The Law of Comparative Advantage Forms the Basis of International Trade

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Table of Contents

Introduction
The law of comparative advantage
David Ricardo: Theory of Comparative advantage
The Heckscher-Ohlin Trade Theory
Conclusion
Reference List

Introduction

Factors of production differ from country to country. The difference is significant in the labor skills, availability of raw materials, climate and population density. These factors are generally immobile; hence, their differences tend to persist from country to country.

Even though climate and land are immobile, other factors like capital and labor have tight restrictions in terms of their physical, legal, cultural, and social form especially when their movement is between two countries as opposed to the movement within one particular country. This hence differentiates the ability in terms of supplying goods between countries.

The difference is attributed to the difference in cost of production of goods. These differences ultimately establish the solid foundation of trade. Comparative advantage on the other hand is the beneficial trade between countries, despite one country having the upper hand of producing all of its goods by use of minimum resources. This therefore brings about relative efficiency that differentiates production of goods between the two countries (Suneja, 2000, p. 172).

The law of comparative advantage

According to Maneschi, “the principle of comparative advantage has been named the deepest and the most beautiful result in all of economics” (Maneschi, 1998, p.1). This concept plays a crucial role in international trade despite lacking a satisfactory and common definition to define it.

In the dictionary of economics, this concept has been defined as a systematic definition of gains attained from trade in reference to division of labor and specialization. It is the perception of others to define specialization effects in terms of comparative advantage as well as use theories in consideration of its sources.

Overall, comparative advantage is side supplying of differences between various countries in regard to technologies as well as factor endowments. This explanation has been subjected to criticism from different quarters, with some arguing that the explanation failed to account beyond reasonable doubt, the trade pattern after World War II, in particular concerning the expansive fraction of world trade, which was tribute to growth, and the nature of intra-industry.

This has partly led to the constant challenging of Hecksher-Ohlin theory over the last two decades by the new trade theory. Despite of these shortcomings, the trade models founded on comparative advantage continue to be popular in regard to international economics. The concept continues to receive praises from high-learned professionals (Maneschi, 1998, p.1).

Comparative advantage is achieved by a country if it is more productive in a given commodity as compared to both other countries other products. In defining the law of comparative advantage, one can consider the scenario of a country exporting products whose production is cheaper as compared to other countries.

It is easier to understand this scenario, as no complicated commodities exist. However, complications may arise especially when the scenario becomes general in terms of technology as well as a number of factors and products (Maneschi, 1998, p.2).

David Ricardo: Theory of Comparative advantage

The theory states that, despite a nation having absolute disadvantage in producing commodities as compared to other countries, trade could still be undertaken, which is mutually advantageous. The nation with less efficiency is supposed to focus on both the production and exportation of commodities with advantage that is more absolute.

It is this kind of commodity that the nation in question has comparative advantage. In addition to this the vice versa should happen which means the nation should undertake importation of commodities which it has less advantage. In 1821, Ricardo indicated that despite a country having absolute advantage in production of every commodity that does not mean it has comparative advantage in the production of every commodity.

This therefore signifies the fact that it is impossible for a nation to be importing everything (Condon and Sinha, 2003, p. 32). According to Ghai and Gupta, it was the theory of comparative advantage that incorporated together a large portion of trade within the world by eliminating the necessity that pertains to absolute differences in cost, which in the past was used in trade (Ghai and Gupta, 2002, p. 237).

In this theory as Suggested by David Ricardo, even lack of absolute differences in cost, the two countries could still engage in beneficial and mutual trade. The mutual benefits in trade are still possible despite the fact that one country could be less efficient in producing both commodities as compared to counterpart nation.

One nation may undertake to specialize in producing and exporting commodities of a lesser disadvantage and at the same time import a commodity that has a higher absolute advantage. The restriction in this case is that absolute advantage should not be similar in the two commodities. The assumptions in this theory include; Presence of two countries, the trade is free and no transportation cost (Ghai and Gupta, 2002, p. 237).

Katsioloudes and Hadjidakis (2007) suggested that prices were dictated mainly by the labor quantity that was in use during production. In addition to this, capital costs also play a significant role in determination of prices. The effect of increase in wages average prices is attributed as a result of the quantity of labor and capital costs, which are factors of production in the different commodities (Katsioloudes and Hadjidakis, 2007, p. 74).

In a simpler format, a country’s comparative advantage in certain commodities and comparative disadvantage in other commodities is attributed to the fact that the country’s endowment of climate, technology, natural resources and the productivity of labor force.

The prediction that is normally kept across of an international trade is that a nation is likely to export the commodities whose endowment in terms of land, capital and labor has room for output expansion with minimal sacrifice of any other domestic goods. Technology was also used to create trade opportunities (Kletzer, 2002, p. 12).

The Heckscher-Ohlin Trade Theory

The Heckscher-Ohlin Trade Theory, attempts to answer the pending questions that were not answered by David Ricardo and his theory. Questions that reflects on the reason behind comparative advantage or why there is a difference in comparative costs in regard to production of commodities in various countries and the impact of international trade in terms of earnings received by the two countries in trade.

These are some of the questioned that have been tackled by the Heckscher-Ohlin Trade Theory. This theory as the name suggest, was named after Eli F. Heckscher and Bertil Ohlin who were economists. The two economists also shared the same nationality, which was Swedish.

Hecksher was the first economist that published an article in 1919 that had the heart of the Hecksher-Ohlin theory. Bertil on the other hand was a student of Hecksher who later worked on the unnoticed publication of Hecksher to give it life through publishing of his own book in the year 1933. In 1977, Ohlin received the Nobel Prize in the field of economics as his work was internationally accepted and was crucial in international trade (Ghai and Gupta, 2002, p. 278).

The Heckscher-Ohlin Trade Theory is founded on the foundation of general equilibrium theory. The validation of the general theory was considered particularly for one market. It was later concluded that due to the differences that existed between international trade and domestic trade, it was ideal to have a separate theory that incorporated international trade.

This however was not in agreement with Ohlin who perceived international trade as a case of interregional trade. In addition to this, he considered the application of general equilibrium theory to both domestic and international trade. The assumptions considered in this theory include the use of the similar technology in the two countries of trade, Presence of perfect competition and the trade is free without barriers among others (Ghai and Gupta, 2002, p. 279).

Heckscher-Ohlin Trade theory does not contradict nor reject the theory of comparative advantage, but instead it acts as a supplement to the theory as it removes the main limitation from the theory and provides a comprehensive explanation of comparative advantage. The differences in prices of commodities to be traded, act as the main reason behind the trade of the two countries.

The commodity’s price in return is affected by the factor prices that differ from country to country. In addition to this, the rise in the factor prices is initiated by the difference in supply factor between the countries of trade. In consideration of Heckscher-Ohlin Trade theory, the distribution of income, tastes, and preferences of the consumer and distribution factors of production determines the level of demand for the commodities.

This means that the demand that is based on the factors of production depends on the demand that is based on final commodities. In this case the taste and preference of consumers in the two countries is similar as well as the income distribution. Therefore, the demand of factors and the demand for commodities play an insignificant role in the final prices of the commodity (Ghai and Gupta, 2002, p. 281).

Conclusion

Differences in prices in various countries represent the difference in cost of production thus signifying the basic cause of trade. In the world trade in one way or the other tries to reduce, the resource costs attributed to production.

This tend to happen more often as in the world of trade producers from different countries can specialize on economic trade activities that tend to utilize the country’s resources to the maximum. The differences in international trade of the relative cost of production indicate the comparative advantage notion, which is the basis of international trade theory.

The introduction of comparative advantage was brought about by David Ricardo and later on upon extension; it was refined by the two economists Eli Heckscher and Bertil Ohlin. International trade in consideration of the two theories will result to expansion of export production sector and at the same time contraction will be taking place on the import sector. This is attributed to shift of focus by a nation to commodities of comparative advantage.

Reference List

Condon, J. B. and Sinha, T., 2003. Drawing lines in sand and snow: border security and North American economic. NY: M.E. Sharpe, Inc.

Ghai, p. and Gupta, A., 2002. Microeconomics Theory and Applications. New Delhi: Sarup & Sons.

Katsioloudes, I. M. and Hadjidakis, S., 2007. International business: a global perspective. MA: Elsevier Inc.

Kletzer, G. L., 2002. Imports, exports, and jobs: what does trade mean for employment and job loss? Michigan: W.E. Upjohn Institute for Employment Research.

Maneschi, A., 1998. Comparative advantage in international trade: a historical perspective. Massachusetts: Edward Elgar Publishing, Inc.

Suneja, V., 2000. Understanding business: a multidimensional approach to the market economy. NY: Routledge.

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