The Model of Comparative Advantage
- International trade decreases prices and increases the variety of goods/services available to a nation
- This results in a higher standard of living
- This results in a higher standard of living
- Comparative advantage is the theory developed by David Ricardo in 1817 which states that a country should specialise in the goods/services that it can produce at the lowest opportunity cost
- By specialising, the volume of production increases
- Excess production can be exported
- Goods/services which are not produced in the country can be imported
The assumptions of comparative advantage
- As with any economic model, there are underlying assumptions to the theory of comparative advantage:
- Transport costs are zero: it does not account for moving goods or services between countries. Depending on a nation's location, this is more or less of a problem
- There is perfect knowledge: each country knows what it has a comparative advantage in and also the comparative advantages of other countries
- Factor substitution is easily achieved: economies can quickly adjust to changing global market conditions by switching from capital to labour - and vice versa
- Constant costs of production: the theory does not take into account the economies of scale that can be achieved with an increase in output