Irrelevance of Absolute Levels of Productivity - Theorem - Coursework Example

Comparative Analysis Theorem Introduction: The Theorem was first formulated and conceptualised by the Robert Torrens in 1815, but it was only with the coming of David Ricardo that the theorem was evolved and became more popular. David Ricardo detailed it in his Book ‘On the Principles of Political Economy and Taxation’, in the year of 1817. The theorem basically follows the principle of the comparative advantage that each firm has in production of certain goods and services in relation to others at a lower opportunity cost which gives them an advantage in the market. The theorem then goes on to explain as to how this advantage should be exploited to ensure that the maximum utilization of the resources is being carried out during the production process. It continues to say that if each specialise and then trade then the production opportunities can be exploited to ensure greater and more efficient production for the minimal amount of resources used. Irrelevance of absolute levels of productivity: The theorem most believe calls for establishment of international trade practices to be established. This may hold true to a certain extent but the reality of the matter remains that what Ricardo was talking about was the comparative advantage of opportunity cost in specialization (Courant, Paul N, Deardorff A V, 1992). He gave the example of England and Portugal. As he pointed out the cost of production of wine and cloth in Portugal was cheaper than the cost of production of wine and cloth in England. But even though the cost of labour in the production of cloth is cheaper in Portugal than in England, it would be cheaper if Portugal produced only wine and channalized all its resources towards production of wine. England has a high cost of wine production and could channalize all its resources towards production of cloth and the two can then go on to trade. It would prove cheaper to both countries to specialise in one arena and then establish trade relations. Given this scenario that was detailed by Ricardo most people believe that he was advocating foreign trade, which holds true to a certain extent But the theorem of comparative advantage is not focusing on trade but on the fact that each company or firm has a certain opportunity cost advantage over the other in the production of certain goods. Given this advantage the company should focus on the production of that good alone so as to look into minimal wastage of the limited amount of resources that mankind has at its disposal and optimum usage can be ensured. But there has to be realised that the focus of the theorem of comparative advantage is not on the absolute advantage that a firm may have over another firm as this may lead to the wastage of material. It is about the comparative advantage that a firm holds over the production cost of the other (Lutz M 2008). For example, in the example illustrated by Ricardo in his book, the absolute cost advantage for both cloth as well as wine was present in the Portugal and the cost of production of both cloth and cotton was higher in comparison in England. But the cost of production of wine was considerably higher than that of cloth, which was cheaper. It would be cheaper for Portugal to focus on the production of just wine and direct all the resources towards the production of wine in the country. Thus, the level of employment would not detoriated as the country would be producing larger amounts of wine to export to England although the production of cloth would stop. On the other hand in England the focus would be only on the production of cloth and wine production would be stopped. This would help both countries realise the comparative cost advantage of production in wine as well as cloth, although the absolute advantage is in favour of Portugal. In the same manner, in case of companies or firms it might be easier for one firm to produce one product and specialise in the production so that a comparatively lower cost of production can be established than say if the firm was producing a number of products and specialising in none (Chang Ha-Joon 2008). Thus, the amount of resources that are employed in the production process would be reduced considerably while the levels of production will increase leading to better efficiency and economy in all firms. This would lead to the development of a more sustainable method of production. Allocation of funds and resources and comparative advantage: The theorem is considered to be one of the most important theorems in the economic sphere as it looks at establishing the basic procedure of production that should be followed by a company to ensure maximum output and profit with the use of minimum resources. The theorem helps answer the three basic questions involved in the production, what should be produced, the method that should be employed to produce the products and the amount, that is, the estimated requirement, that should be produced. The fact remains that the employment of the theorem is of utmost importance while carrying out any production endeavour (Deardorff A 2005). The question of where should the production process take place and to which factory what production and resources should be employed can be answered in relation to the theorem. There has to be realised that in different areas, there are different facilities and resources that are available. In a firm while deciding upon where to set up the process of production and to which factory what resources should be deployed there are a number of factors that need to be kept in mind. The first and the foremost fact that has to be considered while realising what should be produced where, is the comparative cost of production of a product in the areas. In order to do so one must look at the various resources that will have to be employed in the process of production including electricity, raw materials, labour, water and other such inputs. Then there has to be seen that comparatively which products can be produced in which area with a minimal cost of production. If for example the company or the firm has two factories under it and it has to produce say cotton and sugar, then in accordance to the comparative cost advantage theorem it has to look into the cost of production that will be undertaken if both are produced in both the factories, or if one is produced in one and the other is produced in another (Vasile D 2005). For example, in the production process for cotton the labour that is employed is more than the labour that is employed during the production of sugar. In such a case scenario, the firm will set up the production of cotton in the factory which is situated in an area where the labour is cheap and in abundance. This can clearly be seen in the production processes that are undertaken by firms in the global market economies today. Multinational companies and corporations are setting up production enterprises in areas where the resources are more easily and comparatively cheaply available than in other areas (Chang HJ 2002). Also there can be seen that although in some cases the resources that are available might be more expensive than in other areas, but the cost of production is comparatively cheaper given certain special concessions. For example, in the current day scenario, the creation of SEZs have allowed multinationals to set up their enterprises in certain nations like China. The cost of transportation and storage may have increased but the over all cost of production has reduced comparatively, which would not have been possible if the same production would have been carried out in say a more urban centre where the market forces are allowed to function freely. Another example could be that the company may allocate funds towards employment of labour instead of setting up technological machinery as the comparative cost advantage of the labour method of production may be more, although the absolute cost advantage of the technical method of production may be higher (Dornbusch, R, Fischer, S, Samuelson P A, 1977). In such a given case scenario the firm would allocate resources towards setting up a production process which is more labour inclusive to ensure better utilisation of resources and minimal wastage of funds during the method of production of goods and services. The fact that has to be kept in mind while analysing any method of production that is to be employed by the firm is the relative cost of production that will be employed. Based on this, the firms can decide upon the allocation of resources to its various factories depending upon, which has a higher comparative or relative cost advantage in production of which commodity or goods. Relativity thus allows one to allocate resources in a more efficient and economic manner. Undertaking of production processes or outsourcing and comparative advantage theorem: As has been mentioned above the main aim of the production process that is undertaken by any company, organization or firm is to ensure that the production process is carried out with minimal wastage of funds and maximum utilization of resources so as to ensure that profit maximisation takes place. Thus, while the method of production is being formulated there are various areas that have to be researched. For example, say if the company is producing cars, there are various body parts that the company will have to produce. Thus, the whole process of production of the car will become highly complicated and long drawn. But instead of producing each of the body parts, if the company decides to outsource this part of the production process then the process can be simplified. The firm or organization can outsource the production of the bolts to some other firm, the car body to another firm, and the wheels to another and so on (Hirra R, Hira A, Dobbs L, Craig P C, Samuelson P 2005). This would help in outsourcing the production process and create specialisation, which would lead to a cheaper cost of production in comparison to if only one firm was producing the whole car. But, if it is seen that it would be cheaper and efficient to produce the body parts under one organization and that outsourcing is taking away from the process of production then the other should be employed. There has to be realised that the latter case scenario is more difficult to come by in today’s economic setup as specialisation in one area always leads to more production at a lesser price. Also maximum utilization of resources takes place usually when there is division of labour and specialisation is employed in the production process. Thus, there can be seen that in the current global market economy structure the principle of outsourcing is becoming more and more popular and gaining more support. This is clearly reflected in the fact that most of the companies today are incorporating this method into their production process. But the fact remains that outsourcing cannot replace the forms and companies as they not only create and undertake the enterprise of production but also coordinate all the various market forces. The fact remains that the concept of firms cannot be replaced simply because outsourcing is mote economic as the integration of the various processes of production; marketing, etc are undertaken by the firms and the organizations. It is just comparatively more advantageous to outsource as it allows for maximum utilization of the limited amount of resources that are available. The relevance and the advantage of the study and analysis of the comparative advantage theorem cannot be denied and its application in the daily functioning and working of organizations can lead to the development of a more sustainable as well as profitable production system around the globe which is not only profitable but also ensures maximum utilisation and exploitation of the potential of the resources and the funds. References: Chang HJ 2002: Kicking away the ladder; Development strategy in historical perspective, London Anthem Press, pp 45-59. Chang Ha-Joon 2008: Bad Samaritans: The myth of free trade and the Secret history of Capitalism, Bloomsbury Press, pp 87-96. Courant, Paul N, Deardorff A V, 1992: International Trade with Lumpy Countries, Journal of Political Economy, Vol 100, No 1 pp 198-210. Deardorff A 2005: How Robust is Comparative Advantage?, Review of International Economics, Vol 13, No 5 pp 1004-1016. Dornbusch, R, Fischer, S, Samuelson P A, 1977: Comparative Advantage, Trade and payments in a Ricardian Model with a Continuum of goods, American Economic Review, Vol 67, No 5, pp 823-839 Hira R, Hira A, Dobbs L, Craig P C, and Samuelson P 2005: Outsourcing in America: What’s behind our national crisis and how we can reclaim American jobs, American Management Association, pp 36-38. Lutz M 2008: Revisiting the relevance of International Trade theory, Forum for Social Economics, Vol 37, No 2 pp 147-164. Vasile D 2005: The general validity of comparative advantage in trade exchangers, MPRA paper, 6882, University Library of Munich, Germany. Read More