02. Comparative Advantage_1

02. Comparative Advantage_1 - Principle of Comparative...

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Principle of Comparative Advantage The theory of comparative advantage is perhaps the most important concept in international trade theory. It is also one of the most commonly misunderstood principles. There is a popular story told amongst economists that once when an economics skeptic asked Paul Samuelson (a Nobel laureate in economics) to provide a meaningful and non-trivial result from the economics discipline, Samuelson quickly responded with, “comparative advantage.” http://internationalecon.com/Trade/Tch40/T40-0.php The punch line of this theory is, indeed, hard to believe. Country A is technologically superior to Country B in every possible industry. Yet it is always possible for both countries to benefit from trade – even if Country A has more of every productive resource (more land, more labor, more capital, more education)! The principle of comparative advantage was discovered by Robert Torrens around 1815, but is more commonly associated with the great classical economist, David Ricardo. The underlying idea comes from opportunity cost. Ricardo’s example related to British cloth and Portuguese wine. Imagine that England has superior technology in both industries. For example: Portuguese wine costs twice as much as British wine and Portuguese cloth costs four times as much as British cloth. Wine: requires one hour of labor per jug in England, two hours in Portugal Cloth: requires one hour of labor per yard in England, four hours in Portugal The bad news for Portugal is that cloth has a lower opportunity cost in England than in Portugal. A yard of cloth costs one just of wine in England, but two jugs in Portugal (the four hours required to produce a yard of cloth could be used to produce two jugs of wine). The good news for Portugal is that (remember from the notes on opportunity cost) opportunity costs are reciprocal. This means that wine must have a lower opportunity cost in Portugal than in England! A jug of wine costs one yard of cloth in England, but only ½ of a yard of cloth in Portugal. So, if England wants more wine, it should produce more cloth and trade it for Portuguese wine. A.
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This note was uploaded on 05/09/2008 for the course ECN 212 taught by Professor Nancy during the Fall '07 term at ASU.

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02. Comparative Advantage_1 - Principle of Comparative...

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