Explain how the theory of comparative advantage relates to the need for international business.
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If you're behind a web filter, please make sure that the domains *.kastatic.org and *.kasandbox.org are unblocked. Comparative advantageIt can be argued that world output would increase when the principle of comparative advantage is applied by countries to determine what goods and services they should specialise in producing. Comparative advantage is a term associated with 19th Century English economist David Ricardo. Ricardo considered what goods and services countries should produce, and suggested that they should specialise by allocating their scarce resources to produce goods and services for which they have a comparative cost advantage. There are two types of cost advantage – absolute, and comparative. Absolute advantage means being more productive or cost-efficient than another country whereas comparative advantage relates to how much productive or cost efficient one country is than another. ExampleIn order to understand how the concept of comparative advantage might be applied to the real world, we can consider the simple example of two countries producing only two goods - motor cars and commercial trucks. Comparative advantageUsing all its resources, country A can produce 30m cars or 6m trucks, and country B can produce 35m cars or 21m trucks. This can be summarised in a table. In this case, country B has the absolute advantage in producing both products, but it has a comparative advantage in trucks because it is relatively better at producing them. Country B is 3.5 times better at trucks, and only 1.17 times better at cars. However, the greatest advantage - and the widest gap - lies with truck production, hence Country B should specialise in producing trucks, leaving Country A to produce cars. Economic theory suggests that, if countries apply the principle of comparative advantage, combined output will be increased in comparison with the output that would be produced if the two countries tried to become self-sufficient and allocate resources towards production of both goods. Taking this example, if countries A and B allocate resources evenly to both goods combined output is: Cars = 15 + 15 = 30; Trucks = 12 + 3 = 15, therefore world output is 45 m units. Opportunity cost ratios It is being able to produce goods by using fewer resources, at a lower opportunity cost, that gives countries a comparative advantage. The gradient of a PPF reflects the opportunity cost of production. Increasing the production of one good means that less of another can be produced. The gradient reflects the lost output of Y as a result of increasing the output of X. Having a comparative advantage in X, Country A sacrifices less of Y than Country B. In terms of two countries producing two goods, different PPF gradients mean different opportunity costs ratios, and hence specialisation and trade will increase world output. Only when the gradients are different will a country have a comparative advantage, and only then will trade be beneficial. Identical PPFsIf PPF gradients are identical, then no country has a comparative advantage, and opportunity cost ratios are identical. In this case, international trade does not confer any advantage. CriticismsHowever, the principle of comparative advantage can be criticised in a several ways:
Read more on: Gravity Theory See: Brexit How does the theory of comparative advantage relate to the need for international business?Comparative advantage is a key principle in international trade and forms the basis of why free trade is beneficial to countries. The theory of comparative advantage shows that even if a country enjoys an absolute advantage in the production of goods, trade can still be beneficial to both trading partners.
What is comparative advantage theory of international business?comparative advantage, economic theory, first developed by 19th-century British economist David Ricardo, that attributed the cause and benefits of international trade to the differences in the relative opportunity costs (costs in terms of other goods given up) of producing the same commodities among countries.
Why is comparative advantage important for business?The benefit of comparative advantage is the ability to produce a good or service for a lower opportunity cost. A comparative advantage gives companies the ability to sell goods and services at lower prices than their competitors, gaining stronger sales margins and greater profitability.
What is comparative advantage and why is it important in international trade quizlet?While a country has an absolute advantage in producing a good over another country only if it uses fewer resources to produce that good, a country can have a comparative advantage when a good can be produced at a lower cost in terms of other goods.
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