Absolute Advantage Theory and Its Relevance to International Trade
(a) Discuss the absolute advantage theory and its relevance to international trade.
John Solman and Mark Sutcliffe, Economics of Business, states that “that the reasons for international trade are just extensions of the reasons for trade within a nation and that instead of people or countries being self-sufficient it makes more sense to specialize in different trades’. Solman and Sutcliff advised that ‘firms or companies usually specialize in certain types of goods or services which allow them to gain the economies of scale and the ability to exploit their entrepreneurial and management skills along with the skills of the labour force. It also allows firms and companies to benefit from their particular location and from ownership of any particular capital equipment or other types of assets in their possession. Too countries that specialize also make more than they need of certain goods and what is not used locally is exported and the revenues earned from the exports are used to import goods which certain countries are not able to produce sufficiently at home. [1]
The law of comparative advantage
According to Solman and Sutcliffe, countries that have different endowments of factors of production also differ in population density, labour skills, climate, raw materials and capital equipment, etc. The difference tend to persist because the factors are normally immobile but even with labour and capital there is the practice of more restrictions, (physical, social, cultural or legal) on their international movement more so than on their movement within countries. For example, a country may be able to make one fridge for the same cost as six tons of wheat or three compact disc player whereas another country may be able to produce one fridge for the same cost as three tons of wheat but four CD-players. These are the differences in relative costs that form the basis of trade. [1]
A simply theory of comparative advantage is noted in the two countries
John Solman and Mark Sutcliffe, Economics of Business, states that “that the reasons for international trade are just extensions of the reasons for trade within a nation and that instead of people or countries being self-sufficient it makes more sense to specialize in different trades’. Solman and Sutcliff advised that ‘firms or companies usually specialize in certain types of goods or services which allow them to gain the economies of scale and the ability to exploit their entrepreneurial and management skills along with the skills of the labour force. It also allows firms and companies to benefit from their particular location and from ownership of any particular capital equipment or other types of assets in their possession. Too countries that specialize also make more than they need of certain goods and what is not used locally is exported and the revenues earned from the exports are used to import goods which certain countries are not able to produce sufficiently at home. [1]
The law of comparative advantage
According to Solman and Sutcliffe, countries that have different endowments of factors of production also differ in population density, labour skills, climate, raw materials and capital equipment, etc. The difference tend to persist because the factors are normally immobile but even with labour and capital there is the practice of more restrictions, (physical, social, cultural or legal) on their international movement more so than on their movement within countries. For example, a country may be able to make one fridge for the same cost as six tons of wheat or three compact disc player whereas another country may be able to produce one fridge for the same cost as three tons of wheat but four CD-players. These are the differences in relative costs that form the basis of trade. [1]
A simply theory of comparative advantage is noted in the two countries
References: [1] John Sloman and Mark Sutcliffe, Economics for Business, 3rd Edition, Chapter 24, The Advantages of Trade, pgs. 510 – 512. [2] International Trade (2010). In Encyclopedia Britannica, Inc. Retrieved August 19, 2010, from Encyclopedia Britannica Online: http://www.britannica.com/EBchecked/topic/291349/international-trade/61686/Simplified-theory-of-comparative-advantage