International Trade : Absolute vs comparative Advantage

International TradeAbsolute & Comparative Advantage

Absolute AdvantageA party’s ability to produce more goods than a competitor using the same amount of input(s)

(assume single input : labor)

Example 1

Party Good/Hour

A 4

B 7

Example 1

Party Good/Hour

A 4

B 7

Party B has an absolute advantage over A

Example 2

Party Good2/Hour Good1/Hour

A 6 4

B 2 7

Example 2

Party Good1/Hour Good2/Hour

A 6 4

B 2 7

A has AA in Good1 and B has AA in Good2

Absolute Advantage TheoryBy Adam Smith

1. Specializing in production of one commodity2. Exchanging parts of output with other nation

Party Good1/Hour Good2/Hour

A 6 4

B 2 7

Two countries A, B

Party Good1/Hour Good2/Hour

A 6 0 (+1 L. hour)

B 0 (+1 L. hour) 7

Two countries A, B

Party Good1/Hour Good2/Hour

A 6 + 6 0

B 0 7 + 7

Two countries A, B

Comparative AdvantageSpea e No e :

A pe son has a ompa a e ad an a e a p odu n some h n he an p odu e a owe os han an one e se.

Ha n a ompa a e ad an a e s no he same as be n he bes a some h n . In a , someone an be omp e e uns ed a do n some h n , e s ha e a ompa a e ad an a e a do n ! How an ha happen?

F s , e 's e some mo e o abu a . Someone who s he bes a do n some h n s sa d o ha e an abso u e ad an a e. M hae o dan has an abso u e ad an a e a bas e ba . Fo a I now, M hae o dan ma a so be he as es p s n he wo d, n h m an abso u e ad an a e a p n , oo. S n e he's be e a p n han ou, an' he pe mo e heap han ou? Tha s, someone has an abso u e ad an a e n some h n , doesn' he au oma a ha e a ompa a e ad an a e n ?

The answe s no! I o dan a es me ou om shoo n hoops o do a h s own p n , he sa es he a e n ome he ea ns om en e a n n ans o bas e ba .

I , ns ead, h s se e a does he p n , he se e a es up an a e na e se e a a ob—o pe haps a mu h owe sa a p a n bas e ba . Tha s, he se e a s he owe - os p s .

Comparative Advantage1. A country should specialise in the production

of good or service in which it has lower opportunity cost

2. It should import commodities which have a higher opportunity cost of production

Example

Party Time/ painting Time/ handicraft

You 1 1

Your Neighbour 1.5 3

Commodity Profit

Painting 400

Handicraft 350

Case 1 : Not specializingSharing a 6 day work week among two.

Party Paintings Produced

Handicrafts Produced Total Profit

You 3 3 2250

Your Neighbour 2 1 1100

Total Units produced in all 9

Case 2 : SpecializingAnd producing the product with comparative advantage

Party Paintings Produced

Handicrafts Produced Total Profit

You 6 0 2400

Your Neighbour 0 4 1400

Total Units produced in all 10

Specializing is always goodAnd you can(should) specialize even if you are good at everything

Thank youShivek KhuranaCluster Innovation CentreUniversity Of Delhi