The Concept and Sources of Comparative Advantage

According to Colander, "The reason two countries trade is that trade can make both countries better off" (2004, p. 416). In economics, the theory of comparative advantage clarifies why it can be advantageous for two countries to trade, even though one of them may be able to produce every kind of item more cheaply than the other. What matters is not the absolute cost of production, but instead, the ratio between how easily the two countries can produce different kinds of goods. The basic idea of the principle of comparative advantage is that as long as the relative opportunity costs of producing goods differ among countries, then there are potential gains from trade.

If each country specializes in areas where its advantages are greatest or disadvantages are least, the gains from trade will make each country better off than it would be if it remained self-sufficient. [3]

Define the concept of comparative advantage. How can a country gain or lose its comparative advantage in the production of a good?

Comparative advantage in economics is when a country can produce a good at a lower opportunity cost relative to other producers. It is because of this theory that output will increase because a producers within a country specializes Countries will gain the ability to maximize their efficiency and their labor force which facilitates mass-production of products, resulting in higher profits and international trade. This is because the economies of scale reduces overall cost, by producing more units. If the two countries moved towards protectionism and attempted to become self-sufficient then the production of goods would then

Comparative advantage states that the division of labor should operate freely, without outside interference, because some countries, people, states, etc., have special advantages over the others, that allows them to produce certain goods more

Nations trade with one another because it is mutually advantageous for both parties when one is more efficient at producing a certain good and at a lower cost, and the other is proficient at producing a different good or service more efficiently. This is based on Ricaro’s theory of comparative advantage.

The term competitiveness defines the ability of a region to export more than its imports while including all “terms of trade” to reflect government legislation and import barriers. In other words, according to the world competitiveness report, competitiveness is “… the ability to design, produce, and market goods and services, the price and non- price characteristics of which form a more attractive package than those of competitors.” (Pg3.) Each nation has different competitiveness level, which relies on multitude factors such as; raw materials, innovative technologies, energy prices, the type of economy, legislations, and the exchange rate fluctuations. Nevertheless, the prosperity of countries depends on the nation’s competitiveness status.

There has been a dual view of trade since the time of the ancient Greeks. The two sides of these philosophers views are the recognition of the benefits of international exchange, but that there is concern that certain domestic industries would be harmed by foreign

Free trade is an important economic policy that has been brought to the forefront of debate. Arguments have varied from the potential harm it brings to specific groups of people, to the idea that free trade is extremely beneficial in the increasing of competition and improving the nationwide economy. Free trade is a policy that practices removing restrictions such as tariffs, taxes, and bans, allowing for free participation among all kinds of economies and producers. In other words, free trade is a way to “break down” economic barriers. Comparative advantage is a term often used to support the policy of free trade. The theory of comparative advantage displays that if trading partners produce where there is the lowest opportunity cost, then

The Ricardian trade model is a simple yet powerful theory that refutes common fallacies about the causations of trade flows. It illustrates that, instead of absolute advantage, it is comparative advantage that brings forth the gains from trade. Comparative advantage refers to the ability to produce a product at a lower opportunity cost than another. This ability is the result of

The country can maximize their wealth by putting the resources in the most competitive industries. Government created comparative advantage rather than free trade because now easier moves the production processes and the machines into countries that can produce more goods (Yeager & Tuereck, 1984). However, many countries now move to new trade theory suggests the ability firms to limit the number of competitors associated with economic scale (reduction of costs with a large scale of output) (Krugman, 1992). The comparative advantage occurs when two-way trade in identical products, it will useful where economic scale is important, but it will create problem with this model. As a result, government must intervene in international trade for protection to domestic firms (Krugman, 1990)

The theory of comparative advantage explains the benefit of free trade. According to this theory by David Ricardo in the early 19th century, “Both countries will be better off if each specializes in the industry where it has a comparative advantage, and if the two trade with one another.” (Citation) International trade opens up markets to foreign supplier, and domestic companies need to improve their efficiency, boost productivity, and lower cost to increase competitiveness instead of enjoying monopolies or oligopolies that enabled them to keep prices well above marginal costs. On the other hand, international trade also offers domestic companies bigger demands and broader markets; therefore more jobs relevant to export have been created. Furthermore, jobs in the US supported by goods exports pay 13-18 percent more than the US national average (ustr.gov).

Comparative advantage is when an individual or company is made to produce services or goods at a lower opportunity cost than other individuals or companies. Opportunity cost is what you give up when you make a certain choice. When you make a decision you are valuing one decision over another and that decision that you did not choose is your opportunity cost.

Considering that absolute advantage is determined by the comparison between the productivities of labor, it is therefore possible that one party can be disadvantaged to have no absolute advantage in anything. In such a case, it is normally realized that no trade can occur between such a party and other parties. Absolute advantage is normally contrasted with the theory of comparative advantage which means that one party has the ability to produce a particular good or service cheaply or at a lower opportunity cost. In any case, the two theories rely on the basic concept of economic advantage which refers to the ability of one group or party to realize the same output with more economy than another party.

The principle of comparative advantage provides a simplified theory explaining why free trade is possible, even when one country has an economic disadvantage. Both the Ricardian and Heckscher-Ohlin theories rely on fixed economic assumptions of constant return and perfect competition. However, intuitively the basic principle of business is to increase returns through innovation, improving processes and technology or increasing economies of scale. Organizations understand they control pricing and are price setters, rather than price takers as suggested by perfect competition (Krugman & Obstfeld, 2003). The idea of increasing returns and imperfect competition challenge the foundations of comparative advantage.