The principles of absolute and comparative advantage rely on the following principles:
- There are no transport costs
- There are only 2 countries involved in trade (trade is bilateral)
- Factors of production are perfectly mobile
- There are no economies of scale (constant returns)
- There is full employment
As a result, these assumptions limit the ability of these theories to account for a country's pattern of trade.
Absolute advantage occurs when one country has the ability to produce more of one good than another. If both countries specialise in what they can produce more of, both can be better off as a result of trade taking place. World production will increase.
Factor Endowment determines whether or not a country has absolute or comparative advantage, as the abundance of factors of production in that country will determine what goods it can produce more of.
Comparative advantage occurs when one country has…