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Absolute Cost dvantage - International Trade (NTA NET) BY TANYA BHATIA
Absolute Cost Advantage Adam Smith propounded the theory of absolute cost advantage as the basis of foreign trade; under such circumstances an exchange of goods will take place only if each of the two countries can produce one commodity at an absolutely lower production cost than the other country
Numerical Example Absolute differences in production costs Commodity Country Country Country II 20 10 10 20
Explanation As we can see country I requires 10 units of labour for producing Commodity A and Country 2 requires 20 units of Labour for commodity A. Country 1 requires 20 units of labour for producing Commodity B and Country 2 requires 10 units of labour for commodity B.
Thus Country 1 has Absolute Advantage in Commodity A and Country 2 has Absolute Advantage in Commodity B.
For Practice Country Oil (hours per unit) Corn (hours per unit) Saudi Arabia 4 United States 2 2
For Practice Country Australia England Wine ( per unit Cost in Cloth (Per unit Cost in labor hours) 80 120 labor hours) 90 100
Comparative Cost Advantage In 1817, David Ricardo, a businessman, economist, and member of the British Parliament, wrote a treatise called On the Principles of Political Economy and Taxation. In this treatise, Ricardo argued that specialization and free trade benefit all trading partners, evern those that may be relatively inefficient.
Comparative Cost Advantage Theory David Ricardo believed that the international trade is governed by the comparative cost advantage rather than the absolute cost advantage. A country will specialise in that line of production in which it has a greater relative or comparative advantage in costs than other countries and will depend upon imports from abroad of all such commodities in which it has relative cost disadvantage
Example Suppose India produces computers and rice at a high cost while Japan produces both the commodities at a low cost. It does not mean that Japan will specialise in both rice and computers and India will have nothing to export. If Japan can produce rice at a relatively lesser cost than computers, it will decide to specialise in the production and export of computers and India, which has less comparative cost disadvantage in the production of rice than computers will decide to specialise in the production of rice and export it to Japan in exchange of computers.
Assumptions Labour is only Factor of Production. All labour units are homogeneous. Labour is perfect mobile within the Country but is perfectly immobile between different countries. trade takes place between two countries and in two commodities produced by Labour alone. In other word it is 2*2*1 model. There is free trade between the two Countries. All factors of Production are fully employed in both the countries.
Assumptions There is no intervention by the government in economic system. Perfect competition exists both in the commodity and factor markets. There are static conditions in the economy. It implies that factors supplies, techniques of production and tastes and preferences are given and constant
TABLE 2.3. Labour Cost of Production Labour cost per unit of commodity inman-hours Country 1 2 16 CommoditY Y 10 1 2 In country A Y= 12/10=1.2x X-10/12-0.83Y In Country B X=12/16=0.75Y Y-16/12-1.33X Clearly Country B has Comparative Advantage in Producing good X and Country A has Comparative Advantage in Producing Good Y
Q3-Suppose Russia has an absolute advantage in the production of all goods. In this instance, Russia a. will have no incentive to engage in international trade. b. should specialize in producing the goods for which it has a lower opportunity cost than other countries. c. also has a comparative advantage in the production of those goods. d. is producing at a point on its production possibilities frontier
Q5-According to the theory of comparative advantage, a country will export a good only if a. It can produce it using less labor than other countries. b. Its productivity is higher in producing the good than the productivity of other countries in producing it. c. Its cost of producing the good, relative to other goods, is at least as low as in other countries. d.. All of the above
output Autralia Brazil Sleds 300 200 Clarinets 2 Q6-Suppose that Australia and Brazil have the outputs per worker in producing sleds and clarinets shown in the table at the right. Then Brazil has a. Comparative advantage in sleds. b. Comparative advantage in clarinets. C. Absolute advantage in sleds. d. Absolute advantage in clarinets.
Q7 Which of the following is not an Assumption of Ricardo theory'? 1. Labour is only factor of Production. 2. Government Interventio n 3. Free Trade 4. Full employment
Q8-lf a nation does not have an absolute advantage in producing anything, it a. has no comparative advantage either b. could have a comparative advantage in producing something. c. will try to get along without trade. d. will export raw materials and import finished products.