Comparative advantage

Theory of Comparative Advantage proposed by Ricardo countries should specialize in producing those goods of which they are relatively more efficient producers these countries should then trade with the rest of the world to obtain needed commodities if countries do specialize this way, total world production will be greater

Theory of Comparative Advantage Suppose that this is the marginal cost data for Tajikistan and Kirgizstan for the production of wine and cloth

Theory of Comparative Advantage In Ricardo’s analysis, marginal costs were assumed to be constant If we let total resource costs be fixed for each country at 100, the production possibility frontier for Tajikistan is 8W + 4C = 100 and for Kirgizstan it is 2W + 2C = 100

Theory of Comparative Advantage The RPTs (relative marginal cost) differ between these countries:

Theory of Comparative Advantage Although Kirgizstan has an absolute advantage in the production of both goods, both countries could benefit from trade wine is relatively less costly in Kirgizstan Kirgizstan has a comparative advantage in wine cloth is relatively less costly in Tajikistan Tajikistan has a comparative advantage in cloth

Theory of Comparative Advantage Suppose that, prior to trade, each country devotes half its resources to each good For Tajikistan: W = 50/8 = 6.25 C = 50/4 = 12.5 For Kirgizstan: W = 50/2 = 25 C = 50/2 = 25

Theory of Comparative Advantage World output can be increased if Tajikistan was to produce less wine and more cloth and Kirgizstan was to produce more wine and less cloth Suppose that Tajikistan decided to devote all of its resources to the production of cloth W = 0/8 = 0 C = 100/4 = 25

Theory of Comparative Advantage Suppose that Kirgizstan decided to devote 70% of its resources to the production of wine, with the remaining 30% used to produce cloth W = 70/2 = 35 C = 30/2 = 15 World output of wine has increased from to 35, and cloth output has risen from 37.5 to 40