Theory of Comparative Advantage

Comparative Advantage:

 A country has a comparative advantage over another in the production of a good if it can produce it at a lower opportunity cost: i.e. it has to forego less of other goods in order to produce it.

OUTPUT  

	Textiles	Books
UK	1	4
India	2	3
Total	3	7

For the UK to produce 1 unit of textiles it has an opportunity cost of 4 books.

However for India to produce 1 unit of textiles it has an opportunity cost of

1.5 books

• Therefore China has a comparative advantage in producing clothing because it has a lower opportunity cost

 

• The UK has a comparative advantage in producing computers

 (because it has a lower opportunity cost of .025 compared to Chinas 0.66)

• If each country now specializes in one good then assuming constant returns to scale output will double

 

	clothing	Computers
UK	0	8
CHINA	4	0
TOTAL	4	8

• Therefore output of both goods has increased illustrating the gains from comparative advantage.

 

There are many examples of comparative advantage in the real world e.g. Saudi Arabia and Oil, New Zealand and butter, USA and Soya beans, Japan and cars e.t.c

limitations of comparative advantage

 

 

 

Revision Notes on Trade

International Trade

Benefits of Free Trade

Arguments against Free Trade

Trade Protectionism

Comparative Advantage

Limitations of Comparative Advantage

Balance of Payments