Economics Assignment on Absolute and Comparative Advantage Theories

This economics assignment delves into the core concepts of international trade, specifically focusing on absolute and comparative advantage theories. It begins by explaining Adam Smith's absolute advantage theory, where a country should produce goods at the lowest cost. The assignment provides a practical example using the USA and Saudi Arabia to illustrate how each country specializes in production based on cost advantages. The document then transitions to David Ricardo's comparative advantage theory, which emphasizes producing goods at the lowest opportunity cost. The assignment uses the same countries and goods to demonstrate how opportunity costs determine specialization and trade patterns. The document concludes by highlighting that the comparative advantage theory is an improved version of the absolute advantage theory. References for the assignment are also included.

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ECONOMICS ASSIGNMENT
INTERNATIONAL ECONOMICS

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Contents
Question 1..................................................................................................................................3
Absolute advantage....................................................................................................................3
Comparative advantage..............................................................................................................3
Reference....................................................................................................................................5

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Question 1
Absolute advantage
Absolute cost theory is an economic theory for trade posited by Adam Smith. According to
the theory, a country should produce that product in which it has an absolute cost advantage.
The absolute cost advantage is referred to as the advantage which is gained by a country for
producing a product at the lowest cost (Adão, 2015). Each of the countries produces that
product in which it has an absolute cost advantage and trade happens between the two
countries this way.
USA SAUDI ARABIA
RICE 2 10
FLOWER 8 4
Table 1: the Absolute advantage of the two countries
(Source: Chacholiades, 2017)
For example, suppose there are two countries the USA and Saudi Arabia and two products,
rice and flower. The cost of making a flower for the USA is 8 units and that of Saudi Arabia
is 4 units. Therefore clearly, Saudi Arabia has an absolute advantage in exporting flower
according to the theory. On the other hand, the USA produces Rice at 2 units cost and Saudi
Arabia produces rice in 10 units of cost. In this case, the USA has the absolute cost advantage
in rice production (Chacholiades, 2017). Therefore, according to the theory, the USA will
export rice to Saudi Arabia and import flower as in this good there is an absolute cost
disadvantage to the USA. Saudi Arabia will export flower to the USA and import rice as it
has an absolute cost disadvantage in producing rice.
Comparative advantage
Comparative advantage, on the other hand, is referred to as the advantage acquired by a
country when it can produce well in the lowest opportunity cost. Opportunity cost is the
benefit that is given up for the production of another product. This theory is known as the
theory of comparative advantage and was posited by David Ricardo (Watson, 2017). Each of
the country’s exports that product which it can produce at a lower opportunity cost than
others.

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USA SAUDI ARABIA
RICE 16 12
FLOWER 12 10
Table 2: the comparative advantage of countries
(Source: Cicala, Fryer & Spenkuch, 2017)
For example, assume that there are two countries the same as before, the USA and Saudi
Arabia. The products are Rice and Flower. The opportunity cost of producing rice in the USA
is (12/16) and for Saudi Arabia is (10/12). From these two values, it can be said that the
opportunity cost of producing rice is lesser in the USA and hence it has a comparative
advantage in producing rice. On the other hand, the opportunity cost of producing a flower in
the USA is (16/12) and in Saudi Arabia is (12/10). Therefore, in this case, Saudi Arabia has a
comparative advantage in producing flower as its opportunity cost of producing flower is low
compared to that of the USA (Watson, 2017). Therefore, according to the theory of
comparative advantage, in this case, the USA will export rice and Saudi Arabia will export
flower. It needs to be noted that, in this case, the USA has an absolute advantage in both the
goods and therefore, comparative advantage theory is an up-gradation or the better version of
the absolute advantage theory.

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Reference
Adão, R. (2015). Worker heterogeneity, wage inequality, and international trade: Theory and
evidence from brazil. Unpublished paper, MIT, 45-51.
Chacholiades, M. (2017). The pure theory of international trade, New York Routledge.
Cicala, S., Fryer, R. G., & Spenkuch, J. L. (2017). Self-selection and comparative advantage
in social interactions. Journal of the European Economic Association, 16(4), 983-1020.
Watson, M. (2017). Historicising Ricardo’s comparative advantage theory, challenging the
normative foundations of liberal International Political Economy. New Political
Economy, 22(3), 257-272.