Comparative + Absolute Advantage Flashcards
What is absolute advantage
Where greater production can take place by a country using the same quantity of factors of production as another country - simply can produce a G/S more cheaply than another country as they can use factors of production more efficiently
What is comparative advantage
Idea that two countries should specialise in G/S they can produce at a lower opportunity cost compared to another country - means both countries benefit by consuming beyond their ppc - means country should specialise in 1 and import the other
What is needed for trade to take place between 2 countries
If the rate of exchange of G/S lies between the opportunity cost ratios of production and money exists to act as a means of exchange
How can a country gain comparative advantage
Due to either greater quantities of factors of production or better quality factors of production compared to another country
If country has a higher skilled workforce - advantage in manufactured goods
On other hand countries in Africa have lots of natural resources - advantage in primary commodity
How can it change over time (2)
For example due to greater R+D and innovation
Also education investment
Problem with information
Comparative advantage assumes perfect information for both producers and consumers - if consumers however lack info of where cheapest goods are produced - may buy from an inefficient producer - allowing these businesses to survive and be profitable
How is the law of comparative advantage contradicted
Multiple countries can specialise in one area of producing the same goods and services for successful export - explains why some countries without comparative advantage can produce at high cost and charge high prices
Problem of transport
Transport costs are assumed to be zero - which does not clearly hold in the real world - large transport costs may erode a country’s comparative advantage and make it cheaper to import goods from less efficient producers located closer
Comparative advantage assumes no economies or scale advantage
In reality even countries without a comparative advantage can set up large scale production of a good or service purely to benefit form economies of scale as output increases which can then allow them to compete with countries with a comparative advantage and overtime take over comparative advantage in production
Ignores exchange rates
Comparative advantage ignores the impact of exchange rates - for example a country with a comparative advantage will lose out to another less efficient producer if their exchange rate strengthens - the other country will benefit from more competitive exports - eliminating a comparative advantage cost difference - therefore can be successful while more inefficient
Effect of protectionist measure
Tariffs and quotas can be used by governments in countries without comparative advantage t0 inflate the price of imports from countries with comparative advantage - provides domestic producers an advantage
Highly price non competitive effect
Countries without comparative advantage may be highly price non competitive - as these countries might focus more on quality, branding and advertising - provides strong consumer base - despite prices higher than other countries - as realised consumers do not only consume based on price but also non price factors
