Set Up A Ricardo Type Comparative Advantage Numerical 398490

Set Up A Ricardo Type Comparative Advantage Numerical Example With Two

Set up a Ricardo-type comparative advantage numerical example with two countries and two goods. Distinguish “absolute advantage” from “comparative advantage” in the context of your example. Then select an international terms-of-trade ratio and explain in some detail how trade between the two countries benefits each of them in comparison with autarky. When would either of your countries NOT benefit from engaging in trade? Explain.

Paper For Above instruction

Introduction

The principle of comparative advantage, first articulated by David Ricardo, is fundamental to understanding international trade. It explains how countries can benefit from trade even if one country is more efficient at producing all goods (absolute advantage). In this paper, I develop a numerical example involving two countries and two goods to illustrate the concepts of absolute and comparative advantage, choose an international terms-of-trade ratio, discuss benefits of trade, and analyze scenarios where trade might not be advantageous.

Numerical Example and Absolute Versus Comparative Advantage

Consider two countries: Country A and Country B, and two commodities: Wheat and Cloth. The productivity of each country is measured in terms of the units of each good produced per hour of labor. The data are as follows:

| Country | Wheat (units/hour) | Cloth (units/hour) |

|--------------|-------------------|-----------------|

| Country A | 10 | 5 |

| Country B | 8 | 4 |

Absolute advantage refers to the ability of a country to produce more of a good with the same amount of resources. Here, Country A has an absolute advantage in both Wheat (10 vs. 8) and Cloth (5 vs. 4).

Comparative advantage, on the other hand, depends on relative efficiencies, measured through opportunity costs. The opportunity cost of producing one unit of Wheat for each country:

- For Country A: To produce 1 unit of Wheat, it foregoes 0.5 units of Cloth (since 10 units of Wheat are produced per hour and 5 units of Cloth per hour, so opportunity cost of Wheat in terms of Cloth is 5/10 = 0.5).

- For Country B: To produce 1 unit of Wheat, it foregoes 0.5 units of Cloth (8 units of Wheat per hour and 4 units of Cloth per hour, opportunity cost is 4/8=0.5).

Similarly, the opportunity cost of producing Cloth:

- For Country A: 1 unit of Cloth costs 2 units of Wheat (since 10 units of Wheat versus 5 units of Cloth: opportunity cost is 10/5=2).

- For Country B: 1 unit of Cloth costs 2 units of Wheat (8 units of Wheat versus 4 units of Cloth: 8/4=2).

In this case, both countries have identical opportunity costs, indicating no comparative advantage differentiation. To create a meaningful scenario of comparative advantage, modifications can be made such that the opportunity costs differ.

Suppose the productivity changes as follows:

| Country | Wheat (units/hour) | Cloth (units/hour) |

|--------------|-------------------|-----------------|

| Country A | 10 | 5 |

| Country B | 6 | 4 |

In this case:

- Country A's opportunity cost of Wheat: 5/10 = 0.5 units of Cloth

- Country B's opportunity cost of Wheat: 4/6 ≈ 0.67 units of Cloth

- Country A's opportunity cost of Cloth: 10/5 = 2 units of Wheat

- Country B's opportunity cost of Cloth: 6/4 = 1.5 units of Wheat

Now, Country A has a comparative advantage in producing Wheat because it has a lower opportunity cost (0.5 vs. 0.67). Conversely, Country B has a comparative advantage in producing Cloth because its opportunity cost (1.5 vs. 2) is lower.

Terms-of-Trade and Gains from Trade

Let us select a terms-of-trade ratio between the opportunity costs, for example, 1.2 units of Cloth per unit of Wheat. This ratio falls between the two countries' opportunity costs, making trade mutually beneficial.

Before trade (Autarky):

- Country A would specialize in Wheat, producing 10 units/hour. Its consumption is limited to its production unless it trades.

- Country B would specialize in Cloth, producing 4 units/hour.

With trade:

- Country A can trade some of its Wheat for Cloth from Country B. For example, trading at 1.2 units of Cloth per unit of Wheat allows both countries to consume outside their autarkic consumption points, gaining more than they would individually.

Benefits:

- Country A: by specializing in Wheat, can obtain Cloth at a rate better than its opportunity cost (which is 2 units of Wheat per unit of Cloth). Since the trade ratio of 1.2 Cloth per Wheat is favorable for Country A, it can consume more of both goods than in autarky.

- Country B: specializes in Cloth. Trading at 1.2 cloth per Wheat, which is better than its opportunity cost of 1.5, thus increasing its consumption possibilities.

Both countries expand their consumption possibilities through trade, leading to higher overall efficiency and welfare.

When Would Countries Not Benefit from Trade?

Countries might not benefit from trade under certain circumstances:

1. Autarkic Advantage: If tariffs or trade restrictions prevent beneficial exchange, or if transport costs are prohibitively high, the gains from trade diminish or disappear.

2. Same Opportunity Costs: When countries have identical opportunity costs (as in the initial example), the gains from trade are minimal or nonexistent.

3. Domestic Markets and Sovereignty Concerns: Countries may forsake advantageous trade due to political or economic considerations, such as protecting inefficient industries.

4. Short-term Disruptions or Adjustment Costs: Structural adjustments may impose costs that temporarily outweigh gains from trade.

In the scenario where both countries have identical efficiencies and opportunity costs, no advantage arises from engaging in trade, as neither can procure a better rate than autarky. Similarly, if transportation costs or tariffs are excessive, the net effect may be detrimental, overshadowing the potential gains.

Conclusion

This example highlights the core principles of Ricardo's comparative advantage. Country A’s absolute advantage in both goods does not negate the benefits of specialization and trade, provided that each country's comparative advantage guides their focus. The chosen terms-of-trade ratio exemplifies how mutually beneficial exchanges can be structured. However, real-world factors like trade costs, policies, and identical opportunity costs can limit or nullify potential gains. Recognizing these nuances is essential for designing effective trade policies and understanding international economic dynamics.

References

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