COMPARATIVE AND ABSOLUTE ADVANTAGE

This theory is used to explain why nations trade but is also shows why regions specialise and trade in the output of one particular product.

     Any factor, a person or a piece of land may be better than another in one use. A doctor might be better than others at medicine, or country specialises where it has a high supply of a factor or natural resource-France with its climate and land is better at growing grapes but England better at lamb and wool. These are examples of ABSOLUTE ADVANTAGE, one country is simply more efficient in an industry. Absolute advantage means a country produces at a lower unit cost using fewer factors of production for a given output than less efficient rivals. Two countries may have a recipricol absolute advantage, i.e. each has a cost advantage in producing one of the two products they trade.

A country may have an absolute advantage but not always a comparative advantage which is more to do with the opportunity costs each country faces in specialising.

 Countries will specialise in their Comparative advantage not just their absolute advantage. They do not specialise simply where they are more efficient, but where they have the greatest efficiency and thus the lowest opportunity cost of specialising (their CA).

Example A doctor may be more skilled at painting his house than a local housepainter, but he employs the painter, why? By doing so though it releases him to spend more of his scarce time on medicine where his skill and earnings are greater than in painting. It pays him to specialise not in his absolute advantage of house painting but where he has a greater or greatest comparative advantage- medicine. Medicine’s earnings may allow him to buy two hours decorating from an hour spent as a doctor. Britain may be more efficient than Pakistan in producing shirts, but it pays us to let them produce shirts so we can specialise in financial services where our advantage is even greater. It would be silly to produce shirts when the same labour could buy even more shirts if they sell insurance or other invisible export. There is too great an opportunity cost in producing something a country is only good at, it gives up what it is superb at.

Just as a doctor specialising and “trading” time with a builder increases the output and living standards of both so it is with countries which engage in free trade. Each country benefits from increased output. World output will be much higher if all countries trade and concentrate their resources in industries where they have the greatest comparative advantage, not in their simple absolute advantage. Countries concentrate where they have the greatest relative efficiency.  The DCs should not produce textiles or food even if they can produce more efficiently than an LDC because the opportunity cost of the resources tied up would be so high. MDCs would have to…