Trade Theories

Question: Write an essay onAbsolute Advantage and Comparative Advantage trade theories. Answer: The study elucidates the concept of Absolute Advantage and Comparative Advantage trade theories along with the differences between them. Apart from this, the limitations of these trade theories are demonstrated in this particular theory. International trade defines the process of exchanging goods and services between people and entities in two different countries (Hanson 2012). More specifically, a deal of business policies and strategies constitute international trade. Different countries involved in international trade because more benefit is expected from exchange (Hanson 2012). Absolute Advantage and Comparative Advantage trade theories and their limitations: Absolute Advantage Trade Theory In context of trade theory, Seretis and Tsaliki (2015) defined that a country has absolute advantage when it is capable in producing same amount of goods at lower cost comparing to other countries. It further defines that less amount of resources are required to produce same amount of goods. Hanson (2012) argued that it becomes difficult to measure absolute advantage when producing the same good inputs different factors in different countries. However, Seretis and Tsaliki (2015) mentioned that a country produced only the goods in which it is more efficient, and trade the goods in which it has less efficiency. Absolute increase can be enhanced by increasing the level of available capital such as factories and infrastructures. For example, India has abundant of labor force and the labor cost is much lower in comparison to that of Philippines. This led India to acquire absolute advantage against Philippines in operating call centers (Hanson 2012). Limitations of Absolute Advantage Trade Theory As opined by Hanson (2012), some limitations are there in absolute advantage trade theory. These are: Account transportation cost is majorly involved in selling the goods and services in the international market. However, it is not considered in determining the absolute advantage of a country. The absolute advantage is determined by the assumption that the exchange rates are stable. It assumes that labor can easily switch between products. This is because, it assumes the labors will work with same efficiency. Comparative Advantage Trade Theory Bahar, Hausmann and Hidalgo (2014) explained that a country has comparative advantage when it is capable to produce a particular good at lower relative opportunity cost comparing to that of other countries. The major difference of comparative advantage with absolute advantage can be elaborated in terms of amount of production. As the comparative advantage defines only the ability of particular production at lower opportunity cost, it does not mean that the country will produce the product at a greater volume. For example, suppose 'Country A' has absolute advantage in producing both the goods X and Y in comparison to 'Country B'. Then, 'Country B' will produce the good in which it has less opportunity cost (Markusen 2013). Limitations of Comparative Advantage Trade Theory Baldwin and Robert-Nicoud (2014) brought out some limitation in comparative advantage trade theory: It is based on a wrong assumption that the wages of the industries between two countries will not vary. Different goods have different demand elasticity. It can be supported by an example. Suppose, 'Country A' is specialized in producing jewelry and thus it is exported in order to import food from 'Country B'. In the tough economic times, when global demand may fall, 'Country A' might confront difficulties to trade jewelry products to import food. Conclusion: The major difference between absolute advantage trade theory and comparative advantage trade theory is highlighted in this study. It concludes that absolute advantages defines a country's ability in producing certain goods more efficiently than others. Whereas, the comparative advantage defines a country's ability in producing certain goods with a lower opportunity cost than another country. However, a number of limitations are there in correct measurement of both absolute and comparative advantage. It concludes that most of the wrong measurement is based on the wrong assumptions of international trade. Reference List Bahar, D., Hausmann, R. and Hidalgo, C.A., 2014. Neighbors and the evolution of the comparative advantage of nations: Evidence of international knowledge diffusion?. Journal of International Economics, 92(1), pp.111-123.Baldwin, R. and Robert-Nicoud, F., 2014. Trade-in-goods and trade-in-tasks: An integrating framework. Journal of International Economics, 92(1), pp.51-62.Hanson, G.H., 2012. The rise of middle kingdoms: Emerging economies in global trade. The Journal of Economic Perspectives, 26(2), pp.41-63.Markusen, J.R., 2013. Putting per-capita income back into trade theory.Journal of International Economics, 90(2), pp.255-265.Seretis, S.A. and Tsaliki, P.V., 2015. Absolute Advantage and International Trade Evidence from Four Euro-zone Economies. Review of Radical Political Economics, p.0486613415603160.