Discuss the theory of comparative advantage in International Trade. How is it different from absolute advantage theory?
International trade is necessary to obtain the gains that international specialization makes possible. Trade allows each individual, region or country to concentrate on producing those goods and services that it produces relatively efficiently while trading to obtain goods and services that it would produce less efficiently than others.
Absolute advantage versus comparative advantage : A country enjoys an absolute advantage over another country in the production of a product if it uses fewer resources to produce that product than the other country does. Suppose country A and country B produce rice, but A’s climate is more suited to rice and its labor is more productive. Then country A will produce more rice per acre than country B and use less labor in growing it and bringing it to the market. In this case, country A enjoys an absolute advantage over country B in the production of rice.
A country enjoys comparative advantage in the production of a good if that good can be produced at lower cost in terms of other goods. Suppose countries C and D both produce wheat and corn and C enjoys an absolute advantage in the production of both—that is, C’s climate is better than D’s and fewer of C’s resources are needed to produce a given quantity of both wheat and corn. Now C and D must choose between planting land with either wheat or corn. To produce more wheat, either country must transfer land from corn production and to produce more corn, either country must transfer land from wheat production. The cost of wheat in each country can measured in quantity kilogram of corn, and the cost of corn can be measured in kg of
Suppose that in country C, a kg. of wheat has an opportunity cost of two kg. of corn. That is, to produce an additional kg. of wheat, C must give up two kg. of corn. At the same time, producing a kg. of wheat in country D requires the sacrifice of only one kg. of corn. Even though C has’an absolute advantage in the production of both the products, D enjoys a comparative advantage in the production of wheat because the opportunity cost of producing wheat is lower in country. D. Under these circumstances, Ricardo claims, country D can benefit from trade if it specializes in the production of wheat. Thus, Ricardo’ e theory of comparative advantage states that specialization and free trade will benefit all trading partners, even those that may be absolutely less efficient producers.