Absolute advantage refers to the ability to produce more or better goods and services than somebody else. Comparative advantage refers to the ability to produce goods and services at a lower opportunity cost, not necessarily at a greater volume or quality.
Comparative advantage is a key insight that trade will still occur even if one country has an absolute advantage in all products. To see the difference, consider an attorney and their secretary. The attorney is better at producing legal services than the secretary and is also a faster typist and organizer. In this case, the attorney has an absolute advantage in both the production of legal services and secretarial work.
Nevertheless, they benefit from trade thanks to their comparative advantages and disadvantages. Here, the role of opportunity cost is crucial. Their opportunity cost of secretarial work is high. They are better off by producing an hour's worth of legal services and hiring the secretary to type and organize.
The secretary is much better off typing and organizing for the attorney; their opportunity cost of doing so is low. Competitive advantage refers to a company, economy, country, or individual's ability to provide a stronger value to consumers as compared with its competitors. It is similar to, but distinct from, comparative advantage. David Ricardo famously showed how England and Portugal both benefit by specializing and trading according to their comparative advantages.
In this case, Portugal was able to make wine at a low cost, while England was able to cheaply manufacture cloth. Ricardo predicted that each country would eventually recognize these facts and stop attempting to make the product that was more costly to generate. Indeed, as time went on, England stopped producing wine, and Portugal stopped manufacturing cloth.
Both countries saw that it was to their advantage to stop their efforts at producing these items at home and, instead, to trade with each other in order to acquire them. Comparative advantage is closely associated with free trade, which is seen as beneficial, whereas tariffs closely correspond to restricted trade and a zero-sum game. Chinese workers produce simple consumer goods at a much lower opportunity cost. American workers produce sophisticated goods or investment opportunities at lower opportunity costs.
Specializing and trading along these lines benefit each. The theory of comparative advantage helps to explain why protectionism is typically unsuccessful. Adherents to this analytical approach believe that countries engaged in international trade will have already worked toward finding partners with comparative advantages. If a country removes itself from an international trade agreement, if a government imposes tariffs , and so on, it may produce a local benefit in the form of new jobs and industry.
However, this is not a long-term solution to a trade problem. Eventually, that country will be at a disadvantage relative to its neighbors: countries that were already better able to produce these items at a lower opportunity cost.
Why doesn't the world have open trading between countries? Comparative advantage and absolute advantage. Opportunity cost and comparative advantage using an output table. Terms of trade and the gains from trade. Input approach to determining comparative advantage.
In this case, international trade does not confer any advantage. Read more on: Gravity Theory. Stagflation is a combination of high inflation, high unemployment, and stagnant economic growth. Because inflation isn't supposed to occur in a weak economy, stagflation is an unnatural situation.
Slow growth prevents inflation in a normal The laissez-faire economic theory centers on the restriction of government intervention in the economy. According to laissez-faire economics, the economy is at its strongest when the government protects individuals' rights but otherwise doesn't intervene.
What Is Adverse Selection? Adverse selection is a term that describes the presence of unequal information between buyers and sellers, distorting the market and creating conditions that can lead to an economic collapse. If the 40 workers in the United States are making refrigerators, and each worker can produce 1, refrigerators, then a total of 40, refrigerators will be produced.
As always, the slope of the production possibility frontier for each country is the opportunity cost of one refrigerator in terms of foregone shoe production—when labor is transferred from producing the latter to producing the former see Figure 1.
Figure 1. Production Possibility Frontiers. All other points on the production possibility line are possible combinations of the two goods that can be produced given current resources. Point A on both graphs is where the countries start producing and consuming before trade. Point B is where they end up after trade. Table 3 shows the output of each good for each country and the total output for the two countries. Continuing with this scenario, each country transfers some amount of labor toward its area of comparative advantage.
For example, the United States transfers six workers away from shoes and toward producing refrigerators. As a result, U. Mexico also moves production toward its area of comparative advantage, transferring 10 workers away from refrigerators and toward production of shoes. Notice that when both countries shift production toward each of their comparative advantages what they are relatively better at , their combined production of both goods rises, as shown in Table 4.
The reduction of shoe production by 1, pairs in the United States is more than offset by the gain of 2, pairs of shoes in Mexico, while the reduction of 2, refrigerators in Mexico is more than offset by the additional 6, refrigerators produced in the United States.
This numerical example illustrates the remarkable insight of comparative advantage: even when one country has an absolute advantage in all goods and another country has an absolute disadvantage in all goods, both countries can still benefit from trade.
Even though the United States has an absolute advantage in producing both refrigerators and shoes, it makes economic sense for it to specialize in the good for which it has a comparative advantage.
The United States will export refrigerators and in return import shoes. When you first met the production possibility frontier PPF in an earlier module, it was drawn with an outward-bending shape.
This shape illustrated that as inputs were transferred from producing one good to another—like from education to health services—there were increasing opportunity costs. In the examples in this module, the PPFs are drawn as straight lines, which means that opportunity costs are constant.
When a marginal unit of labor is transferred away from growing corn and toward producing oil, the decline in the quantity of corn and the increase in the quantity of oil is always the same.
In reality this is possible only if the contribution of additional workers to output did not change as the scale of production changed. The linear production possibilities frontier is a less realistic model, but a straight line simplifies calculations. It also illustrates economic themes like absolute and comparative advantage just as clearly. This example shows that both parties can benefit from specializing in their comparative advantages and trading.
By using the opportunity costs in this example, it is possible to identify the range of possible trades that would benefit each country. Mexico started out, before specialization and trade, producing 4, pairs of shoes and 5, refrigerators.
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