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International Trade : Absolute vs comparative Advantage

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A comparison between Adam Smith's absolute and D. Ricardo's comparative advantage theory in international trade. "No matter what, you should always specialize"

A comparison between Adam Smith's absolute and D. Ricardo's comparative advantage theory in international trade. "No matter what, you should always specialize"

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  • 1. International Trade Absolute & Comparative Advantage
  • 2. Absolute Advantage A party’s ability to produce more goods than a competitor using the same amount of input(s) (assume single input : labor)
  • 3. Example 1 Party Good/Hour A 4 B 7
  • 4. Example 1 Party B has an absolute advantage over A Party Good/Hour A 4 B 7
  • 5. Example 2 Party Good2/Hour Good1/Hour A 6 4 B 2 7
  • 6. Example 2 A has AA in Good1 and B has AA in Good2 Party Good1/Hour Good2/Hour A 6 4 B 2 7
  • 7. Absolute Advantage Theory By Adam Smith 1. Specializing in production of one commodity 2. Exchanging parts of output with other nation
  • 8. Two countries A, B Party Good1/Hour Good2/Hour A 6 4 B 2 7
  • 9. Two countries A, B Party Good1/Hour Good2/Hour A 6 0 (+1 L. hour) B 0 (+1 L. hour) 7
  • 10. Two countries A, B Party Good1/Hour Good2/Hour A 6+6 0 B 0 7+7
  • 11. Comparative Advantage Spea e No e : A pe son has a ompa a e ad an a e a owe os han an one e se. p odu n some h n he Ha n a ompa a e ad an a e s no he same as be n he bes a , someone an be omp e e uns ed a do n some h n , ompa a e ad an a e a do n ! How an ha happen? an p odu e a e a some h n . In s ha e a F s , e 's e some mo e o abu a . Someone who s he bes a do n some h n s sa d o ha e an abso u e ad an a e. M hae o dan has an abso u e ad an a e a bas e ba . Fo a I now, M hae o dan ma a so be he as es p s n he wo d, n h m an abso u e ad an a e a p n , oo. S n e he's be e a p n han ou, an' he pe mo e heap han ou? Tha s, someone has an abso u e ad an a e n some h n , doesn' he au oma a ha e a ompa a e ad an a e n ? The p I , se se answe s no! I o dan a es me ou om shoo n hoops o do a h s own n , he sa es he a e n ome he ea ns om en e a n n ans o bas e ba . ns ead, h s se e a does he p n , he se e a es up an a e na e e a a ob—o pe haps a mu h owe sa a p a n bas e ba . Tha s, he e a s he owe - os p s .
  • 12. Comparative Advantage 1. A country should specialise in the production of good or service in which it has lower opportunity cost 2. It should import commodities which have a higher opportunity cost of production
  • 13. Commodity Painting 400 Handicraft Example Profit 350 Party Time/ painting Time/ handicraft You 1 1 Your Neighbour 1.5 3
  • 14. Case 1 : Not specializing Sharing a 6 day work week among two. Party Paintings Produced Handicrafts Produced Total Profit You 3 3 2250 Your Neighbour 2 1 1100 Total Units produced in all 9
  • 15. Case 2 : Specializing And producing the product with comparative advantage Party Paintings Produced Handicrafts Produced Total Profit You 6 0 2400 Your Neighbour 0 4 1400 Total Units produced in all 10
  • 16. Specializing is always good And you can(should) specialize even if you are good at everything
  • 17. Thank you Shivek Khurana Cluster Innovation Centre University Of Delhi