Comparative Advantage and Trade Theory

This assignment delves into the topic of comparative advantage and its significance in international trade theory. It provides an overview of the concept's development from Ricardo's Law to modern-day applications. The assignment also touches on related topics such as revealed comparative advantage, the product cycle model, and the impact of technology on innovation and trade. By examining these aspects, students can gain a deeper understanding of how countries specialize in producing goods and services and engage in international trade.

Running head: FUNDAMENTALS OF ECONOMICS
Fundamentals of economics
Name of the student
Name of the teacher
Author note

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Introduction:
21st century is a complex world, where world economy has been facing new threats every
day. With rise in the interdependence between the nation, world market is now highly complex
in nature that makes it even harder for the researchers to develop new theories that aid to have
sustainable growth (Sachs 2015). Natural resource being exploited by all the economies has
become scare that makes it tough for the economies to have sustainable growth. Thus, with most
of the countries involved in trades, it is highly important to understand the framework of
resource production, allocation and consumption. Among most of the trade theories that tried to
explain the phenomenon under analysis in this essay, comparative advantage theory produced by
David Ricardo is one of the suitable one (Weder 2017). This essay is meant to analyse how well
the Ricardian theory of Comparative can explain the framework of scare resource production,
allocation and consumption. While analysing the phenomenon under research, this essay will
provide insight to the real world scenarios and trace the magnitude of efficiency of the
comparative advantage theory compared to other models of trade theories.
Theory of comparative advantage and difference from absolute advantage framework:
Since last two centuries, there has been various researches to trace how trading can define
how scare resources are produced, allocated and distributed in the global economy, however
most of them has proved to be failure to provide any fruitful solution (Tietenberg and Lewis
2016). Absolute advantage produced by Adam Smith was the then latest theory of trade that
explained the trade flow properly (Feenstra 2015). If two economies are performing trade with
two commodities, then the country that has absolute advantage in one good will exports the same
and import the other and vis-a-vis (Levchenko and Zhang 2016). An economy that can produce a
commodity with higher efficiency compared to other nation is said to have absolute advantage in

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production of that good compared to its trading partner. If there is difference in efficiency in
production of tradable, then trade can take place between two countries (Watson 2017).
However, absolute advantage model failed to provide any solution in the case if a country has
absolute advantage in production of both the goods, then how trade will take place and scare
resource will be produced, allocated and consumed. During 1817, another trade theory developed
by David Ricardo came in and it explained the resource production, allocation and consumption
theory in different way (Laursen 2015). According to the theory of David Ricardo, though one
trading partner may have absolute advantage in production of both the tradable, yet trade can
take place due to mutually beneficial trading (Granot 2017). Ricardian model of trade theory
considers opportunity cost as the deciding factor of trade flow. According to the Morales (2017),
Ricardian model accepts the opportunity cost that accepts the value, which has to be forgone to
producing something else. It may so happen a country has absolute advantage in producing both
the good; however it may not have comparative advantage in production of both the
commodities. Depending upon this theory, Ricardian model tried to explain the scare resource
production, allocation and consumption framework and achieved success (Rossi-Hansberg
2017).
Analytical framework of comparative advantage:
Utilising an analytical framework of comparative advantage, production, allocation and
consumption theory of scare resources can easily get explained. As showcased in table 1, it can
be seen that UK has absolute advantage in production of both the commodities. While endowing
all the resources, UK can produce either 5 clothes or 12 aeroplanes and US can produce either 4
clothes or 1 plane utilising all the available resources. According to the absolute advantage
theory, UK has production efficiency in both the commodities and there may not be any trade

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between these two nations (Cstinot et al. 2015). However, when the same production matrix is
contested through the Ricardian model, then the result will be different.
Clothing Aeroplanes
UK 5 12
US 4 1
Table 1: Maximum production matrix
Source: (Created by Author)
According to the Ricardian model, it will try to find the opportunity of producing both the
commodities and decide the trade flow (Hoekstra et al. 2018). From table 1, it can be seen that
opportunity cost of producing clothes for UK is (12/5 = 2.4) and US producing clothes is (1/4
= .25). On the other hand opportunity cost of producing aeroplanes by UK is (5/12 = .41) and
opportunity cost of producing aeroplanes for US is (4/1 = 4). From this analysis it can be seen
that US has higher opportunity cost in the case aeroplane production and UK has higher
opportunity cost of producing clothes. Thus, according to the Ricardian model it is better for UK
to produce aeroplanes and let the US produce clothes.
Heckscher- Ohlin model of comparative advantage:
From the above analytical example it can be said that Ricardian model has the ability to
explain how scare resources are produced, allocated and consumed through trading, however,
over the time various other theories came in that either tried to develop the Ricardian model or
tried to bring in new model of trade analysis. One such, example is Heckscher – Ohlin model
which came in to existence during 1919 (Nunn and Trefler 2014). It argued that factor
endowment capability is another deciding factor that controls the trade flow. According to this
model of trade, different goods and services need different proportion of input for production and

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different countries have different level of factor endowment capability (Bodislab et al. 2016).
Considering this factor endowment model, it can be said that a trading country will import only
that goods or service in which production need those factors that are scare in that nation and
export that commodity in which it has abundance of factor inputs. Thus, according to this new
proposed model, factor endowment is another essential factor that determines the trade flow
(Baldwin 2017). Utilising this framework it can be said that a trading country will produce only
capital intensive goods if it has abundance of capital and import the labour intensive good. On
the other hand a trading country, which has abundance in labour, will produce labour intensive
good, while importing capital intensive good. Thus, this extended version of comparative
advantage explains the scare resource production, allocation and consumption framework from
the perspective of factor endowment.
Comparative advantage model of Leontief:
During the 19th century, trade theories that explain the scare resource production,
allocation and consumption framework become well documented; however, most of them
explain the scenario from the theoretical perspective (Balistreri and Tarr 2016). Leontief
attempted to test the validity of the Heckscher – Ohlin model and found himself in precarious
situation. According to the Heckscher – Ohlin model of comparative advantage, country that has
labour abundance, will export the labour intensive good and country that has capital abundance,
will export capital intensive good. However, while contesting this phenomenon with the US data
of export since 1947, Leontief found that, though US is a capital intensive nation, it has exported
those goods, which are labour intensive in nature and imported those goods, which are capital
intensive in nature (Iannaccone 2016). This phenomenon is acknowledged as the Leontief
paradox and it rejects the Heckscher – Ohlin model and return to basis of Ricardian model of

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comparative advantage to describe the phenomenon under assessment in this essay. Leontief,
proposed that, rather than focusing on factor endowment, it will be better for the economies to
consider the terms of technology as the deciding factor of scare resource production, allocation
and consumption framework.
Vernon model of intra-industry trade:
Vernon model of intra industry trade is one of the most developed theories that explain
the present trading scenario. According to the research of Vernon, every product goes through a
life cycle, which is sub-divided into five stages. According to the figure 1, product development
is the first stage, where profit is negative. During introduction stage product started to gain
customer and profit rises. Moving forward, growth stage, producer starts to export the good to
the foreign market and profit enhances leading the product to the maturity stage (Matsuyama
2017). At this stage production is at its peak as well as profit. However, post this stage,
importing countries gain technological knowledge regarding this product and starts to produce it.
It has been found by Vernon that, most of the products are being produced by the
developed nations and exported to the developing nations initially (Charter and Tischner 2017).
However, post the maturity stage, importing countries gain maturity in technology and become
producer of the same good at lower cost. In this scenario, developed nation become the importer
of the good that they were exporting.

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Figure 1: Vernon product life cycle model
Source: (Tolentino 2017)
Jogn and GIllies contradicted the Vernon’s model and argued that with the governmental
restrictions, trade can flow can be altered during the product life cycle (Lall 2016). For instance,
Minimum wage law in developed nation constrained them to produce goods at lower cost and
enhance the scope of intra –industry trade between developed and developing nations. This
contradicts the Vernon’s principal greatly and makes it limited under factor like governmental
law.
Classical trade theories of comparative advantage with porter model:
Classical trade theories of comparative advantage argue that factors like firm’s strategy,
structure and rivalry defines the production, allocation and consumption of scare resources. With
higher rivalry and better strategy scope of developing new technology is high, which will lead to

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export of goods and services t foreign nation. On the other hand enhanced demand will force to
go for further development in technology aiding to higher production, allocation and
consumption (Wu, Ma and Zhuo 2017).
Figure 2: national advantage diamond
Source: (Konsolas 2017)
With the help of governmental aid, demand and factor endowment condition can get
enhanced, leading to higher degree of innovation, resulting in further trading (Akbar 2017).
Besides this, Krugman’s theory of economies of scale is still valid to trace the framework of
resource production, allocation and consumption framework (Balistrei and Tarr 2016).
Critical analysis of comparative advantage in global economy:
Comparative advantage is one of the best models that described the scare resource
production, allocation and consumption framework (Duchin et al. 2016). However, considering
the present situation of the trading economy it can be seen that the model is not up to date.
Though, initially comparative advantage was beneficial to trace the scare resource production,

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allocation and consumption framework, however owing to lack of finding the deciding factor of
trade, it has now become obsolete (Gilpin 2016). New theories has been developed over time that
considers the intra-industry trade as the incentive of trade and utilising the models like Vernon’s
life cycle framework, porter’s model it has become well established. In the complex scenario of
21st century, it has become clear that opportunity cost of production does not matter anymore,
rather factors like skilled labour, knowledge of production, advancement in technological field,
governmental support and cultural values influence the trade largely (Terjesen, Hessels and Li
2016). For instance, from the scenario of Russia, it can be seen that, though the country has
abundance in oil, it does not export the same to Europe due to government restriction. Rising
tension in the middle-east has imposed various sanctions on Russian export that has constrained
the trading (Richter and Holz 2015). Thus, in present scenario factor abundance or opportunity
cost of producing goods is not able to describe the production, allocation and consumption of
scare resources that makes the comparative advantage theory obsolete.
Conclusion:
From the above analysis it has been clear that comparative advantage is one of the best
trading theories that explain the production, allocation and consumption of scare resources. With
the help of the opportunity cost as the determinant of trade, it described the trade flow
framework during 19th century. Successive modification in the model by various researches like
Heckscher – Ohlin, Leontief has made the Ricardian model of comparative advantage more
efficient to describe the trade flow. However, over the time trading economy become complex
and lack of clarity in the Ricardian model made it exhausted. New theories of intra-industry trade
have explained the trade flow from the multi spectrum view that has deliberately explained the
scare resource production, allocation and consumption theory. Thus, to conclude this, it can be

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said that, Ricardian model of comparative advantage was potent during the early days however,
in present scenario it is not that much able to describe the production, allocation and
consumption of scare resources that one might have thought during initial phase of this research
work.

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