(PDF) Fundamental of Economics

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Running head: FUNDAMENTALS OF ECONOMICSFundamentals of EconomicsName of the StudentName of the UniversityAuthor Note
1FUNDAMENTALS OF ECONOMICSComparative Advantage: Utilization of Scarce ResourcesIntroductionEconomics, as a subject, deals with several key aspects of concern, among which theprimary one is that of optimally meeting the demands and needs of all the people in an economy,with the help of the scarce resources present in the economy. The resources of production, beingbroadly classified into four types- labor, land, capital and entrepreneurship, are limited and aretherefore required to be utilized efficiently in order to maximize the production of goods andservices from the same (Baumol and Blinder 2015). However, not all countries have abundancein all the resources of production and thus, different countries produce different types ofcommodities and services based on the resources present with them, which in turn gives rise tothe concept of inter-country trade.Over the years, various economic theories and concepts have come to existence in theaspect of international trade and trade relations. One of the most widely used and comprehensivetrade theories present in the contemporary global scenario is the comparative advantage theory.Keeping this into account, the essay tries to discuss the comparative advantage theory, itsimplications and usefulness in the real scenarios of contemporary global trade activities (Laursen2015). The primary objective of the essay is to explain the effectiveness of such theories inexplaining the production, consumption and allocation of scarce resources of production, in thelight of real trade scenarios in the global framework.
2FUNDAMENTALS OF ECONOMICSComparative Advantage: Theoretical FrameworkThe theory of Comparative Advantage in international trade came into existence as asuccessor of the Absolute Advantage Theory, proposed by Adam Smith. This theory, firsthighlighted the aspect of country specific specialization in production stating that a countryshould emphasize in producing goods and services which can be more efficiently produced withthe help of the resources that are abundantly present in the country itself and should trade thesame in exchange of those commodities in the production of which the country do not enjoy suchproductive advantages (Costino and Donaldson 2012).However, in many real scenarios of trade set ups between two particular countries, it wasobserved that one of the countries enjoy absolute advantage in production of all the goods andservices over the other country. This, in the absolute advantage framework, nullified the scope ofany trade relation among the two concerned countries. This, being the primary drawback ofabsolute advantage theory, gave way to the Comparative Advantage Theory as was suggested byDavid Ricardo (Hausmannet al.2014). The Comparative Advantage Theory proposed by DavidRicardo, incorporates the economic notion of opportunity cost in the production process, whileassessing the comparative advantages of different countries in the production of differentcommodities and services. The opportunity cost of production of one additional unit of acommodity is measured in terms of the values of other commodities which have to be sacrificedfor the production of the former (Rios, McConnell and Brue 2013).The above theoretical framework of the Comparative Advantage Theory, incorporatingthe opportunity cost mechanism can be explained with the help of the following hypotheticalexample, considering two countries, each producing ice cream and chocolates with theirresources:
3FUNDAMENTALS OF ECONOMICSCommoditiesCountry 1Country 2Ice creams3035Chocolates621The hypothetical table, given above, shows the maximum number of ice creams andchocolates each of the two countries can produce by fully utilizing their productive resources.From the above numbers, it can be seen that Country 1, with maximum utilization of itsresources, can produce either 30 ice creams or 6 chocolates, whereas Country 2, can produceeither 35 ice creams or 21 chocolates. This in turn, implies that Country 2 enjoys absoluteadvantage of production in ice creams as well as chocolates, over that of Country 1, therebymaking trade an invalid option in the light of Absolute Advantage Theory (Schumacher 2012).This in turn, in the Absolute Advantage Theoretical framework implies that all the commoditiesshould be produced by Country 2 only. However, this is not a feasible solution in real casescenarios as the resources cannot remain non-utilized in country 1.The Comparative Advantage Theory provides a more realistic solution with the help ofthe opportunity cost mechanism, which is shown with the help of the following table:Opportunity CostCountry 1Country 2Ice Creams0.20.6Chocolates51.67From the above table, it can be observed that the opportunity cost of production of icecreams in Country 2 (0.6) is higher than the same in Country 1 (0.2). Again the opportunity costof production of chocolates is higher in Country 1 (5) than that of the same in Country 2 (1.67).This makes it more feasible for Country 1 to produce ice creams only and Country 2 to producechocolates only and trade between one another. In doing so, the global production of both
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