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Political Economy - Essay Example

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According to Suranovic (2003), the theory of comparative advantage is "perhaps the most important concept in international trade theory." Comparative advantage exists when a country has a margin of superiority in the production of a good or service i.e. where the opportunity cost of production is lower (tutor2u 2005)…
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Political Economy Essay
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Download file to see previous pages If a country is relatively more efficient in the production of a good than another country then it has comparative advantage in production of that good (Kili 2002, p.3).
However, the theory itself is also one of the most commonly misunderstood principles (Suranovic 2003). Suranovic lists that one of its sources of "misunderstandings" derives from its property of being counter-intuitive, that is, many results from its formal model are contrary to simple logic. Secondly, the theory is easy to be confused with another concept regarding advantageous trade, known in trade theory as the theory of absolute advantage. This confusion between these two concepts leads many people to believe that they have understood comparative advantage in full when in reality, it is absolute advantage that they understand. Finally, the theory of comparative advantage is all too often presented only in its mathematical form. The use of numerical examples or diagrammatic representations is extremely useful in illustrating the basic results and the deeper implications of the theory. However, it is also easy to see the results mathematically, without ever understanding the basic intuition of the theory (Suranovic 2003).
The theory on comparative advantage was first described by Robert Torrens in 1815 in an essay on the corn trade where he concluded that it was to England's benefit to exchange various goods with Poland in return for corn, even though it might be possible to produce that corn more cheaply in England than Poland. However, the theory is attributed to David Ricardo, who explained it in greater detail in his 1817 book The Principles of Political Economy and Taxation and explained the concept on foreign trade in an example involving the same two countries. The theory has been developed in the context of Ricardo's labour theory of value. The following table shows Ricardo's 1817 example of foreign trade production functions on cloth and wine for England and Portugal in one year's time:
Output/Country
Wine
Cloth
England
120
100
Portugal
80
90
According to Ricardo, if England is circumstanced that in order to produce the cloth may require the labour of 100 men in a year and if this country attempted to make wine, the labour of 120 men will be needed at the same time. Ricardo quotes that it would be in England's best in interest to import wine and to purchase it through the exportation of cloth.1 On the other hand, to produce the wine in Portugal, the labour of 80 men will be required for one year while producing cloth in the same country will need the labour of 90 men for the same time. According to Ricardo, it would be therefore best for Portugal to export wine in exchange for cloth. In Ricardo's words:
"This exchange might even take place, notwithstanding that the commodity imported by Portugal could be produced there with less labour than in England. Though she (Portugal) could make the cloth with the labour of 100 men to produce it, because it would be advantageous to her rather to employ her capital (the labour employed) in the production of winethan she could produce by diverting her portion of capital from the cultivation of vines to the manufacture of cloth."
According to Feucht (2002, p.3), the reason for comparative advantage is that even if the costs for all products may be lower in one country than in its trading partner, there is still the one product where the relative cost saving compared to all ...Download file to see next pagesRead More
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