Absolute and comparative advantages Flashcards
(11 cards)
Define comparative advantage
A country has comparative advantage when it can produce a good at a lower opportunity cost compared to another country
Define absolute advantage
A country has absolute advantage in the production of a good when it can produce more than another country
What are the assumptions of the theory of comparative advantage?
No transport costs
Constant costs - no EoS
Two economies are producing two goods
Goods are homogenous
Factors of production are perfectly mobile
No tariffs or trade barriers
Perfect information
Evaluate ‘No transport costs’ as an assumption of the theory of comparative advantage
In reality, there will be transport costs – the higher the costs the less likely international trade is
Evaluate ‘Constant costs – no economies of scale’ as an assumption of the theory of comparative advantage
Previous examples are simple to understand, but economies of scale would make the benefits of focussing on one good even more pronounced
Evaluate ‘Two economies are producing two goods’ as an assumption of the theory of comparative advantage
The real world is more complicated – however, countries should still be able to find goods that they have a relative efficiency at producing
Evaluate ‘Goods are homogeneous’ as an assumption of the theory of comparative advantage
Many goods are differentiated making comparison of their comparative advantage more difficult
Evaluate ‘Factors of production are perfectly mobile’ as an assumption of the theory of comparative advantage
In reality many resources have a limited range of uses
Give the opportunity cost formula used for comparative advantage
Opportunity cost = amount forgone / amount gained
In Albania, 25 units of wheat or 10 cars can be prodced. What is the opportunity cost of producing wheat?
10/25 = 0.4 cars
In Albania, 25 units of wheat or 10 cars can be prodced. What is the opportunity cost of producing cars?
25/10 = 2.5 units of wheat
