Challenging Comparative Advantage Essay

Moving to chapter 2 – the longest chapter of the book, Irwin demonstrates the significant differences between absolute advantage and comparative advantage. Starting with classic theories of Adam Smith and David Ricardo described the gains from trade in a systematic way, Irwin points out to the readers about the three main advantages of trade. The first and also the main advantage is improved resource allocation trade could lead to higher income. It means that when countries know and understand their competitive advantage, they could be able to allocate the resources in a reasonable manner in order to earn more profit. But trade not only helps to allocate existing resources properly but also makes those resources more productive, that’s the second advantage. By shifting resources capital and labor into sectors in which domestic industries are

 Free Trade: David Ricardo (support free trade)   o Theory of comparative advantage: For two nations without input factor mobility,  specialisation and trade could result in increased total output and lower costs  than if each nation tried to produce in isolation.    Both nations can benefit from trade if each specialises in good that they  have the lowest opportunity cost, even if one economy is more efficient in  making everything.    However, Comparative advantage in not static, and changes over time in  reality.    Also, comparative advantage assumes that factors of production can’t  move between countries  therefore comparative advantage is set to be  outdated

The impact of economies and diseconomies of scale Tesco face As businesses grow and their output increases, they commonly benefit from a reduction in average costs of production. Total costs will increase with increases in output, but the cost of producing each unit falls as output increases. This reduction in average costs is what gives larger firms a competitive advantage over smaller firms. This fall in average costs as output increases is known as Economies of Scale.

However, it was apparent to economists that nations with similar resource endowments exchanged similar products with each other. Economists felt that trade explained solely by comparative advantage was an incomplete analysis of international trade. Furthermore, since the classical trade theory was unable to explain intraindustry trade, economists decided to expand on the classical trade theory by creating a new theory of trade (Carbaugh, 2011). The new theory states that economies of scale provide incentive for a country to specialize in a particular product (Carbaugh, 2011). Furthermore, based on economies of scale, nations with similar factor endowments will trade with each other as sometimes it is beneficial (Carbaugh, 2011). Arguments stemming from this new trade theory puts the economic case for free trade in doubt.

The Ricardian trade model is a simple yet powerful theory that refutes common fallacies about the causations of trade flows. It illustrates that, instead of absolute advantage, it is comparative advantage that brings forth the gains from trade. Comparative advantage refers to the ability to produce a product at a lower opportunity cost than another. This ability is the result of

Due to the differences between the countries in its profitable fundamentals; the International Trade occurs. The contracts between the countries consider as the primary driver of the global exchange. These contracts concluded on the basis of the countries beneficial elements and advantages. Each international trade between the countries depends on numerous focal points of this exchange process. The economics and producers effectiveness measured by absolute advantage for these economics/producers. For example; if the producer needs lesser amount of contributions/inputs to provide specific product, then this producer has an absolute advantage in producing

Economic analysts say trading among other countries with no stipulations improve global efficiency in resource allocation (Tupy, 2005). Free Trade delivers goods and services to those who value them most and allows partners to gain from specializing in the producing those goods and services they do best; according to Tupy’s findings, Economists call that the law of comparative advantage. Tupy also states when producers create goods they are comparatively skilled at i.e. Germans producing beer and the French producing wine, those goods increase in abundance and quality. Trade allows consumers to benefit from more efficient production methods, for example, without large markets for goods and services, large production runs would not be economical. Large production runs, in turn, are instrumental to reducing product costs while lower production

The theory of comparative advantage explains the benefit of free trade. According to this theory by David Ricardo in the early 19th century, “Both countries will be better off if each specializes in the industry where it has a comparative advantage, and if the two trade with one another.” (Citation) International trade opens up markets to foreign supplier, and domestic companies need to improve their efficiency, boost productivity, and lower cost to increase competitiveness instead of enjoying monopolies or oligopolies that enabled them to keep prices well above marginal costs. On the other hand, international trade also offers domestic companies bigger demands and broader markets; therefore more jobs relevant to export have been created. Furthermore, jobs in the US supported by goods exports pay 13-18 percent more than the US national average (ustr.gov).

Which is cost difference determines the patterns of international trade. Absolute advantage is trade benefits when each country is at least cost producer of one of the goods being traded. In the 1800s, David Ricardo developed the theory of comparative advantage to measure gains from trades. This theory is based on comparative advantage and it states each nation should specialize in production of those goods for which its relatively more efficient with a lower opportunity cost.

Adam Smith, author of The Wealth of Nations, shows support for free trade and emphasises it as a trade policy which ought to be adopted. Krugman and Obstfeld back Smith's support by stating that the efficiency of trade is increased by free trade and accumulates the national income of countries. Free trade is a theory which suggests that each nation benefits in specialising in an economic activity from which it gains absolute advantage, enjoying absolute superiority over other nations in a specif economical activity (Peng). With free trade follows opportunity, replacing regulation and growth of economic activity. (Rugmann and Collinson).

The concept of absolute advantage is one of the most fundamental areas of concern in the study of economics. In its basic meaning, absolute advantage refers to the ability of one individual or party to produce more of a particular good or service than other competitors given the same amount of resources. In this regard, absolute advantage becomes a very important aspect in the concept of international trade as it clearly defines the different areas where countries should specialize in order to maximize their productivity and enhance international trade. The principle of absolute advantage was first elucidated by Adam Smith in his study of international trade using labor and capital as the only factor inputs(Free, 2010).

In today’s global economy, it makes sense for nations to benefit from producing those goods that they specialize in, and consequently trade amongst each other the excess quantities. As a result, consumers across the globe have access to vast varieties of products produced at the lowest costs. However, when two nations’ efficiencies are equivalent in the same product, one might think that trading products between these nations is futile. Moreover, when one nation is better at producing all items considered for trade, self-sufficiency might seem the obvious choice to the unwitting. Here, we analyze trade between two nations, and reveal that trade benefits indeed exist when exploiting specialization while considering opportunity costs.

Countries are enabled by free international trade to specialise or to focus in the production of the goods in which they have a comparative advantage. Specialisation countries can take the benefit of efficiencies generated from increased output and economies of trade. The size of the firm’s market are increased by the international trade which results in lower average costs and increasing in productivity, as it ultimately leads to increase in production.

The country can maximize their wealth by putting the resources in the most competitive industries. Government created comparative advantage rather than free trade because now easier moves the production processes and the machines into countries that can produce more goods (Yeager & Tuereck, 1984). However, many countries now move to new trade theory suggests the ability firms to limit the number of competitors associated with economic scale (reduction of costs with a large scale of output) (Krugman, 1992). The comparative advantage occurs when two-way trade in identical products, it will useful where economic scale is important, but it will create problem with this model. As a result, government must intervene in international trade for protection to domestic firms (Krugman, 1990)

Chapters twenty and twenty-one went over the relationship of international markets in a global economy. In an increasingly interconnected world, global trade has caused countries to shift to specializations in their markets. Therefore, raising average wages due to increased productivity. Countries can have absolute or comparative advantages in a certain market. As written in the text, an example of absolute advantage would be Saudi Arabia in the oil industry. This is because they have such an abundance of easily assessable oil very few countries can complete in that market. A comparative advantage is when a country can produce a product at a much lower cost. Comparative advantage is a balance of opportunity cost that leads a nation to specialized in a specific market. Comparative advantage can also be gained through the exploitation of workers or practices that are severity destructive to the environment. To protect a nations cultural, economic, and social interest a country will use tariffs, import quotas, and non-tariff barriers to deter domestic companies from purchasing goods from counties who practice unpleasant or morally object able methods, such as child labor.