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Introduction

Globalization and trade play a key role in the economic reality of the world. Today, trade and its concomitant economic growth in countries have made countries of the world to import certain products and export certain products. For instance, China exports consumer electronics, machinery and textile to the US, while imports soybeans, semiconductors, aircraft parts, and passenger cars from USA (Rapoza, 2011). This trade dynamics suggests that USA can produce soybeans, semiconductors, and aircraft parts with less resources, while Chin can produce consumer electronics, machinery and textiles with more efficiently.  The fundamental force behind this specialization of US and China in these products is comparative advantage as China has comparative advantage in the products it exports, while the USA has comparative advantage in soybeans, semiconductors and etc. This coursework look into competitive advantage can be identified in relation to electronics industry.

The concept of comparative advantage was first introduced by the seminal economics, Adam Smith (Smith, 2003). He asserted that countries should concentrate on producing goods which they can do so with less resources and trade those goods for goods which they can’t produce as efficiently.  Economies around the world can derive a number of key benefits such as consumer benefits, economic efficiency and etc. from specialization. Therefore, it is must for them to determine in which products (i.e. goods) economies have a comparative advantage and focus on producing these goods. There are a number of methods employed by economist to determine whether or not a particular economy has a comparative advantage in a producing certain goods.

Opportunity Costs

Opportunity costs are benefits forgone when countries decide to produce one particular category of goods over another (Begg, 2005).  The opportunities costs can be key in determining whether or not a country has a comparative advantage in producing particular goods.  For instance, if the Montenegro has lower opportunity costs when it produces cheese, then it means that it has a comparative advantage.  The application of opportunity costs in relation to determining comparative advantage is given below;

China

  • can produce 4,000 wine/hour or
  • can produce 1,333 cheese/hour
  • opportunity cost of 1 cheese is 3 wine
  • opportunity cost of 1 unit of wine is 0.333 cheese

Montenegro

  • can produce 1,333 wine/hour or
  • can produce 4,000 cheese/hour
  • opportunity cost of 1 cheese is 0.333 wine
  • opportunity cost of 1 unit of wine is 3 cheeses
  Opportunity cost of  
One wine one cheese  
China 1/3 cheese 3 wine
Montenegro 3 cheese 1/3 wine

To produce one unit of cheese, Montenegro has to forgo 0.33 wine, while China has to forgo 3 wines to produce one unit of cheese, which testifying to how Montenegro has the comparative advantage in cheese production. On the other hand, to produce one unit of wine, Montenegro has to forgo 3 cheese, while China has to forgo 0.33 cheese. Therefore, China has a lower opportunity cost in producing wine, and has a comparative advantage in wine production.

Figure 1

Opportunity costs model also has limitations as the model assumes that there are two products a country can produce, and that there is one import/export country (Gibbons et al, 2005).

Ricardian model of trade

The Ricardian model of trade is one of the most prevalently used models in determining whether or not a country has a comparative advantage in producing a particular category of goods, and is based on opportunity costs, rather than actual costs (Golub and Hsieh, 2002). The Ricardian model of trade is based on a number of assumptions and it assumes that there are two countries, producing two products, and there is one input (i.e. labor). The Ricardian model of trade assumes that labor is fixed (Deardoff, 2007).   The application of Ricardian model with relation of cheese and wine is presented below;

 Cheese production

US France

Q C = quantity of cheese produced in the US.

L C =amount of labor used to cheese production in the US.

a LC = unit-labor requirement in cheese production in the US. (hours of labor necessary to produce one unit of cheese)

Wine production 

US France

Q W = quantity of wine produced in the US.

L W = amount of labor used to produce wine in the US.

a LW = unit-labor requirement in wine production in the US. (hours of labor requreid produce one unit of wine)

Unlike other models of determining comparative advantage, the Ricardian model of trade underlines how all countries can benefit from engaging in trade (Bernhofen and Brown 2004). Nonetheless, the Ricardian model of trade has a number of limitations such as how it overlooked that there are a number of inputs involved in producing goods (more than labor) and does not deal with the sources of comparative advantages of some countries (Salvo et al, 2014). In addition, the Ricardian model does not take transportation costs into account, highlighting another limitation.

ULR

Unit labor requirement can also be juxtaposed to determine which country has a lower opportunity cost, and thus, comparative advantage. This model of ULR juxtaposition is contingent upon the hours of labor required to produce one unit of a particular product (Levchenko and Zhang, 2014).

Below presented is the application of ULR in relation to wheat and cloth in US and UK;

  Cloth Wheat
UK 2 hours 6 hours
USA 3 hours 2 hours

To produce one unit of clothing, ULR required for UK is 2 hours, whereas USA requires 3 hours, suggesting that UK has the comparative advantage in producing clothes. On the other hand, regarding wheat, UK requires 6 hours of labor to produce one unit of wheat, while USA need 2 hours. Therefore, USA has a comparative advantage in producing wheat.

Like other models of calculating comparative advantage, ULR has  a number of limitation, as it is contingent upon the labor hours required to produce one particular category of goods (Erik, 2011).

Conclusion

Overall, comparative advantage is the driving force behind international trade, and ensures that countries can concentrate on producing goods in which they have comparative advantages and importing those in which other countries have a lower opportunity costs. Comparative advantage can be determined with a number of ways, and they have been analyzed above.

Reference

  1. Rapoza K, The Things China Buys From The US, Forbes, accessed 10 April 2018 <https://www.forbes.com/sites/kenrapoza/2011/09/20/the-things-china-buys-from-the-us/2/#4c5f44df5d9e>
  2. Smith A, 2003, The Wealth of Nations (Batnam Classics), Bantam Classics; Annotated Edition
  3. Begg D, 2005, Economics, McGraw-Hill Higher Education
  4. Golub, S and Hsieh, Ch, 2002, Classical Ricardian Theory of Comparative Advantage Revisited, Review of International Economics
  5. Deardorff A, 2007, The Ricardian Model, Research seminar in international economics, University of Michigan
  6. Salvo, M, Begalli D, Signorello G, 2014, The Ricardian analysis twenty years after the original model: Evolution, unresolved issues and empirical problems, Journal of Development and Agricultural Economics, Vol. 6(3), pp. 124-131
  7. Levchenko and Zhang, 2014, The Evolution of Comparative Advantage: Measurement and Implications, Federal Reserve Bank of Chicago
  8. Erik V, 2011, Determinants of comparative advantage in services. Working paper, Group d’Economie Mondiale, Paris, France
  9. Bernhofen A and Brown D, 2004, A Direct Test of the Theory of Comparative Advantage: The Case of Japan, The Journal of Political Economy, Vol. 112, No. 1
  10. Gibbons R, KAts L, Lemieux Th, Parent D, 2005, Comparative Advantage, Learning, and Sectoral Wage Determination, Journal of Labor Economics, Vol. 23, No. 4

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