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what are the limitations of this theory?
plz explain in detail.
plz explain in detail.
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absolute and comparative advantage
- Thread starter 123add1
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Here are the limitations of comparative and absolute advantages:
1) Two countries, two goods - the theory is no different for larger numbers of countries and goods, but the principles are clearer and the argument easier to follow in this simpler case.
2) Equal size economies - again, this is a simplification to produce a clearer example.
3) Full employment - if one or other of the economies has less than full employment of factors of production, then this excess capacity must usually be used up before the comparative advantage reasoning can be applied.
4) Constant opportunity costs - a more realistic treatment of opportunity costs the reasoning is broadly the same, but specialization of production can only be taken to the point at which the opportunity costs in the two countries become equal. This does not invalidate the principles of comparative advantage, but it does limit the magnitude of the benefit.
5) Perfect mobility of factors of production within countries - this is necessary to allow production to be switched without cost. In real economies this cost will be incurred: capital will be tied up in plant (sewing machines are not sowing machines) and labour will need to be retrained and relocated. This is why it is sometimes argued that 'nascent industries' should be protected from fully liberalised international trade during the period in which a high cost of entry into the market (capital equipment, training) is being paid for.
6) Immobility of factors of production between countries - why are there different rates of productivity? The modern version of comparative advantage (developed in the early twentieth century by the Swedish economists Eli Heckscher and Bertil Ohlin) attributes these differences to differences in nations' factor endowments. A nation will have comparative advantage in producing the good that uses intensively the factor it produces abundantly. For example: suppose the US has a relative abundance of capital and India has a relative abundance of labor. Suppose further that cars are capital intensive to produce, while cloth is labor intensive. Then the US will have a comparative advantage in making cars, and India will have a comparative advantage in making cloth. If there is international factor mobility this can change nations' relative factor abundance. The principle of comparative advantage still applies, but who has the advantage in what can change.
7) Negligible transport cost - Cost is not a cause of concern when countries decided to trade. It is ignored and not factored in.
Before specialization, half of each country's available resources are used to produce each good.
8 ) Perfect competition - this is a standard assumption that allows perfectly efficient allocation of productive resources in an idealized free market.
To be brief, remember these:
1) Transport costs may outweigh any comparative advantage
2) Increased specialisation may lead to diseconomies of scale
3) Governments may restrict trade
4) Comparative advantage measures static advantage but not any dynamic advantage for example in the future India could become good at producing books if it made the necessary investment
1) Two countries, two goods - the theory is no different for larger numbers of countries and goods, but the principles are clearer and the argument easier to follow in this simpler case.
2) Equal size economies - again, this is a simplification to produce a clearer example.
3) Full employment - if one or other of the economies has less than full employment of factors of production, then this excess capacity must usually be used up before the comparative advantage reasoning can be applied.
4) Constant opportunity costs - a more realistic treatment of opportunity costs the reasoning is broadly the same, but specialization of production can only be taken to the point at which the opportunity costs in the two countries become equal. This does not invalidate the principles of comparative advantage, but it does limit the magnitude of the benefit.
5) Perfect mobility of factors of production within countries - this is necessary to allow production to be switched without cost. In real economies this cost will be incurred: capital will be tied up in plant (sewing machines are not sowing machines) and labour will need to be retrained and relocated. This is why it is sometimes argued that 'nascent industries' should be protected from fully liberalised international trade during the period in which a high cost of entry into the market (capital equipment, training) is being paid for.
6) Immobility of factors of production between countries - why are there different rates of productivity? The modern version of comparative advantage (developed in the early twentieth century by the Swedish economists Eli Heckscher and Bertil Ohlin) attributes these differences to differences in nations' factor endowments. A nation will have comparative advantage in producing the good that uses intensively the factor it produces abundantly. For example: suppose the US has a relative abundance of capital and India has a relative abundance of labor. Suppose further that cars are capital intensive to produce, while cloth is labor intensive. Then the US will have a comparative advantage in making cars, and India will have a comparative advantage in making cloth. If there is international factor mobility this can change nations' relative factor abundance. The principle of comparative advantage still applies, but who has the advantage in what can change.
7) Negligible transport cost - Cost is not a cause of concern when countries decided to trade. It is ignored and not factored in.
Before specialization, half of each country's available resources are used to produce each good.
8 ) Perfect competition - this is a standard assumption that allows perfectly efficient allocation of productive resources in an idealized free market.
To be brief, remember these:
1) Transport costs may outweigh any comparative advantage
2) Increased specialisation may lead to diseconomies of scale
3) Governments may restrict trade
4) Comparative advantage measures static advantage but not any dynamic advantage for example in the future India could become good at producing books if it made the necessary investment