Absolute Versus Comparative Advantage

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From the course by University of California, Irvine

The Power of Macroeconomics: Economic Principles in the Real World

1405 ratings

University of California, Irvine

The Power of Macroeconomics: Economic Principles in the Real World

1405 ratings

In this course, you will learn all of the major principles of macroeconomics normally taught in a quarter or semester course to college undergraduates or MBA students. Perhaps more importantly, you will also learn how to apply these principles to a wide variety of situations in both your personal and professional lives. In this way, the Power of Macroeconomics will help you prosper in an increasingly competitive and globalized environment. This course is also available in Portuguese. To join the fully translated Portuguese version, visit this page: https://www.coursera.org/learn/macroeconomia-pt/

From the lesson

International Trade and Protectionism

Absolute Versus Comparative Advantage 4:28

The Nuts and Bolts of Comparative Advantage and the Gains from Trade 6:55

Tariff, Quotas, Trade Barriers, Protectionism, and the Dead Weight Loss8:48

The Pros and Cons of Protectionism 5:29

The Limitations of Ricardian Free Trade in the Real World and the Case of China3:35

Meet the Instructors

Dr. Peter Navarro
Professor
Paul Merage School of Business

[MUSIC]

Welcome to the power of macroeconomics.

Lecture nine.

International trade and protectionism.

>> Here is some alphabets soup for you, NAFTA, GATT and the Euro.

And then of course there are words like tariffs and quotas and trade deficits.

And dumping, and non-tariff barriers and protectionism.

People across the globe are now speaking this language of international economics

on television, in the newspapers, in corporate offices, in stores and

in union halls.

And while it may seem like a foreign language to you now,

it is a language that we must come to master.

In this lecture we're going to examine the economic principles

governing international trade.

The questions we want to examine are these.

Why do nations trade?

And how do nations decide what to import and export?

To answer these questions,

we must explore the mysteries of absolute advantage versus comparative advantage.

The idea of absolute advantage, as a basis for trade, was said forth by Adam Smith.

A country that can produce a good at a lower cost than another country

is said to have an absolute advantage in the production of that good.

For example, Saudi Arabia has millions of barrels of cheaply accessible oil but

growing food in its desert climate and sandy soil is very expensive.

In contrast, the United States can grow food cheaply in its temperate climate and

fertile soi,l but American oil isn't as cheap to extract as Saudi crude.

Because it can produce a certain amount of oil with fewer resources, Saudi Arabia

has an absolute advantage over the United States in producing oil, just as

the United States has a absolute advantage over Saudi Arabia in producing food.

And the theory of absolute advantage would predict.

In this case, quite correctly.

That America should sell food to Saudi Arabia and buy oil from it.

At first glance, the principle of absolute advantage appears to make imminent sense.

Nonetheless it has a significant implication and one that is badly flawed.

Take a look at this table to see what I mean.

Here we have two countries, Germany and Algeria,

producing two goods food and auto with the same amount of resources.

From the table it is clear that the Germans are able to produce both food and

autos with fewer resources than Algeria.

In this case, the theory of absolute advantage

would predict that Germany has nothing to gain from trading with Algeria.

After all why should Germany trade with the country that cannot produce anything

as efficiently as it can.

Why indeed?

Because this is where a more subtle understanding of trade patterns

enters the picture.

This more subtle understanding is embodied in the theory of comparative advantage.

The Theory of Comparative Advantage was first set forth in 1817 by

the same English economist who helped us in an earlier

lecture develop a theory of land rent, namely David Ricardo.

The historical context for the development of Ricardo's Theory of

Comparartive of Advantage is interesting in on of itself.

At the time, Europe was considering protecting it's market

from American imports through the use of tariffs and quotas.

Europe's concern was that America with its abandoned land and

inexpensive labor would have in absolute advantage in producing many goods and

might therefore not import anything from Europe but

mealy export its cheaper goods, thereby destroying jobs in Europe.

Ricardo addressed these concerns by articulating the Principle of

Comparative Advantage.

It holds that each country will benefit if it specialized in

the export of those goods that it can produce at relatively low cost.

Conversely, each country will benefit if it imports those goods

that it produces at relatively high cost.

And it is this simple principle that provides the unshakeable basis for

international trade.

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