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CRITICALLY EVALUATE THE THEORIES OF ABSOLUTE ADVANTAGE (ADAM SMITH MODEL) AND COMPARATIVE ADVANTAGE (DAVID RICARDO MODEL). TO WHAT EXTENT DO YOU THINK THAT THEY EXPLAIN

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Introduction

CRITICALLY EVALUATE THE THEORIES OF ABSOLUTE ADVANTAGE (ADAM SMITH MODEL) AND COMPARATIVE ADVANTAGE (DAVID RICARDO MODEL). TO WHAT EXTENT DO YOU THINK THAT THEY EXPLAIN TODAY'S TRADE PATTERNS? In order to understand how international trade increases the welfare of its citizens, we need to consider why trade takes place. To do this the principles of absolute and comparative advantage should be considered. This essay will also be explaining, analysing and evaluating the extent to which these principles explain today's trade patterns. Adam Smith (1723-1790), believed that "the real wealth of a country consists of the goods and services available to its citizens". Smith developed the theory of absolute advantage, which holds that different countries produce some goods more efficiently than other countries, thus, global efficiency can increase through free trade. (International Business Environments and Operations, 2004). A country has an absolute advantage over its trading partners if it is able to produce more of a good or service with the same amount of resources or the same amount of a good or service with fewer resources. In the case of Zambia, the country has an absolute advantage over many countries in the production of copper. This occurs because of the existence of reserves of copper ore or bauxite. We can see that in terms of the production of goods, there are obvious gains from specialisation and trade, if Zambia produces copper and exports it to those countries that specialise in the production of other goods or services. David Ricardo (1772-1823), in his theory of comparative costs suggested that countries will specialise and trade in goods and services in which they have a comparative advantage. ...read more.

Middle

Ricardo argued that trade gains could arise if countries first specialise in their comparative advantage good and then trade with the other country. Specialisation in the example means that the U.S. produces only cheese and no wine, while France produces only wine and no cheese. These quantities are shown in the following Table. Also shown are the world totals for each of the goods. Production with Specialisation in the Comparative Advantage Good Cheese (lbs) Wine (gals) U.S. 24 0 France 0 8 World Total 24 8 At this point, we can already see a remarkable result. When countries specialise in their comparative advantage good, world output of both wine and cheese rises. Cheese output rises from 19 to 24 pounds. Wine output rises from 6 to 8 gallons. What is more, the output increases occur without an increase in the quantity of labour used to produce them. In autarky, it took 48 worker-hours to produce 19 pounds of cheese and 6 gallons of wine. With specialisation, the same 48 worker-hours produce 24 cheese and 8 wine. This means that there is an increase in world productivity - more output per unit of labour. Often times, this productivity improvement is referred to as an increase or improvement in world production efficiency. The increase in world production efficiency does not benefit the countries unless they can trade with each other after specialisation. Both production points were feasible under autarky but the countries demanded some of each good. Thus, the countries will want some of each good after specialisation and the only way to accomplish this is through trade. Now, if the world can produce more of both goods through specialisation, clearly there must be a way to divide the surplus ...read more.

Conclusion

Alone, the United States, Germany and Japan account for about a third of all global trade. Further, G7 countries account for half the global trade. A growing share is being accounted by the developing countries of Asia, with China accounting for the most significant growth both in absolute and comparative terms. Those geographical and economic changes are also reflected over Trans-Oceanic trade with Trans-Pacific trade growing faster than Trans-Atlantic trade. Regionalisation has been one of the dominant paradigms of global trade. The bulk of international trade has a regional connotation, promoted by proximity and economic blocs, such as NAFTA and the European Union. The growth of the amount of freight being traded, as well as a great variety of origins and destinations, promotes the importance of international transportation as a fundamental element supporting the global economy. Therefore, on whether the theory of comparative advantage explains the pattern of world trade today, we can safely say that the answer is "no", as the world is characterised by what is called intra-industry trade (i.e., trade in differentiated products). For example, Germany exports cars such as BMW, Mercedes-Benz and Volkswagen but it also imports cars such as Toyota, Honda, Fiat, Ford, etc.. This means that some of the Ricardian assumptions such as perfect competition and constant returns to scale, may not hold due to market imperfections, transport costs, diminishing returns to scale in production, etc.. Personally, I believe that both absolute and comparative theories are very useful but very rarely fit with today's trade patterns because there are trade barriers, such as NAFTA and the European Union. However, there are areas of trade where both theories are accurate, but only if two countries and two commodities are focused, and exclude large multi-national corporations. ...read more.

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