Preview

Absolute Advantage Theory and Its Relevance to International Trade

Good Essays
Open Document
Open Document
971 Words
Grammar
Grammar
Plagiarism
Plagiarism
Writing
Writing
Score
Score
Absolute Advantage Theory and Its Relevance to International Trade
(a) Discuss the absolute advantage theory and its relevance to international trade.

John Solman and Mark Sutcliffe, Economics of Business, states that “that the reasons for international trade are just extensions of the reasons for trade within a nation and that instead of people or countries being self-sufficient it makes more sense to specialize in different trades’. Solman and Sutcliff advised that ‘firms or companies usually specialize in certain types of goods or services which allow them to gain the economies of scale and the ability to exploit their entrepreneurial and management skills along with the skills of the labour force. It also allows firms and companies to benefit from their particular location and from ownership of any particular capital equipment or other types of assets in their possession. Too countries that specialize also make more than they need of certain goods and what is not used locally is exported and the revenues earned from the exports are used to import goods which certain countries are not able to produce sufficiently at home. [1]

The law of comparative advantage

According to Solman and Sutcliffe, countries that have different endowments of factors of production also differ in population density, labour skills, climate, raw materials and capital equipment, etc. The difference tend to persist because the factors are normally immobile but even with labour and capital there is the practice of more restrictions, (physical, social, cultural or legal) on their international movement more so than on their movement within countries. For example, a country may be able to make one fridge for the same cost as six tons of wheat or three compact disc player whereas another country may be able to produce one fridge for the same cost as three tons of wheat but four CD-players. These are the differences in relative costs that form the basis of trade. [1]

A simply theory of comparative advantage is noted in the two countries



References: [1] John Sloman and Mark Sutcliffe, Economics for Business, 3rd Edition, Chapter 24, The Advantages of Trade, pgs. 510 – 512. [2] International Trade (2010). In Encyclopedia Britannica, Inc. Retrieved August 19, 2010, from Encyclopedia Britannica Online: http://www.britannica.com/EBchecked/topic/291349/international-trade/61686/Simplified-theory-of-comparative-advantage

You May Also Find These Documents Helpful

  • Better Essays

    International trade is based on having a comparative advantage. Countries produce products that are easier for them to produce, then other countries. A country having an advantage, can come from many different factors, availability, natural resources, relative efficiency of factors of production, and the state of technology. Each country offer a different set of advantages, like labor, land, capital, and entrepreneurship. If a country has a strong labor intensive work force, and has fertile soil, and a good climate suitable for growing, that country will excel, and have an advantage of producing agricultural goods.…

    • 1417 Words
    • 6 Pages
    Better Essays
  • Satisfactory Essays

    Managerial Economics Quiz

    • 4814 Words
    • 20 Pages

    23. According to the theory of comparative advantage, a nation can gain from trade if it is not equally less…

    • 4814 Words
    • 20 Pages
    Satisfactory Essays
  • Good Essays

    In the world market, countries trade products they wouldn't be able to produce on their own. Countries like Cuba specializes in cigar production, Japan in electronics, and Russia in rocket technology. However, even if a country has an absolute advantage in producing all goods, they still will benefit from trade. Many economic factors are involved with trade. Among the major factors are opportunity costs, comparative advantage, specialization and finally trade.…

    • 491 Words
    • 2 Pages
    Good Essays
  • Good Essays

    One of the reason countries trade with each other, is that they need to satisfy their own wants and needs, and that is, because they do not have the capacity, or resources to satisfy their wants and needs. Each country has a domestic resource that other countries need, and want. These countries take their domestic resource, and by developing and exploiting it, they can produce a surplus that then they can trade for the resources they do need. (March 2013)…

    • 379 Words
    • 2 Pages
    Good Essays
  • Powerful Essays

    _The countries shouldn’t have the same techniques of production , and there is no technological change…

    • 1536 Words
    • 7 Pages
    Powerful Essays
  • Good Essays

    The course aims to give students a broad training in international economics at the advanced level using various techniques. The course consists of the fundamentals of trade theory and its application to policy. Topics to be covered are in a wide range such as; Comparative advantage and the gains from trade, the international location of production and patterns of international trade, International trade and factor mobility, Foreign Direct Investment and Multinational corporations, and International trade and economic geography.…

    • 634 Words
    • 3 Pages
    Good Essays
  • Good Essays

    Specialization in Trade

    • 809 Words
    • 4 Pages

    b) The theory of comparative advantage suggests that even though one country is “better” at producing both goods (concerning two countries), these countries should still trade having in mind the opportunity costs (how much they have to give up of the other good). The theory of absolute advantage determines that a country that has an absolute advantage produces a greater output of goods and services than other countries, while using the same amount of resources.…

    • 809 Words
    • 4 Pages
    Good Essays
  • Better Essays

    • Balassa, B. 1965, ‘Trade liberalization and ‘revealed’ comparative advantage’, Manchester School of Economics and Social Studies, vol. 33, no. 1, pp. 92 ' ' 123.…

    • 2008 Words
    • 9 Pages
    Better Essays
  • Powerful Essays

    In economics, comparative advantage refers to the ability of a party to produce a particular good or service at a lower marginal and opportunity cost over another. Even if one country is more efficient in the production of all goods (absolute advantage in all goods) than the other, both countries will still gain by trading with each other, as long as they have different relative efficiencies.[1][2][3]…

    • 8029 Words
    • 33 Pages
    Powerful Essays
  • Good Essays

    Comparative Advantage

    • 1041 Words
    • 5 Pages

    The theory of comparative advantage is perhaps the most important concept in international trade theory. As the economies that exist in our world our becoming increasingly more intertwined, it is becoming even more important. Nearly every country in the world depends on other countries to supply them with goods that they cannot produce in their own country. I believe that comparative in necessary in today's economy. In this paper I am going to discuss comparative advantage and it's effect on globalization.…

    • 1041 Words
    • 5 Pages
    Good Essays
  • Best Essays

    Who are the winners and losers in the contemporary international trade regime and how do international institutions affect this distribution?…

    • 2924 Words
    • 12 Pages
    Best Essays
  • Powerful Essays

    Comparative Advantage

    • 1700 Words
    • 7 Pages

    When a country trades with other countries it’s consumptions possibilities are greater. The population of a country will have a larger gross domestic product to consume and invest if it focuses on the production of goods in which it has a comparative advantage and trades for the goods it maintains a comparative disadvantage. A country has a comparative advantage in the production of any good that it can produce with a smaller sacrifice of some alternative good or goods, that is, at a lower opportunity cost, than can the rest of the trading world. For example: In terms of the number of units of labor and capital necessary to produce a thousand gallons orange juice, country A may use 3 times more of each than other countries. Yet if country A must give up 500 hundred loaves of bread for 1000 gallons of orange juice and can trade the 1000 gallons of orange juice for more than 500 million loaves of bread, country A has a comparative advantage in producing orange juice.…

    • 1700 Words
    • 7 Pages
    Powerful Essays
  • Best Essays

    In modern globalised economy the theory of comparative advantage introduced by David Ricardo can be relative but needs to consider all other factors and concept. Comparative advantage theory suggests it is beneficial to trade and encourages countries to trade between each other. Even though one country is more efficient at producing all goods than other country trade can be beneficial for both countries. (Hill, 2011, 61-88) has described comparative advantage as ‘the theory that countries should specialise in the production of goods and services they can produce relatively more efficiently’. This may seem irrelevant today as the theory is based on number of unrealistic assumptions. This theory ignores the fact that each country does not have a fixed endowment of resources.…

    • 2333 Words
    • 10 Pages
    Best Essays
  • Good Essays

    According to the classic model of international trade introduced by David Ricardo (19th-century English economist) to explain the pattern and the gains from trade in terms of comparative advantage, it assumes a perfect competition and a single factor of production, labor, with constant requirements of labor per unit of output that differ across countries. The basis for trade in the Ricardian model is the differences in technology between countries. As a result, there are two different ways to describe technology differences: the first method, called absolute advantage, is the way most people understand technology differences; and the second method, called comparative advantage, is a much more difficult concept.…

    • 917 Words
    • 3 Pages
    Good Essays
  • Satisfactory Essays

    In many industries we experience significant economies of scale. This has encouraged firms and countries to specialise in the production of certain goods. Specialisation means firms are more reliant on splitting up the production process into different countries…

    • 251 Words
    • 2 Pages
    Satisfactory Essays