Eco203 ch.2
Download as PPTX, PDF
1 like211 views
This document discusses the economic theory of comparative advantage. It explains that according to the law of comparative advantage, even if one nation has an absolute disadvantage in producing both of two commodities, there is still a basis for mutually beneficial trade. The nation should specialize in the commodity where its disadvantage is smaller, and import the commodity where its disadvantage is greater. It also discusses opportunity costs and how comparative advantage is determined based on which nation has a lower opportunity cost of production for a given commodity, not based on absolute labor values. A production possibility frontier graph is provided as an example.
Eco203 ch.2
- 1. ECO 203 (L2) Saber Shaker Saber_doctor@hotmail.com
- 2. The Law of Comparative Advantage Dr. Saber Shaker Saber_doctor@hotmail.com 2
- 3. 2.4 Trade Based on Comparative Advantage: David Ricardo A. The Law of Comparative Advantage (LCA) According to LCA, even if one nation has an absolute disadvantage with respect to the other nation in the production of both commodities, there is still a basis for mutually beneficial trade. This nation should specialize in the production and export of the commodity in which its absolute disadvantage is smaller (this is the commodity of its comparative advantage) and import the commodity in which its absolute disadvantage in greater (this is the commodity of its comparative disadvantage). 3
- 4. 2.5 Comparative Advantage and Opportunity Costs A. Comparative Advantage and the Labor Theory of Value (LTV) According the LTV, the value or price of a commodity depends exclusively on the amount of labor going into its production. This implies that; 1) either labor the only factor of production or it is used in the same fixed proportion in the production of all commodities. 2) labor is homogeneous (i.e. of only one type). Since neither of the assumptions is true, we cant base the explanation of comp-adv. on the LTV. 4
- 5. B. The Opportunity Cost Theory (OCT) According to the OCT, the cost of a commodity is the amount of a second commodity that must be given up to release just enough resources to produce one additional unit of the first commodity. Thus, the nation with the lower opportunity cost in the production of a commodity has a comp-adv. in that commodity. If the US has to give up 2/3 of a unit of cloth to release enough resources to produce an additional unit of wheat, then the opp. cost of wheat is 2/3 of a unit of cloth (i.e. 1W=2/3 C) 5
- 6. .CThe Production Possibility Frontier (PPF) under Constant Costs The PPF: a curve showing the alternative combinations of the two commodities that a nation can produce by fully utilizing its resources with the best technology available to it. US UK Wheat Cloth Wheat Cloth 180 0 60 0 150 20 50 20 120 40 40 40 90 60 30 60 60 80 20 80 30 100 10 100 0 120 0 120 6
- 7. FIGURE 2-1 The PPFs of the United States and the United Kingdom. 7