The Theory of Comparative Advantage Essay Example | Topics and Well Written Essays - 2000 words

The Theory of Comparative Advantage - Essay Example 47). The terms like comparative or relative advantages have often failed to create same impression as that of absolute advantage and hence this concept of comparative advantage has often been misunderstood. The concept of absolute advantage as described by Adam Smith suggests that a commodity produced cheaper by a foreign nation should rather be bought from that nation and the resources available should be employed in a way which we have some advantage (Bromley et al., 2004, p. 46). This simplicity of absolute advantage has made the concept very popular and easy to comprehend. Moving on to the concept of comparative advantage given by David Ricardo; the concept is not at all intuitive at first go and will require explicit numerical examples for better explanation. To begin, we consider two nations "Nation A" and "Nation B" and both producing two goods, cloth which is a manufactured good and fruit wine which can be considered as an agricultural product. Both the products are produced in these countries. As Ricardo had assumed, we start with Nation A which can produce fruit wine efficiently while Nation B is considered more productive and can produce both cloth and fruit wine efficiently. ... A country is said to have a comparative advantage in the production of cloth if it can produce it at a lower opportunity cost. The opportunity cost in the given business scenario of cloth production is the amount of wine that must be given up to produce for producing a unit of cloth. If Nation A is in comparative advantage in the production of cloths then the fruit wine production it is giving up to produce another unit of cloth is less than that of Nation B. The theory of comparative advantage when applied to modern business scenario, we consider two countries producing two goods using labor as the only factor of production. Here the goods have been considered as a homogeneous output and at the same time labor is also a homogeneous entity within the same nation. But the same labor is heterogeneous across different countries. Other factors like goods transportation between countries and labor relocation within country are all been considered costless. Relocation of labor across countries is not possible. Labor is fully employed and it's the labor productivity parameters according to which production technology are being reflected (Bromley et al., 2004, p. 56). The business model based on this theory actually gives an overview of what exactly will happen when a country moves from a state of economic island to a free trade to the other country. The main things which require care are trade's effects on the prices of the goods in each country , the production levels of the goods, employment levels in each of the nation involved, the trade pattern, consumption level and national as well as individual welfare. The liberated trade and