Introduction to International Economics - Absolute and Comparative Advantage

Welcome to the study of international economics!

If we look at any country, say, Brunei, and we add all the FoPs (land, labor, capital and enterprise) the country can use to make g/s, we have determined Brunei's factor endowment.  Of course, these vary greatly between countries in terms of simple numbers of all four components and how advanced these components are.  For example, China has the most potential labor on Earth, but consider how productive workers are in Liechtenstein.  Moreover, think about how many valuable raw materials Nigeria has at its disposal and compare and contrast that with resource poor Singapore and its economic performace!  These are issues  discussed further in the field of development economics (see May posts).

There are two critical theories that are an excellent introduction to international economics: absolute and comparative advantage.  Developed by the great Adam Smith of “invisible hand” fame, a county has an absolute advantage in producing a g/s if it can produce more of it with the same number of productive inputs.  Although absolute advantage is helpful to know, it doesn’t explain why some countries trade since they may be able to create more of many, many g/s than many other countries.  It’s David Ricardo’s comparative advantage that explains why countries trade.  A country has a comparative advantage when it can produce a g/s at a lower opportunity cost than another country.  Consider the following example.

Switzerland                        Austria

Production of cheese              12,000 tons                        8,500 tons

with same FoPs

Production of tanks                 2,300 tanks                        2,000 tanks

with same FoPs

The opportunity cost of producing 1,000 more tons of cheese for Switzerland is about 522 tanks. The cost of producing 1,000 more tons in Austria is 425 tanks.  Austria thus has a comparative advantage in the production of tanks because it can produce them at a lower opportunity cost, even though Switzerland has an absolute advantage in both.  A trick on the graph…the country with no absolute advantage with either product will produce the product where the two lines are closer at the axis.