Fundamental of Economics - Essay
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Added on 2021-04-16
Fundamental of Economics - Essay
Added on 2021-04-16
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Running head: FUNDAMENTALS OF ECONOMICSFundamentals of economicsName of the studentName of the teacherAuthor note
1FUNDAMENTALS OF ECONOMICSIntroduction:21st century is a complex world, where world economy has been facing new threats everyday. With rise in the interdependence between the nation, world market is now highly complexin nature that makes it even harder for the researchers to develop new theories that aid to havesustainable growth (Sachs 2015). Natural resource being exploited by all the economies hasbecome scare that makes it tough for the economies to have sustainable growth. Thus, with mostof the countries involved in trades, it is highly important to understand the framework ofresource production, allocation and consumption. Among most of the trade theories that tried toexplain the phenomenon under analysis in this essay, comparative advantage theory produced byDavid Ricardo is one of the suitable one (Weder 2017). This essay is meant to analyse how wellthe Ricardian theory of Comparative can explain the framework of scare resource production,allocation and consumption. While analysing the phenomenon under research, this essay willprovide insight to the real world scenarios and trace the magnitude of efficiency of thecomparative 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 definehow scare resources are produced, allocated and distributed in the global economy, howevermost of them has proved to be failure to provide any fruitful solution (Tietenberg and Lewis2016). Absolute advantage produced by Adam Smith was the then latest theory of trade thatexplained the trade flow properly (Feenstra 2015). If two economies are performing trade withtwo commodities, then the country that has absolute advantage in one good will exports the sameand import the other and vis-a-vis (Levchenko and Zhang 2016). An economy that can produce acommodity with higher efficiency compared to other nation is said to have absolute advantage in
2FUNDAMENTALS OF ECONOMICSproduction of that good compared to its trading partner. If there is difference in efficiency inproduction 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 hasabsolute advantage in production of both the goods, then how trade will take place and scareresource will be produced, allocated and consumed. During 1817, another trade theory developedby David Ricardo came in and it explained the resource production, allocation and consumptiontheory in different way (Laursen 2015). According to the theory of David Ricardo, though onetrading partner may have absolute advantage in production of both the tradable, yet trade cantake place due to mutually beneficial trading (Granot 2017). Ricardian model of trade theoryconsiders 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 toproducing something else. It may so happen a country has absolute advantage in producing boththe good; however it may not have comparative advantage in production of both thecommodities. Depending upon this theory, Ricardian model tried to explain the scare resourceproduction, allocation and consumption framework and achieved success (Rossi-Hansberg2017). Analytical framework of comparative advantage:Utilising an analytical framework of comparative advantage, production, allocation andconsumption theory of scare resources can easily get explained. As showcased in table 1, it canbe seen that UK has absolute advantage in production of both the commodities. While endowingall the resources, UK can produce either 5 clothes or 12 aeroplanes and US can produce either 4clothes or 1 plane utilising all the available resources. According to the absolute advantagetheory, UK has production efficiency in both the commodities and there may not be any trade
3FUNDAMENTALS OF ECONOMICSbetween these two nations (Cstinot et al. 2015). However, when the same production matrix iscontested through the Ricardian model, then the result will be different. ClothingAeroplanesUK512US41Table 1: Maximum production matrixSource: (Created by Author)According to the Ricardian model, it will try to find the opportunity of producing both thecommodities and decide the trade flow (Hoekstra et al. 2018). From table 1, it can be seen thatopportunity 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) andopportunity cost of producing aeroplanes for US is (4/1 = 4). From this analysis it can be seenthat US has higher opportunity cost in the case aeroplane production and UK has higheropportunity cost of producing clothes. Thus, according to the Ricardian model it is better for UKto 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 toexplain 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 ortried to bring in new model of trade analysis. One such, example is Heckscher – Ohlin modelwhich came in to existence during 1919 (Nunn and Trefler 2014). It argued that factorendowment capability is another deciding factor that controls the trade flow. According to thismodel of trade, different goods and services need different proportion of input for production anddifferent 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
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