for a country that is inefficient at producing a good or service to specialise in the production of that good it is least inefficient at, compared with producing other goods.

The Production Possibility Curve can be used to illustrate the principles of absolute and comparative advantage.

Prodution possibility frontiers - comparative advantage

Country A has an absolute advantage in the production of both maize and wheat. At all points its production possibility curve lies to the right of that of Country B. Country B has an absolute disadvantage. Due to abundance of raw materials or more productively efficient production techniques, Country A is able to produce more wheat and more maize that Country B. Perhaps common sense tells us that Country A should produce both goods and export surpluses and Country B neither. However, when comparative advantage is considered a different story emerges.

Consider the opportunity cost of Country A producing one more unit of maize. Half a unit of wheat has been foregone. When country B produces one more unit of maize two units of wheat are foregone. Economics is concerned with the allocation of scarce resources. Fewer resources are foregone if Country A concentrates its resources in the production of maize.

Now consider the opportunity cost of Country B producing one more unit of wheat. Two units of maize have been foregone. When Country B produces one more unit of wheat only half a unit of maize is foregone. Fewer resources are foregone if Country B specialises in the production of wheat.

In the above case Country A should produce maize and Country B wheat. The surpluses produce should then be traded.

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Related Glossary Items:
Production Possibility Curve
Opportunity Cost
Comparative Advantage
Absolute Advantage

Related Issues:
An Introduction to International Trade
Zambia's Exports and Imports
Zambia's Balance of Payments Situation

Related Theories:
The Benefits of Trade
The Principle of Absolute and Comparative Advantage