Theories of international trade: Absolute advantage and comparative advantage

1. PRINCIPLEOFCOMPARITIVEADVANTAGE
Prepared By:
Bindu, H A
M.Sc. (Agri.)
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2. ABSOLUTEADVANTAGE
This theory was
putforth by Adam Smith.
Absolute advantage
refers to the ability of a
country to produce a
greater quantity of a good
or service than the other
country using the same
amount of resources.
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3. COUNTRY COTTON WHEAT
A 10 25
B 15 10
COUNTRY COTTON WHEAT
C 100 120
D 90 80
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4. COMPARATIVEADVANTAGE
This theory was developed by David Ricardo in 1817
to explain why countries engage in international trade even
when one country is more efficient in producing every single
good than other country.
Comparative advantage is an economic law referring
to the ability of any given economy to produce goods and
services at a lower opportunity cost than other.
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5. ASSUMPTIONS
• There are two countries producing two goods.
• Labour is the only cost of production.
• Labour is homogeneous.
• Factors of production are perfectly mobile within a
country and immobile between the countries.
• Perfect competition as well as no intervention of the
Government in economic activities.
• Existence of full employment.
• No transportation costs.
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6. COMPARATIVEADVANTAGE
COUNTRY WHEAT
1 Unit
CLOTH
1 Unit
INTERNAL TERMS OF
TRADE
A 80hrs 90hrs 80/90
1W = 0.89C or
1C = 1.13W
B 120hrs 100hrs 120/100
1C = 0.83W
1W = 1.2C
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7. GAINSFROM TRADE
Without specialization: With specialization:
Country Wheat Cloth
A 1 unit 1 unit
B 1 unit 1 unit
2 units 2 units
Country Wheat Cloth
A 1 unit 0.89 unit
B 0.83 unit 1 unit
1.83 unit 1.89unit
SURPLUS = 0.11 unit of Cloth and O.17 unit of Wheat
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8. LIMITATIONS
Restrictive model.
Full employment.
Demand is ignored.
Mobility of factors of production.
No free trade.
Complete specialization.
No transportation costs.
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