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(PLEASEEE BRAILIEST THIS WAS HARD)Trade and Globalization
Essay:
Comparative advantage
Theory: What is ‘comparative advantage’ and why does it matter to understand trade?
In economic theory, the ‘economic cost’ – or the ‘opportunity cost’ – of producing a good is the value of everything you need to give up in order to produce that good.
Economic costs include physical inputs (the value of the stuff you use to produce the good), plus forgone opportunities (when you allocate scarce resources to a task, you give up alternative uses of those resources).
A country or a person is said to have a ‘comparative advantage’ if they have the ability to produce something at a lower opportunity cost than their trade partners.
The forgone opportunities of production are key to understand this concept. It is precisely this that distinguishes absolute advantage from comparative advantage.
To see the difference between comparative and absolute advantage, consider a commercial aviation pilot and a baker. Suppose the pilot is an excellent chef, and she can bake just as well, or even better than the baker. In this case, the pilot has an absolute advantage in both tasks. Yet the baker probably has a comparative advantage in baking, because the opportunity cost of baking is much higher for the pilot.
The freely available economics textbook The Economy: Economics for a Changing World explains this as follows: “A person or country has a comparative advantage in the production of a particular good if the cost of producing an additional unit of that good relative to the cost of producing another good is lower than another person or country’s cost to produce the same two goods.”
At the individual level, comparative advantage explains why you might want to delegate tasks to someone else, even if you can do those tasks better and faster than them. This may sound counterintuitive, but it is not: If you are good at many things, it means that investing time in one task has a high opportunity cost, because you are not doing the other amazing things you could be doing with your time and resources. So, at least from an efficiency point of view, you should specialize in what you are best at, and delegate the rest.
The same logic applies to countries. Broadly speaking, the principle of comparative advantage postulates that all nations can gain from trade if each specializes in producing what they are relatively more efficient at producing, and import the rest: “do what you do best, import the rest”.24
In countries with a relative abundance of certain factors of production, the theory of comparative advantage predicts that they will export goods that rely heavily upon those factors: a country typically has a comparative advantage in those goods that use more intensively its abundant resources. Colombia exports bananas to Europe because it has comparatively abundant tropical weather. Under autarky, Colombia would find it cheap to produce bananas relative to e.g. apples.
Evidence:
Is there empirical support for comparative-advantage theories of trade?
The empirical evidence suggests that the principle of comparative advantage does help explain trade patterns. Bernhofen and Brown (2004)25, for instance, provide evidence using the experience of Japan. Specifically, they exploit Japan’s dramatic nineteenth-century move from a state of near-complete isolation to wide trade openness.
The graph here shows the price changes of the key tradable goods after the opening up to trade. It presents a scatter diagram of the net exports in 1869 graphed in relation to the change in prices from 1851–53 to 1869. As we can see, this is consistent with the theory: after opening to trade, the relative prices of major exports such as silk increased (Japan exported what was cheap for them to produce and which was valuable abroad), while the relative price of imports such as sugar declined (they imported what was relatively more difficult for them to produce, but was cheap abroad).
Net exports and price changes for 1869, Japan – Figure 4 in Bernhofen and Brown (2014)26
