homework, international-tradeI’ve heard a lot about the benefits of comparative advantage, but I’d like to know what are the main differences between absolute and comparative advantages.
I assume you are thinking of a Ricardian model, in which absolute and comparative advantages derive from technology differences.
Taking the textbook approach, suppose there are two countries, named “Home” and “Foreign.” Further, suppose that each country can produce two goods, say Good X and Good Y using one factor of production, labor (many simplifying assumptions buried in the last sentence).
We then look at “unit labor requirements” - the amount of labor needed to produce one unit of each good. Suppose that for home, the unit labor requirements (denoted A) are: $A_X^H = 3$ and $A_Y^H$ = 6… that is, it takes 3 units of labor to produce a unit of good X and 6 units of labor to produce a unit of good Y.
Suppose the other country (Foreign) has a different technology, such that $A_X^F=20$ and $A_Y^F=10$. Here, Home can produce either good with less labor than foreign… it is said to have an absolute advantage in both goods. Naive logic would lead us to the conclusion that there is no possibility of trade between Home and Foreign, since home is better at producing both goods. But we’ll construct a simple example to show otherwise.
In these models, we usually have a fixed labor constraint (endowment). We can allocate our labor to production of good X or good Y. Notice that with the given unit labor requirements, in Home, producing an extra unit of good X requires that they give up ${1}/{2}\;$ units of good Y (that is, they must free-up labor by producing less of good Y). In the foreign country, producing an extra unit of good X requires giving up 2 units of good Y. This is the opportunity cost of good X in terms of good Y (${1}/{2}\;$ for Home and 2 for Foreign). So home has a lower opportunity cost of producing good X than does foreign. Here, we say that home has a comparative advantage in the production of good X and, by symmetry, that Foreign has a comparative advantage in producing good Y (e.g. Home gives up 2 units of X for one unit of Y while Foreign gives up ${1}/{2}\;$ unit of X per unit of good Y).
This difference in comparative advantage gives rise to potential gains from trade. Consider that Foreign might produce a unit of good Y and trade it with Home for one unit of good X. Home will accept this trade because they must usually give up 2 units of good X to get a unit of good Y. Foreign also benefits since, without trade, they would need to give up 2 units of good Y to get a unit of good X.
If you are interested in this sort of logic, you would enjoy studying the Ricardian model in more detail.
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