Personal Finance. Your Practice. Popular Courses. Login Newsletters. Business Business Essentials. Absolute vs. Key Takeaways Absolute advantage and comparative advantage are two concepts in economics and international trade.
Absolute advantage refers to the uncontested superiority of a country or business to produce a particular good better. Comparative advantage introduces opportunity cost as a factor for analysis in choosing between different options for production diversification. Compare Investment Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation. Related Articles. Macroeconomics Absolute vs.
comparative advantage Essay
Comparative Advantage: Comparing the Difference. For example, nonrenewable resources can slowly run out, increasing the costs of production, and reducing the gains from trade. Countries can develop new advantages, such as Vietnam and coffee production. Despite having a long history of coffee production it is only in the last 30 years that it has become a global player. Many countries strive for food security , meaning that even if they should specialise in non-food products, they still prefer to keep a minimum level of food production.
The real world is far more complex, with countries exporting and importing many different goods and services. According to influential US economist Paul Krugman , the continual application of economies of scale by global producers using new technology means that many countries, including China, can produce very cheaply, and export surpluses. This, along with an insatiable demand for choice and variety, means that countries typically produce a variety of products for the global market, rather than specialise in a narrow range of products, rendering the traditional theory of comparative advantage almost obsolete.
Modern approaches to explaining trade patterns and trade flows tend to use gravity theory - which explains trade in terms of the positive attractiveness between two national economies - based on economic size in a similar fashion as planets attracting each other based on their mass - and the 'economic distance' between two economies. Economic size attracts countries to trade, and economic distance makes trade harder.
Economic distance is increased by barriers to trade , and cultural, political and linguistic differences. One advantage of gravity theory is that it can help economists predict the likely effect of changes in government policy on trade patterns, including decisions regarding joining or leaving trading blocs.
UK economy contracts by 0. Comparative advantage. Brexit deal agreed. Read more. Model agencies Accused of price fixing. Focusing on those areas will provide gains from trade.
Of course, the camping example is just conceptual way of framing how division or labor and trade among friends can potentially provide gains. It leaves out many real world complications, which are the focus of many of the essays in this book. How large are the gains from trade?
- David Ricardo's Comparative Advantage After Two Centuries.
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- David Ricardo: The Comparative Advantage!
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- David Ricardo - Econlib.
How will the gains be distributed across the parties involved in the trade? Does trade provide additional gains over time through heightened competition and incentives for innovation? How will trade affect the distribution of income? What are the underlying reasons why countries differ in their profiles of productivity across activities, and to what extent can those reasons be altered by public policy?
What happens when comparative productivity levels shift, so some industries no longer need the same number of workers? Do the potential gains from trade in goods also apply to gains in services? Do the potential gains apply to a global economy with "value chains" of production that cross and re-cross national borders? How do economies of scale fit into the picture?
What about trade in similar-but-not-identical branded products, like cars? What is the appropriate reaction when countries erect barriers to trade or when there are persistent patterns of trade surpluses and deficits? Ricardo actually had thoughts and analysis about a surprisingly large number of these questions, and the essays in this book take up most of the rest of them. Here, I just want to note a few points that seemed worth particular emphasis.
One is that although Ricardo's theory of comparative advantage never disappeared, and has been a mainstay of basic principles of economics for years, there was a period of some decades when it seemed less relevant to the facts of international trade. As Jonathan Eaton explores in his contribution to this volume, Ricardo's basic example of comparative advantage involved one factor of production labor and different technology across countries linked to differences in productivity of labor. By the middle of the 20th century, the focus was on models that had a number of different factors of production, and thus chose different methods of production, although they shared access to the same technology.
Ricardo’s Numerical Example
By the s, emphasis had shifted to models of how large firms would trade similar but not identical goods across countries: for example, international trade in cars or airplanes or machine tools. But perhaps surprisingly, as economists looked at data on international trade with many different products, and explored models where countries differed in technology and productivity, they were led back to a Ricardian framework.
Eaton and his frequent coauthor Samuel Kortum were leaders in this modelling. In the basic Ricardian example, two countries do better by specializing in different goods and exchanging them for each other, even when one country is better at making both.
This example typically gets presented in the first or second chapter of a text on international trade, and sometimes appears even in a principles text. But having served its pedagogical purpose, the model is rarely heard from again.
Absolute vs. Comparative Advantage: What’s the Difference?
The Ricardian model became something like a family heirloom, brought down from the attic to show a new generation of students, and then put back. Nearly two centuries later, however, the Ricardian framework has experienced a revival. Much work in international trade during the last decade has returned to the assumption that countries gain from trade because they have access to different technologies.
These technologies may be generally available to producers in a country, as in the Ricardian model of trade, our topic here, or exclusive to individual firms. This line of thought has brought Ricardo's theory of comparative advantage back to center stage. Of course, this isn't the only approach or only set of questions. Indeed, one of the problems in thinking about the effects of international trade is that the patterns of international trade are deeply interwoven with other political, historical and social variables, so extrapolations are hard. For example, it would probably be unwise to believe that if the nations of Africa or Latin America or Asia sought to form a "Union," it would work out in the same ways for better or worse as the European Union.
The laws about international trade are not the only relevant differences across regions. Indeed, t here is a long-standing argument in economics over whether trade leads to economic growth, or whether economic growth leads to more trade , or whether other external factors like improved technology and transportation affect both. The most extreme case of such deflection is to be found in the rhetoric of populist politicians, from both the left and the right.
These issues and others that could be added make a tall pile of problems; in contract, the contribution of international trade to the US economic issues is pretty small. But it's always a lot easier to criticize the neighbors than to clean up the mess in your own front yard.