Trade and absolute and comparative advantage

Trade and absolute and comparative advantage

Absolute advantage - Adams Smith

Absolute advantage can be identified as the ability of a country to produce a certain good efficiently than any other country who produce it. Producing a good efficiently means producing a certain amount of goods using a minimum number of inputs than the other country or producing the maximum number of goods using the same amount of inputs as the other country. 

Adams Smith in his publication of “The wealth of the nations” suggested that
countries should produce what they have absolute advantage in.
Absolute advantage can be further explained through a simple example. Consider the two countries Sweden and the United Kingdom. Assuming that Sweden can produce 1 unit of herring with the labor of 50 workers whereas the UK requires the labor of 80 workers to produce one unit of herring. It is clear that the Sweden requires a lesser amount of inputs in producing herring. 

Or it can be further explained by the number of outputs that the two
countries can produce using the same number of inputs. Assume that both countries has 100 workers, since Sweden requires 50 workers to produce 1 herring, the number of herrings it can produce using the 100 workers are equal to 2 herrings. On the other  hand, the number of herrings UK can produce by the same number of worker as Sweden uses is approximately 1.25. 

Therefore it is obvious, either way, Sweden has the absolute advantage in producing.

And again in a situation where the two countries produce cloth, assuming that Sweden can make 1 unit of cloth using 80 workers, and the UK can produce 1 unit of cloth using the labor of  100 employees, if the number of inputs are concerned, it can be seen that the UK needs more workers to produce 1 unit of cloth. That means, as far as the number of inputs to produce an equal number of outputs are concerned, Sweden is efficient in producing Cloth than the UK. It can be further explained through finding out the number of outputs that the two countries
make using the same number of input. Considering that the two countries has 100 employees, since the number of workers that is required to produce 1 unit of cloth in Sweden is 80, it can be figure out that, Sweden can make approximately 1.25 units of cloths whereas the UK can only produce only 1 unit of cloth with 100 workers. What can be concluded from above findings is that, Sweden has absolute advantage in producing both herring and cloth.

In a situation like explained above, where one country has the absolute advantage in producing 
the both goods, a question arises whether to engage in International trade or not. 

According to Adams Smith’s absolute advantage theory, Sweden does not gain any benefit by engaging in International trade since it has absolute advantage in both of the goods.

Comparative advantage

But David Ricardo in his publication of “Principles of Political Economy” has mentioned something different to what Adams Smith Suggested. David Ricardo suggests that “countries should produce what they can produce most efficiently and import the goods that they cannot produce efficiently” through his theory of Comparative advantage. According to David Ricardo, even though if one country has absolute advantage in all of the goods, that country should still only produce the goods that it can produce most efficiently. (Charles W. L.Hills, G.Thomas M.Hult, 2019) 

In the example explained above, where Sweden requires 50 workers to produce 1 herring and requires 80 workers produce 1 unit of cloth, and where the UK needs 80 workers to produce 1 herring and 100 workers to produce 1 unit of cloth, to see if the countries can gain from international trade, comparative advantage theory can be used. It can be simply explained through the following table.

 

      Herring

          Cloth

Sweden

50/80= 0.625

80/50 = 1.6

UK

80/100= 0.8

100/80 = 1.25

Opportunity cost

The opportunity cost of producing herring in the Sweden can be figured out through dividing the number of workers required to produce herring in Sweden by the number of workers required to produce cloth, and the opportunity cost of manufacturing cloth can be figured out through dividing the number of workers required to make 1 unit of cloth in Sweden by the number of workers required to make 1 unit of herring. 

Since Sweden requires 50 workers to produce 1 unit of herring and 80 workers to produce 1 unit of cloth, the opportunity costs for herring is 0.625 and the opportunity cost of cloth for Sweden is 1.6. In the same way, the opportunity costs for making herring and cloth should be found out for the UK. As given, the UK requires 80 workers to make 1 unit of herring and 100 workers to produce 1 unit of cloth.

Therefore opportunity cost for the UK for producing herring is figured out to be 0.8; and is calculated by dividing the number of workers required to make herring by the number of  workers required to make cloth in the UK. In the same way, opportunity cost for the cloth is figured out to be 1.25. Now, a comparison between the opportunity costs should be done to find out which country has comparative advantage in which good. Comparing the opportunity costs of producing herring in the two countries, it can be identified, that Sweden has a low opportunity cost than the UK. Therefore, Sweden gets the comparative advantage of producing herring.

 In relation to cloth, it is visible that the UK has a lower opportunity cost of manufacturing cloth compared to the opportunity cost of manufacturing cloth is Sweden.
Therefore, the UK gets the comparative advantage of manufacturing cloth. Considering the fact that the two countries has comparative advantage in the two different goods, trade between the two countries can be considered to be beneficial for the both countries.

Read about International monetary regimes

Read more details – investopedia – Comparative advantage 

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