Theory of Comparative Advantage
Theory of Comparative Advantage
The theory of comparative advantage
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The theory of comparative advantage
Ricardo David bore this theory in the year 1817. This theory states that for a country to be advantageous it simply has to import more goods so that it can be able to free up most of its workforce. David tries to make a comparison between two goods being produced by two different countries. He argues that the trade would still take place between the two countries even if one of the countries were to produce the two goods and also the likelihood of both countries to pull benefits from the trade. He continues to state that even if one of the two countries either country “A” or “B” produces more of all the products trade will still take place, and the two countries can still gain from the trade (Ricardo, 1951).
From his assumption, Ricardo compared to countries that are Portugal and England. In this comparison, both countries were producing both cloth and wine. In the production of the products, Portugal had an absolute advantage in both products. In addition to that, Portugal looked to be efficient compared to England, and it had a comparative advantage in wine production hence when trade is the two countries would still gain from each other (Krugman, 1991. pp. 122-127)
This theory, therefore, sees international trade as a huge interlocking system where trading offs takes place. Here many nations engage in using their abilities to exert in importing and exporting so that they can be able to shade off costs incurred in opportunities and tries to reshuffle factors considered in the production to the most valuable standard. These events occur automatically because, if the owner of given factors used in the production finds more uses that can produce a more valuable products, they will react by moving these factors towards the production of profitable products.
Most often, many misunderstand this theory. People get the wrong notion that the theory implies that for a country to gain full competitive edge in the international market it has to take the best move in gaining more comparative advantage, mainly in its industry sectors. By definition, this is impossible to be achieved (Krasner, 1976. pp. 28). Despite this ideal scenario, that countries aspire to there will still be a scenario where greater margin of superiority will still exists in some industries while some will have a lesser margin. The comparative advantage notion would still be determining the countries rate of import and export and jobs to foreign nations would still be lost (Chang, 2002. pp. 52-65).
In contrast, the comparative advantage theory that in cases where countries experiences productivity differences there must be a mutual gain that occur from the trade. This explains the reasons as to why free traders tend to believe that in accordance to their theory, free trading is the best for any country in regardless of whether the country is poor or rich. Here, the countries that are rich cannot be over pressed by the nations that are poor and, on the other hand, the countries that are poor will not be by the superiority of the rich countries. The logic that forms the fundamental principle of comparative advantage states that it is only possible for mutual beneficial exchanges to take place making such events of one country being affected by the other impossible to take place (Clement, 2002. pp. 39).
Assumptions
The theory has outlined several assumptions to support its stature, but these consist of its flaws. The assumptions include:
There are no externalities
This is like the price tag in missing. It happens in economics in a situation where the economic value of the product is not clearly reflected by its price. In cases of classic negative externality, the true value of resources is reduced without increasing the price of the products that caused harm. Moreover, in cases of a classic positive situation, there is a spillover in technology, and one of the companies that invest in a given product allows other companies to copy or make modifications of the same product so that wealth that the company failed to capture can be (Roberts, 2004. pp. 48).
This theory operates just like any other theory in a free market economy. The prices of products drive it, and in a situation where prices are not right because of either positive externality or negative externality or even both, it will lead to wrong policies recommendations in the industry