F11,q11,q15,q17,r14 abstract when asked to name one proposition in the social sciences that is both true and nontrivial, paul samuelson famously replied. Therefore india has a comparative advantage in producing textiles because it has a lower opportunity cost. The person with the lower opportunity cost should perform the chore. Suppose it takes 10 hours of labor to mine a ton of copper in zambia, and 20 hours of labor to harvest a bushel of corn. The law of comparative advantage describes how, under free trade, an agent will produce more. An example of using inputs to calculate opportunity cost and then using opportunity costs to determine comparative advantage. Benefits and costs of following comparative advantage alan v. Factories were closed, people were fired, and wages were cut. The cost savings resulting from successfully dividing labor and automating production processes dwarf the considerations that made comparative advantage a useful concept in economics. View test prep comparative advantage and opportunity cost from eco 3111 at university of ottawa. Lets downgrade comparative advantage from our list of key concepts in economics, and recognize that the human mind is the mainspring of a market economy.
That is surely not true, but it definitely is true of comparative advantage. For clarity of exposition, the theory of comparative advantage is usually first outlined as though only two countries and only two commodities were involved, although the principles are by no means limited to such cases. Calculate opportunity costs and comparative advantage. As a result, even those who learn about comparative advantage often will confuse it with absolute advantage. Thus if services trade were really just a disguised form of international factor movement, it would still be determined by the principle of comparative advantage. Finally, we determine which country as a comparative advantage in. As important and simple as this concept is, however, it seldom seems to inform public discussions of international.
How does opportunity cost determine comparative advantage. Pdfproject management, achieving competitive advantage. And such a price or range of prices will exist if comparative advantage existswhich is to say, if each person has a different cost of producing each good. The theory of comparative advantage has been used to argue in favor of free trade. Introduction to comparative advantage it has been said that everythings relative. Of course, the real world is a lot more complicated than our airplane and shoe example. Below you will find a rundown of absolute advantage, comparative advantage and terms of trade.
If in a twocountry world country a can produce both goods x and y more cheaply, it is said to have an absolute cost advantage for both. Comparative advantage and gains from trade combines the insights of comparative advantage and gains from trade to state that when two or more organizations can choose to freely trade the products goods or services created by their activities, each organization has the knowledge and incentives to concentrate on those activities where it has a comparative advantage. The second objective is to discuss if an economy that adopts a free market policy. Along the same lines is the concept of comparative advantage. Free trade and absolute and comparative advantage publish. This is because female wages, and therefore the opportunity cost of children are. Opportunity cost is a direct implication of scarcity. The opportunity cost of an action is what you must give up when you make that choice.
Comparative advantage is the worker, firm, region, or country with the lowest opportunity cost of producing an output should specialize in that output. Definition of comparative advantage economics help. International trade and comparative advantage lesson federal. Input approach to determining comparative advantage. Calculate the opportunity cost of producing one unit of a good in terms of another good. Opportunity cost and comparative advantage chapter 1. When both producers specialize according to their comparative advantage, they increase the total amount of goods and services that are available for consumption. This video covers an example of opportunity cost, trade and comparative advantage. Benefits and costs of following comparative advantage.
In ricardos view the advantage that each country gets from free foreign. Comparative advantage vs absolute advantage video khan. The key difference between comparative advantage and absolute advantage is that comparative advantage is relative while absolute advantage is absolute value. But it gave me a comparative advantage over my pretrade roster because my starting players were generating more points. The trade creation and trade diversion effects of customs unions free trade. In my view, the models of comparative advantage are too general to be dismissed altogether in this manner. In other words, if it costs both countries a and b 2 wheat to produce an additional tv, then trade would not benefit them. In the context of a principles of economics class, students are required to read the international trade chapter before coming to lecture.
The first is to discuss whether developing countries can benefit by specializing according to their comparative advantage. The theory of comparative advantage is attributed to political economist david ricardo, who wrote the book principles of political economy and taxation 1817. Comparative advantage, international trade, and fertility nber. One of the most powerful and straightforward economic concepts is comparative advantage. If they do something where they do not have an advantage over others, then they will not be nearly as successful because of the competition. In this video we use the ppcs for two different countries that each produce two goods in order to create an output table based on the data in the graph. In the case of comparative advantage, the opportunity cost that is to say, the. We demonstrate empirically that countries with comparative advantage in. People succeed in life by specializing at what they do best.
It is quite common to see misapplications of the principle of comparative advantage in newspaper and journal stories about trade. Fantasy football, opportunity cost, and comparative advantage. The classical theory of the international trade, also known as the theory of comparative costs, was first formulated by ricardo, and later improved by john stuart mill, cairnes, and bastable. If the uk produces a book, the opportunity cost is 14 0. Opportunity cost and comparative advantage using an output. The chapter examines the historical process of how the comparative advantage theory developed from james and john stuart mill to the modern theory, by way of viners real cost approach, haberler. John can produce 10 units of food per day, or 4 units of clothing. Comparative advantage takes into account ones ability to produce something with the lowest marginal opportunity cost while absolute advantage is the ability to perform a task. Opportunity cost, trade and comparative advantage youtube. The second method, called comparative advantage, is a much more difficult concept. In economics, a comparative advantage occurs when a country can produce a good or service at a lower opportunity cost than another country. Comparative advantage and competitive advantage an economics perspective and a synthesisathens journal of business and economics, january 2015. When there is free trade, why do some countries remain poor at the.
Comparative advantage works as long as the above assumptions hold and the entities have different production costs. This means the opportunity cost of producing a ton of copper is 2 bushels of corn. Old idea, new evidence arnaud costinot and dave donaldson nber working paper no. The trade creation and trade diversion effects of customs unionsfree trade.
Students many times have trouble understanding the opportunity cost concept, connecting opportunity cost to comparative advantage, and differentiating between absolute advantage and comparative advantage. Economics absolute advantage, comparative advantage, and opportunity costs. We then use the output table to determine the opportunity costs of producing each good. This is implicit in some of the theoretical writings on comparative advantage, and can be made explicit quite easily. Opportunity cost and comparative advantage packet 1. What is important is the existence of at least one price that is mutually advantageous for both persons. An agent has a lower opportunity cost of carrying out an activity than another agent. Since many skills are agedependent, population aging decreases the relative supply and increases the relative price of skills which depreciate with age.
Download the international trade bell ringer and make copies of bell ringer handout 2. Instead, one must compare the opportunity costs of producing goods across. Direct and indirect critiques oumar bouare aem following smiths advocacy of free trade and competition, david ricardo attempts to strengthen his theory of absolute advantage, which. Running a world class purchasing organization this book is meant to be a timeless reference guide that will be used over and over to achieve excellence in purchasing. Absolute advantage, comparative advantage, and opportunity. Papa john has a comparative advantage in the production. The uk has a comparative advantage in producing books. Read this article to learn about the theory of comparative costs. The relevance of ricardos comparative advantage in the 21st century voxeu ebook. Absolute and comparative advantage michigan state university. This is because it has a lower opportunity cost of 0. Comparative advantage is a critical concept for free trade proponents. The principle of comparative advantage asserts that everyone is better off if each agent specialises in the activities for which they have a comparative advantage through trade, they can make gains from specialisation.
In this paper we show that demographic differences between countries are a source of comparative advantage in international trade. This fundamental concept in explaining why countries engage in international trade and why they gain from trade can only be understood in terms of relative. Comparative advantage refers to an economys ability to produce goods. The next section develops absolute and comparative advantage in greater detail and relates them to trade. Pdf comparative advantage and competitive advantage. Just remove tariffs and quotas and everyone will be better off. Comparative advantage, opportunity cost, and outsourcing. Does free trade increase unemployment and lower wages. Opportunity cost and comparative advantage econ1101.
They will finish their chores sooner by specializing according to their comparative advantage. I gave up more points in a position with a lower opportunity cost more alternatives for fewer points in a position with a higher opportunity cost fewer alternatives. Project management, achieving competitive advantage abstract. Firstmover advantage reduces cost or enhances value. Comparative advantage overview, example and benefits. With free trade, demand for w will rise in a and fall in b. To determine who has a comparative advantage in producing a. Again for clarity, the cost of production is usually measured only in terms of labour time and effort. Comparative and absolute advantage and the production. Population aging and comparative advantage sciencedirect.
The law of comparative advantage describes how, under free trade, an agent will produce more of and consume less of a good for which they have a comparative advantage in an economic model, agents have a comparative advantage over others in producing a particular good if they can produce that good at a lower relative opportunity cost or autarky price, i. Example of comparative advantage from a table of data video. Opportunity cost and comparative advantage 1 comparative advantage and the basis for trade 1. Opportunity cost this concept of scarcity leads to the idea of opportunity cost. However, the opportunity cost of trying to keep paying for all that would have been hundreds of thousands of jobs lost. Check to see if you are eligible for free downloads. Opportunity cost and comparative advantage the opportunity. Deardorff the university of michigan this paper is the text of a lecture given on november 20, 1997 to inaugurate the john w. Opportunity cost and the production possibilities curve.
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