IGNOU : M.COM : IBO 1 : UNIT 2 : Q- 4. Distinguish between Absolute advantage & comparative advantage.

 

Ans.     1. Absolute Advantage & Comparative Advantage

We assume that 1 and 4 hours of labour produce respectively one unit of cloth and one unit of wheat, Since less labour is required to produce one unit of each good in the second country (call it a foreign country ), it has what is called an absolute advantage over the first country (call it the home country). So far there is no trade between the two countries. But suppose there is trade now and would it be correct to say the foreign country has no incentive to trade because it is more efficient in both goods, whereas the home country is too eager to trade because it is insufficient in the production of both the goods ? The answer is that the so called absolute advantage does not determine the Pattern of trade between two countries. It is the comparative advantage which is relevant.

But what is comparative advantage ? ? In home country 3/5th of a unit of wheat is exchanged for one unit of cloth and in the foreign country  1/4 of a unit of wheat will exchange for one unit of cloth Since 3/5 > 1/4, cloth is more expensive in terms of wheat in the home country than in the foreign country. Thus the foreign country has comparative advantage in cloth production. But home country has comparative advantage in wheat production because here 5/3 units of cloth will exchange for one unit of wheat which is less than 4 units of cloth which will exchange for one unit of wheat in the foreign country. Thus, though the foreign country has an absolute advantage in both goods it has comparative advantage in only one, namely cloth. The home country has absolute disadvantage in both goods but it has a comparative advantage in wheat. But what determines comparative advantage?

In order to answer this question let us find the labour Productivities in the two countries in cloth and wheat production. Look at Table 2.1 which shows the comparative labour productivities in both countries.

                                              Table 2.1: Labour Productivities

	HOME	FOREIGN
CLOTH	1/3	1
WHEAT	1/5	1/4
RATIO	5/3 [3/5]	4 [1/4]

     

 As you remember, labour productivities are just the reciprocals of unit labour requirements. If we compare the ratios of the labour productivity in both to that in wheat production we see that the foreign country has a, higher ratio (4>5/3) and therefore it is relatively more productive in cloth. On the other hand, if we compare the ratios of labour productivity in wheat to that in cloth production, the home country has a higher ratio (3/5 > 1/4) which shows that the home country is relatively more productive in wheat. Thus, the Ricardian theorem on trade pattern states that a country lias comparative advantage in the good in which its relative labour productivity is higher than its trading partner and tends to export this good and tends to import the good in which its trading partner has comparative advantage.